The answer to that question is that it depends. There are three reasons why any business owner should incorporate their business.
The factor that effects real estate agents for the most part is Taxes! As the highest marginal rate is 53.53%. This means once a realtor becomes successful, more than half of their hard earned money is gone in taxes. Getting a PREC can lower your tax rate down to $13.5% from 53.53%, if your taxable income is below $500,000. If it is more than $500,000 taxable, you will be paying 26.50% on income above $500,000.
Note: Any money withdrawn from the corporation still gets taxed on your personal rates.
What do most successful realtors do with this money?
They create an investment portfolio of real estate holdings!
In our last blog post, we discussed whether or not you should incorporate your business. The benefits are pretty much the same for PRECs, with some differences. PRECs are considered professional corporations.
What is a professional corporation?
A professional corporation is a corporation that provides professional services and is regulated by a governing professional body such as the Real Estate Council of Ontario.
Is there limited liability? It depends…
The difference between a professional corporation and a non-professional corporation is limited liability. If you incorporate your DJ business (for example) and you get sued, you will only lose the amount you invested (exceptions apply, but generally you’ll only lose the investment). If you’re not incorporated, you could potentially lose all of your personal assets.
If you’re a professional corporation and are sued for malpractice, it will be a claim against your Errors and Omissions (E&O) insurance. The corporation cannot protect you.
However, if you default on a loan, your personal assets are protected by the corporation.
So if there are limits to limited liability, why would anyone want to set up a PREC?
Tax planning strategy.
As an unincorporated realtor, you could be subject to the highest marginal tax rate (depending on your income). As a PREC, the tax rate is much lower and set at 13.5%. The additional tax savings can then be used to build your investment portfolio.
PRECs are not allowed to invest directly within the corporation, so a holding company should be set up. Although these are taxed at higher rates, they generate a Refundable Dividend Tax on Hand balance which is refunded to the holding company when dividends are paid out to the shareholder. With no other sources of personal income, approximately $40,000 in dividends can be paid out tax free! But wait, there’s more…
When the property is sold, 50% of the gain on the property is allocated to the Capital Dividend Account. Any dividends paid out from this account are entirely tax free!
Want to know if a PREC is right for you?
Reach out today!