Personal Real Estate Corporation “PREC” Prepared By Mark Hunter, CA, CPA
Agenda 1. The Personal Real Estate Corporation (“PREC”)? 1. What is a corporation? 2. What is a PREC? 3. How does a PREC work? 4. What requirements must be met in order for a PREC to receive payments from the brokerage? 2. What are the benefits of using a PREC? 3. What are the drawbacks? 4. Helpful resources
What is a Corporation? • It is a separate legal entity • It can enter into contracts, employee people, earn income, pay expenses • It is a taxpayer and pays corporate tax on its net income • It is owned by shareholders to whom it issues share certificates (stock) • Share certificates can be bought and sold. If done so on a public stock exchange the company is a public company. Most companies in Canada are private companies • A company distributes its after tax earnings to shareholders in the form of a dividend • There are different classes of Shareholder. Two important classes are voting or non ‐ voting
What is a PREC? • A PREC is a corporation incorporated under the Business Corporations Act that meets certain criteria prescribed in the Regulations to the Real Estate And Business Brokers Act, 2002 (“REBBA”) • The PREC will receive the commissions that would otherwise have been paid to you by the brokerage • It will pay the same expenses you currently pay, as well as, if applicable, the wage of the salesperson • The PREC will pay corporate tax on its net income
What is a PREC? ‐ Criteria • All voting shares are held by the salesperson (“the controlling shareholder”) • Family members (spouse (married or conjugal), child or parent) can own non ‐ voting shares • The salesperson is the sole officer, the president • The salesperson is also the sole director • There can be no agreement that transfers or restricts the sole officer from managing the business
How does a PREC work? The brokerage can pay a PREC when: • The PREC is exempt from registration under the REBBA • The remuneration has been earned by the PREC’s controlling shareholder • The brokerage has confirmed, in writing, certain requirements are met The salesperson who is the controlling shareholder of the PREC can receive remuneration from a PREC when: • The brokerage pays the PREC instead of the salesperson, and • The amount paid by the PREC to the salesperson does not exceed the amount of remuneration received from the brokerage for the salesperson
Requirements – Exemption from Registration • The controlling shareholder is employed by the brokerage to trade in real estate • The PREC: • does not carry on the business of trading in real estate other than providing the services of its controlling shareholder to the brokerage • is never represented to the public that it carries on the business of trading in real estate • does not carry on business as a brokerage • does not receive remuneration for trading in real estate from any other source other than the brokerage • The controlling shareholder does not receive remuneration from trading in real estate from any source other than the PREC or the brokerage • The PREC does not, on behalf of the brokerage, hold any money or other property of the clients in connection with trading in real estate
Requirements – Exemption from Registration • There is a written agreement between the PREC, controlling shareholder and brokerage that governs the relationship between the brokerage, the PREC and the controlling shareholder where the PREC agrees: • not to interfere with the brokerage or its broker of record in the performance of their duties under the Act and regulations, or interfere with the controlling shareholder in their performance of the shareholder’s duties under the Act and regulations • to provide whatever reasonable assistance is required to allow the brokerage and its broker of record to comply with the their duties un der the Act and regulations and to enable the brokerage and broker of record to ensure the controlling shareholder is complying with the shareholder’s duties under the Act and regulations • to provide whatever reasonable assistance is necessary to allow the brokerage to determine whether the conditions set out in the section are met.
Requirements ‐ Other Finally, the controlling shareholder must, in writing, provide the registrar with: • The legal name of the PREC • The address for service of the PREC
PREC ownership and Cash Flow Purchaser pays commissions Salesperson to the brokerage The PREC pays wages or 100% Voting shares dividends to the salesperson The Brokerage PREC The brokerage pays commissions to the PREC
What are the benefits of using a Corporation? 1. Deferral of Tax 2. Access the Lifetime Capital Gains Deduction 3. Income Splitting
Deferral of Tax Individual Tax • When an individual earns income they pay personal tax on that income • The top personal tax rate of an individual in Ontario is 53.53% and it starts when income is $220,000 • An individual in Ontario earning $220,000 will pay $80,850 in personal tax • An individual in Ontario earning $300,000 will pay $123,700 in personal tax
Deferral of Tax Corporate Tax • When a corporation earns income it will pay corporate tax on that income • A private company in Ontario earning income from an active business has two tax brackets: • From $0 to $500,000 the tax rate is 12.2% • Income in excess of $500,000 the tax rate is 26.5% • A corporation earning $220,000 of income will pay $26,840 in tax • A corporation earning $300,000 of income will pay $36,600 in tax
Deferral of Tax Income Level $100,000 $220,000 $300,000 Personal Tax $25,000 $80,850 $123,700 Corporate Tax $12,200 $26,840 $36,600 Tax Deferral $12,800 $54,010 $87,100
Deferral of Tax The tax deferral is only good if you leave the after tax income IN the Company Corporately Earned Personally Earned Commissions Earned $100,000 $220,000 $300,000 $100,000 $220,000 $300,000 Corporate Tax $12,200 $26,840 $36,600 N/A N/A N/A Profits retained in Corp $87,800 $193,160 $263,400 N/A N/A N/A Personal Tax $12,950 $54,650 $87,950 $25,000 $80,850 $123,700 Net Cash paid as dividend $74,850 $138,510 $175,450 $75,000 $139,150 $176,300 Effective Tax Rate 25.15% 37.04% 41.52% 25.00% 36.75% 41.23%
The Life ‐ Time Capital Gains Deduction When an individual sells their shares in a qualifying company they pay tax on the capital gain in excess of $883,384. In other words, an individual selling a qualifying company won’t pay tax on the first $883,384 of capital gains. At the top personal tax rate, that’s a savings of $236,500. This benefit is only available to individuals who sell their shares in a qualifying company. What does this mean to you? If, and only if you can sell the PREC and the PREC meets certain qualifications outlined in the Income tax Act would this be a benefit to you.
The Life ‐ Time Capital Gains Deduction Salesperson Assuming the Corporation NOTE: The accumulation of qualifies and the Agent has no investments inside the other income in the year they corporation could jeopardize the 100% sell the company the tax savings available capital gains deduction. would be close to $100,000. Corporation Fair Market Value = $500,000
Income Splitting Salesperson Spouse 100% Voting shares 100% non ‐ voting shares Personal Real Estate Corporation (“PREC”)
Income Splitting The Regulations to the Real Estate And Business Brokers Act, 2002 allow family members of the salesperson to own non ‐ voting shares Family members are defined to include a spouse, children or parents of the salesperson As a shareholder, the family member can receive dividends from the company This splits income between family members and taxes income at lower tax rates However , generally speaking, the Income Tax Act will prevent income splitting with family members who are not actively working in the business. Any amounts paid to a family member who is not actively engaged in the business will be taxed at the top personal tax rate.
What are the Drawbacks of using a Corporation? 1. Legal and Accounting costs to set up the PREC 2. Increased record keeping 3. New government accounts, income tax, HST and payroll taxes, need to be set up 4. New bank accounts and credit cards and investment accounts 5. The PREC must file HST returns and an annual income tax return as well as T4s if the PREC pays you a wage 6. A more complicated process to pay yourself – wages or dividend
Legal and accounting costs The creation of a PREC requires the services of a tax accountant and a lawyer. • The tax accountant will help devise the ownership structure and complete the practice valuation • The tax accountant will also provide instructions to the lawyer on the transfer of the salesperson’s practice to the PREC • The lawyer will prepare and file the Articles of Incorporation and the purchase and sale agreement between the salesperson and the PREC • The lawyer may also prepare the agreement between the brokerage, salesperson and PREC
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