The Ontario Government has published regulations permitting the formation of Personal Real Estate Corporations that can be used by real estate agents to organize their financial affairs and taxation. This allows real estate agents to follow strategies similar to those of most other professional groups, who had been allowed to incorporate for quite a few years.
Real estate brokerages have of course always been allowed to incorporate. Now, the individual agent who provides services to a brokerage and receives commissions from it can incorporate his or her own individual corporation to receive those commissions. These regulations took effect on October 1, 2020.
Real estate agents have been lobbying for years to get the right to incorporate, as noted by the Ontario Real Estate Association, which takes credit for this achievement. The real estate agents’ allies in the legislature had introduced private members’ bills prior to this being taken up by the government. A bill introduced a few years earlier had the title “Tax Fairness for Realtors Act, 2017.”
That title indicates the key benefit of incorporation for professional groups. It is not to provide limited liability, as a professional corporation does not protect against liability for professional negligence.
Tax Savings from the Low Corporate Tax Rate for Small Business
Two of the most significant tax advantages from incorporation for real estate agents are tax deferral and smoothing of annual fluctuations in tax payments. These are discussed in a previous article. The income earned by the corporation is taxed at the low small business corporate tax rate of 12.2% (on up to $500,000 per year).
A real estate agent who is successful and earns a high enough income may leave a significant portion in the accounts of the corporation to be reinvested there. The corporation can buy equipment or supplies for the business, or is also allowed to make passive investments, such as in stocks or bonds. The funds would be gradually withdrawn much later, after retirement, effectively turning the corporation into a pension plan. That can achieve quite significant tax savings.
In order to qualify for this low 12.2% tax rate, the real estate agent must effectively meet the criteria for being a self-employed, independent contractor to the brokerage, rather than an employee. This is a question of fact, as observed in previous case law. Given the nature of the real estate sales business, this is a criterion that most real estate agents would probably satisfy.
Opportunities for Income-Splitting
The ability to shift income to family members who are in lower tax brackets was at one time a major advantage of professional corporations. Unfortunately for real estate agents, the federal government has gotten in the way and significantly reduced the scope for income-splitting, as observed in a companion article.
The new regulation requires that all the “equity shares” (i.e., common shares) of the personal real estate corporation must be owned by the real estate agent who is the controlling shareholder. “Non-equity shares,” (i.e., preference shares), if any, may be owned by the agent’s spouse or children. Due to the tightening amendments to section 120.4 of the Income Tax Act made in 2018, the income-splitting possibilities that emerge for personal real estate corporations are more limited.
This share ownership structure can only allow income-splitting through dividends to the extent that the family members are providing work for the corporation. That is often the case in real estate, where family members assist by answering the phone and making appointments and doing administrative tasks, etc. To qualify, there must be at least 20 hours of work per week by the spouse or child of the owner. The amount of dividends paid to the family member, to escape a tax penalty, is limited to the market value of the work done. As an alternative, a salary could be paid, but in some situations dividends are more advantageous.
In addition, where the corporation has investment income from its previous savings, the controlling shareholder who is above the age of 65 is allowed to do income-splitting with a spouse. That can be a significant advantage for retirement planning.
Lifetime Capital Gains Exemption
The regulation allows only one real estate agent per corporation at one time. However, that should not prevent one real estate agent, when retiring, from selling her personal corporation to another real estate agent. To the extent that goodwill has been built up, the sale of the corporation for its client list could have considerable value. The agent who sells the shares might then qualify for the LCGE, providing a one-time gain of up to about $880,000 that is completely free of tax.