Canada’s real estate market has been buzzing hot. Many Canadians are working as real estate agents under sole proprietorship. It means their finances are not separate from their work, leaving them paying individual taxes. In addition, many professionals, like engineers, lawyers, and accountants, incorporate their practice to get the benefits CRA offers small businesses. Now real estate agents can join the professionals and incorporate their real estate practice as a PREC.
What Sole Proprietors Should Know About PREC
To establish a PREC, you should be an agent or broker working individually. Real estate investors are not eligible for PREC. You will be the sole shareholder of PREC, owning 100% voting rights. However, you can make your family and friends the non-equity and non-voting shareholders.
The income from any estate dealing will come to PREC, and you can withdraw the amount from the corporation for personal use. In PREC, only the income withdrawn for personal use incurs individual tax. The remaining is taxed at the corporate tax rate, lower than the individual tax rate. You can use the tax savings to grow your business.
But there are disadvantages as well. As an entrepreneur, you should consider every aspect before deciding on incorporation. In this article, we will discuss the pros and cons of establishing a PREC to help you make an informed decision.
Weighing the Pros and Cons of Establishing a PREC
One of the advantages of owning a corporation is tax and the several options a separate legal entity gives you to save tax, like lower tax rates, income splitting, and deductions. But it is advantageous in certain situations. So let us see the benefits and challenges PREC can bring, so you can decide on incorporating your real estate agency.
PREC is Taxed at a Lower Tax Rate
Pros: If you work as an individual estate agent, you must pay higher taxes on all the income earned. But if you establish a PREC, you will be paying tax as per the corporate tax rate, which is way lower than the individual rate. Therefore, if your brokerage earnings make you wealthy, incorporation can make a significant difference as the first $500,000 of active income each year is taxed at a lower rate. Moreover, you only pay individual tax when you withdraw. Otherwise, you pay corporate tax for the money invested in the bullishness, thereby deferring taxes till you withdraw funds from the company.
Cons: However, PREC is an added burden if you withdraw all your earnings from your practice, as withdrawals attract individual tax rates. Unless you want to use some of your income to expand your business through marketing and business development, PREC won’t give significant tax benefits.
Some PRECs Can Avail of Income Splitting Benefit
Con: In this, cons come before the pros as the updated Tax on Split income (TOSI) exception removed the tax benefit from income splitting and started taxing it at a higher rate. As the sole equity shareholder of the PREC, you can add your family members as non-equity and non-voting shareholders and pay them dividends. That is income splitting, as every family member can earn the minimum income that doesn’t attract tax. But not everyone can avail of this income-splitting benefit.
Pros: You can avail of income splitting under two conditions:
- If you are above 65 years, you can save on taxes by splitting your income with your spouse regardless of the age of your spouse.
- If your spouse works for the PREC for more than 20 hours per week throughout the year, you can use income splitting to save taxes.
Entrepreneurs Can Deduct Business Expenses From Taxable Income
Pros: You pay a lower tax rate and further reduce taxable income by deducting business expenses like advertising, employee salary, and other administrative costs from their taxable income. As a PREC, you get two specific deductions as well.
- You can create a Health Spending Account to withdraw money tax-free from the business for personal health expenses.
- Counsellor fee is generally taxable, but as a PREC, you can get tax exemption on fees paid to a retirement counsellor.
Cons: While tax deductions can significantly reduce your taxable amount, you must maintain invoices and records for every deduction you claim. That would require you to avail of bookkeeping and accounting services.
Setup cost and Documentation: As a proprietor, it is easy to setup up the business. But establishing a PREC needs more documentation for which you seek bookkeeping and accounting service. It is a con if your business is small with little profit, but a Big Pro if your business is growing rapidly.
PREC Smoothens Succession Planning
The decision to incorporate your real estate business goes beyond taxes into business strategy. If you envision converting your practice into a business that pays for your retirement, outlives you, and gives your future generation an income platform, PREC is for you. It is easier to sell the business as a separate legal entity. If the wealth is just a one-time gig, avoid incorporating the company.
As you saw, one thing can be both good for a particular realtor and bad for another. Other than the above points, it would help if you rethought incorporation from a long-term perspective and considered many other factors. Talk to a business advisor to help you decide on an apt structure for your business.
Contact Ford Keast LLP in London for Business Consultancy
A skilled business consultant can help you plan the structure of your real estate business tax-efficiently. At Ford Keast LLP, our consultants can provide services to set up a PREC and identify ways to withdraw money tax efficiently. To learn more about how Ford Keast LLP can provide you with business consultancy expertise, contact us online or by telephone at (519) 679-9330.