Personal Real Estate Corporations – Part 3
Now that we have discussed the basics of forming Personal Real Estate Corporations (PRECs) in Part One and some of the operating requirements and conditions in Part Two of this series I will now cover the reasons when and why a salesperson or broker may want to form a PREC.
When to form a PREC:
A salesperson or broker may wish to consider forming a PREC when the following apply:
- have more income than their daily living expenses and want to increase their savings for retirement;
- have family members with whom they can split income;
- Intend to sell their business to another salesperson/broker registered with the Real Estate Council of Ontario (RECO) or wish to pass on their business to a family member who is a salesperson/broker registered with RECO;
- Would like to write off partial or non-deductible business expensesrelating to life insurance and entertainment.
I will break down the benefits of the list above by addressing the following questions.
(A) How may a PREC be utilized for deferral of Taxes?
As mentioned above, the PREC may pay out income as dividends, salary, or bonuses, but it may also retain a portion of your business income. This income retained in the PREC may earn interest and thus serve to grow your retirement portfolio. The income then paid out during your retirement will be subject to a lower personal income tax rate.
It is important to note that PRECs are taxed at the small business rate of 12.5% on the first $500,000.00 of active business income compared to the general corporate rate of 26.5% and the highest personal tax rate of 53.53% for income greater than $220,000. This means that incurring non-deductible or partially deductible business expenses through the PREC will result in a reduction in the amount of taxes paid.
(B) How does income splitting work for PRECs?
You will recall that shareholding family members who are 18 years or older who work 20 hours or more per week may receive dividends, salary, or bonuses from the PREC. The flexibility to distribute the business income earned effectively lowers the combined tax burden.
(C) How will selling or passing on your business through a PREC be beneficial?
Canada Revenue Agency (CRA) permits a Lifetime Capital Gains Exemption when the shares of a qualifying small business are sold. This exemption is indexed on a yearly basis and was set at $892,218 for 2021. As an example, should you sell shares of your PREC and generate a profit of $900,000 instead of paying capital gains tax on half that amount ($450,000) you would pay tax on $900,000 minus $892,218 which is $3,891. Therefore, selling your business in the form of a PREC to another salesperson or broker whether a family member or not can be quite beneficial in terms of the capital gains incurred.
(D) Write-Offs – Life Insurance and Entertainment
There are tax advantages to owing life insurance through a corporation (this should be discussed further with your insurance advisor or accountant).
In summary, PRECs offer several key tax advantages for the owner registrant both during their operation by reducing tax through income splitting, deductions on business expenses as well as upon sale of the business by reducing the capital gains owed. To find out if forming a PREC is right a salesperson or broker should take into account the above considerations and seek out advice from a Chartered Professional Accountant regarding their specific circumstances and check for the most up to date information regarding the requirements for operating a PREC with the RECO.
Ontario Regulation 536/20. Ontario Real Estate Association, Personal Real Estate Corporations: https://www.orea.com/Political-Advocacy/Personal-Real-Estate-Corporations
Real Estate Council of Ontario, Personal Real Estate Corporations: https://www.reco.on.ca/precs-ads/