As a real estate professional, the opportunity to incorporate by setting up your own Personal Real Estate Corporation (PREC) brings many incentives. In addition to letting you defer income taxes, a PREC may allow you to take advantage of a range of other tax benefits.
To reap the full rewards, your PREC must be properly structured, and depending on your desired outcomes, the corporate structure of your PREC may shift—making it important to identify your objectives in advance.
Objective 1: Protect your assets
Unlike traditional corporations, PRECs do not confer liability protection for your excess income—such as cash, investments or other passive assets. That means, if you keep those assets in an operating PREC, they can be exposed to litigation or creditor claims.
So, what can you do if you want to retain excess earnings within your corporation to take advantage of tax deferral opportunities? One option is to place those assets in a holding company. By keeping your excess earnings and accumulated assets in a holding company, you can retain and invest them as part of your corporate structure while removing them from direct ownership in the PREC.
Objective 2: Access to the Lifetime Capital Gains Exemption (LCGE) on sale
When shares of a qualifying small business corporation are sold, gains realized on their sale can be sheltered from tax under the LCGE. With the right planning and structuring, that means you could shelter up to $892,218 (for 2021) of capital gains if you decide to sell your PREC to a child, colleague or arm’s length party.
While the rules to qualify for the LCGE are complex, they involve “purifying” the corporation for income tax purposes. This means holding assets that are primarily used to earn active business income in Canada, while limiting the accumulation of passive assets (such as cash and investments).
To enjoy the tax deferral advantages of holding accumulated assets under the corporate umbrella without losing access to the LCGE, proper structuring is essential. If a sale of your PREC is part of your exit plan, it’s important to optimize your structure early on.
Objective 3: Bring in other owners
Depending on your succession or retirement plans, you may want to bring new owners—such as a child, family member or business colleague—into your PREC at some point in the future. Ultimately, this will require you to think about how your ownership structure would potentially allow the new owner to participate in future growth, how to ensure a tax-efficient transition, how to effectively fund a share purchase and much more.
Although there are several mechanisms within a corporate structure that would allow you to achieve these objectives, these transactions are typically more efficient when you lay the groundwork at the outset. Ultimately, you’ll want a corporate structure that’s sufficiently flexible to allow for changes without undue administrative burdens, while enabling you to shift assets and ownership to meet your future transactional needs.
Objective 4: Preserve the preferential small business tax rate
In Canada, the small business deduction provides corporations with a reduced tax rate on the first $500,000 of active business income they earn. This business limit benefit, however, is reduced by $5 for every $1 of investment or passive income earned over $50,000. Because the $500,000 small business limit is shared by associated corporations, this so-called “passive income grind” can reduce the small business deduction available to a PREC, even if investment earnings are in a holding company.
If you intend to earn passive income within your corporate structure, it’s likely worthwhile to adopt a structure or investment strategy that doesn’t compromise your preferential small business tax rate—so you can optimize your after-tax returns.
Objective 5: Multiply the small business limit
As we just saw, the small business limit of $500,000 is shared between associated corporations. That means the deduction available may be limited for taxpayers with multiple corporations, or whose spouses or family members are involved in the PREC.
If you flip properties or have business ventures outside your real estate business, however, it may be possible to take advantage of the small business limit through multiple corporations. Once again, though, proper structuring is necessary to make it work.
Get it right from the start
Given the potential pitfalls of improperly structuring your PREC, it makes sense to get good advice from the start. To make sure you adopt a structure conducive to meeting your objectives, contact your Grant Thornton advisor.