Best way to buy a investment property?
After spending many sleepless nights and countless hours into a business the small business entrepreneur would ideally have extra cash saved in the corporation. This cash sitting in the corporate bank account is usually better optimized by investing than keeping in the bank. While meeting your financial advisor the business owner might invest in securities such as bonds, mutual funds and other securities. Others might opt to invest in buying real estate. This blog is for those individuals looking to buy a investment property in the most tax efficient way. Real estate deals add many layers of complexity as different decisions result in adverse tax and legal situations.
Personally Purchasing investment property:
If you purchase a investment property personally that means your name goes on the land deed. You will have to keep track of all the profit and loss that results from this rental property and report it on schedule 776 on your personal T1 tax return. This rental income gets included to calculate your ‘taxable income’ and the respective taxes will need to be submitted to the CRA. Please note that the initial funds used to purchase the investment property are funds that have been already taxed on the personal level.
Corporation purchasing investment property :
If you purchase the property through your corporation it’s the company’s name that goes on the land deed. Any rental income is added to the corporation tax return and the respective taxes are reported on the T2 tax return. Please note rental income is considered passive income and does not qualify for the CCPC small business deduction hence this is taxed at a higher rate than the 14% corporate tax rate for active income.
Purchasing a property under your personal name generally allows for more mortgage options in the market. Assuming you have a good credit score and have the necessary down payment and the required salary to meet the stress test you can walk on in any of the A list banks and walk out with a mortgage note payable.
A corporation that has not met the 2 years in business will have a tough time getting a mortgage. This is because the banks view the recently incorporated business to be risky and the banks usually avoid lending to corporations for investment properties.
The tax decision really comes down to pre tax dollars vs after tax dollars. Generally keeping the money in the corporation is a better strategy than to take the money out to invest. If your holding or operating company has loads of cash and let’s assume the company earns $500k net profit a year and pays the corporate tax rate of 14% [2018 rates] this would leave after corporate tax income in total cash of $430k. Since this money is left in the corporation and not paid out to shareholders this money is considered to be pre-tax money.
If you want to purchase the property personally you would have to take the $430k out by way of salary and dividend and the personal tax bill can go as high as 54% so your tax bill would be $232k in this case. The total personal taxes are so high that it would make a lot of sense to use the corporation to invest pre-tax dollars ($430k) rather than the after tax dollars personally of $232k.
Personal residence exemption:
Generally, when buying your own home it makes sense to buy it personally. This is because of the Personal residence exemption which states that the gain on any profit from the sale of the real estate property is free of any capital gains tax. This tax exemption is in place to allow Canadians to utilize their mobility rights.
If you buy a property for the purposes of renting it out and the property has not been declared as a primary residence than that property will be subject to the capital gains tax on the sale of the property. Although such a rental property will be taxed for capital gains the tax doesn’t kick in until the property is sold.
Corporations in Canada do not get the primary principal residence exemption so if you are planning on buying a second property perhaps a cottage? It might be better to buy it personally.
A discussion with your lawyer before buying any real estate property is very important. Apart from the tax decisions there are some legal decisions that also need to be made. If a tenant sues they are suing the extra funds in the corporation as well. If a corporation buys a rental property and adds shareholders or plans to add shareholders than the initial rental property is also being sold part of that deal. You are essentially selling a portion of the rental property to the new shareholders.
If you are planning on buying the property personally than you can lower your liability by moving the deed name to your spouse with a hopefully lower liability than you. This will help to mitigate any potential law suits.
What’s my best option?
As you can gauge from the above there isn’t a cookie cut solution. The tax/legal solution depends on your income, corporate structure and future vision. Please reach out to your lawyer/accountant to consult on the best investment solution for you.
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-Written by Jag Bath