As a realtor you’ll likely have experienced all sorts of ups and downs during your time helping clients buy or sell their homes. The real estate market is unpredictable at the best of times which means real estate agents will rarely have the same amount of income from year to year. Not only is income uncertainty an issue for financial planning, but it also makes saving money on your income taxes a nightmare.
Unpredictable income levels can really hurt come tax time, as fluctuating income might mean nasty tax bills in years that your income exceeds expectations. For example, if your total income for 2020 is $100,000, then the taxes you owe would fall under a tax rate of 23.7% (in Ontario) for a of total $23,708. Then, if in 2021 your income increases to $250,000, your effective tax rate would also increase to a whopping 38%, or $95,084. It’s a big difference and a lot of cash out of your pocket so…
What if there was a way to not only dramatically decrease your overall tax bill, but at the same time also smooth out your earnings year after year to make your finances more predictable? What if you could also maintain your personal income within a lower tax bracket every year to avoid spikes in your tax bills for the years you earned more? That would be amazing right?
Well, it exists, and it’s called a Personal Real Estate Corporation or PREC.
How does a PREC help realtors smooth out their income and pay less tax?
It took over a decade of lobbying, but Ontario finally passed legislation in October 2020 that allows realtors to incorporate their business into a Personal Real Estate Corporation.
This was great news because a PREC has a tax rate of only 12.2%. Compare that to the example above – where $100,000 of personal income generated a tax rate of 23%, and a personal income of $250,000 climbed to a 38% general tax rate – and it’s clearly a much lower rate.
In a PREC, the initial $500,000 of profit gets taxed at a rate of 12.2%, giving you flexibility in choosing what to do with the profit in your PREC. For example, if you need only $75,000 per year for personal living expenses, then you would only be required to pay personal income tax on that amount each year. This equates to a personal income tax of $15,070 at a rate of 20%. The rest of the profit you made stays in your PREC and gets taxed at the 12.2% corporate income tax rate.
If you made $100,000 profit in your PREC, and took $75,000 for personal use, then your personal income tax payment would be $15,070 plus an additional corporate income tax of $3,050 for a total of $18,120, (a tax rate of 18%), instead of the 23% you’d need to pay if the total profit amount was claimed as personal income.
If your income total was $250,000 in the PREC, but you only took $75,000 for personal use, then you would pay $15,070 of personal income tax plus $21,350 of corporate income tax. This would total $36,420 at a combined tax rate of 14.5%, opposed to the whopping 38% you’d have to pay if all the profits were claimed as personal income.
The advantage of a PREC is that the tax rate stays 12.2% all the way up to $500,000 of profit. It doesn’t matter if your income is $50,000, $100,000 or $250,000 – the tax rate stays the same within the PREC. However, withdrawing funds for personal use means you will incur personal income taxes at higher rates, but only on the amount you take out. This means a PREC works best when you withdraw only the minimum amount needed for personal living (including your TFSA/RRSP/RESP contributions if possible).
A PREC allows you to choose your personal income, more accurately predict what your personal taxes will be, and helps you stay within lower personal income tax brackets instead of paying over 50% (if your income exceeds $216,512). It’s definitely worth your while to see if a PREC makes financial sense for you.
Visit RealtyTax.ca for more information and advice on if a PREC is the right choice for you. Our partners offer free consultations to all Ontario real estate agents seeking guidance regarding incorporating a PREC for their business and are always happy to answer any questions you might have.
Neal Winokur, CPA, CA