Real estate investments have a number of structures of ownership such as an individual, corporation, partnership or trust, and income tax implications are different. In Canada, the selection of a legal structure for the ownership of real estate is critically important because it can have a significant impact on your total tax liability.
Individual or Co-ownership
The net rental income (loss) plus capital gain (loss) will be reported on the owner’s individual tax return based on the percentage of their property ownership.
Pros:
- accounting fees and legal fees are the lowest among the four legal structures
- if rental loss is incurred, that loss can be applied to another source of income to reduce the taxpayer’s taxable income.
Cons:
- The taxpayer lost the right to defer paying taxes on rental income. If you live in Alberta, you are in the top tax bracket, and the tax rate is 48%. That means your rental income is subject to 48% marginal tax rate and the capital gain is subject to 24% marginal tax rate.
- In addition, if a rental property is sold, the taxable capital gain along with other sources of income may push an individual’s tax bracket to the higher level.
- As a landlord, you may face many legal risks in person when renting property to tenants.
- A creditor might be able to take your property if that person files a lawsuit against you for an unrelated matter.
Corporation
The rental income and capital gain are reported on corporate tax T2, which are separated from the individual tax returns of the owner. The rental income and capital gain are investment income to the corporation. The tax rate varies with the type of corporation. If the corporation has more than 5 full-time employees, it qualifies as a Canadian-Controlled Private Corporation (CCPC), and its tax rate is 11% in Alberta. If not, its tax rate would be 48% in Alberta.
Pros:
- If a corporation is qualified as a Canadian-controlled private corporation (CCPC) and subject to the low tax rate of 11%, owners can defer tax.
- If a company is a Qualified Small Business Corporation (QSBC) – see my previous blog, its owners can claim a Lifetime Capital Gains Exemption (LCGE) when selling the shares of the corporation.
- A corporation can provide its owners with protection from creditors.
Cons:
- If the corporation is not a CCPC, the 47 % tax rate would be applied unless the company pay dividends to its shareholder. If the corporation pay its shareholder dividends, the corporation get 33.33% dividend refund, so the 23% tax rate would be applied. However, the owner still needs to pay individual tax when receive dividend.
- If you own a corporation, rental loss and capital loss are trapped in the corporation and are not applied to the other income you earn outside of the corporation.
Partnership
Partnership is not a legal entity. The rental income and loss are calculated at partnership level and divided between each partner, who reports the figures on their individual tax return. The partner can be individual, corporation, trust, or other partnership. If the partner is a corporation, that income is called passive income and may be subject to a 47% tax rate if the corporation has not paid dividends. If the partner is an individual, that income will be included in his T1.
Each partner must track its ACB in T5013 in case they sell their partnership interest in the future.
ACB= Capital contributed +/- income (loss) of previous year – cash withdraw.
The loss limited partner can claim is limited to “at risk” amount. In simple words, $30,000 tax deductions are not available to limited partner who has less than $30,000 at risk. Selling partnership interest can trial capital gain. The 50% of capital gain would be included in partner’s income.
Pros:
- The flexibility for the different structure entities to be associated with each other
- The flexibility to allocate income through partnership agreement. It is important to allocate income among partners in a fair and reasonable way. If you arbitrarily allocate income between partners for tax purposes, the Canada Revenue Agency may reallocate income for the partnership based on general anti avoidance rule-GAAR
Cons
- Partners with poor tax planning may end up paying higher taxes than necessary.
- Less flexibly for each partner to claim deductions as deductions is claimed at partnership level
Trust
Trust holds the property for the benefit of the beneficiary and allows the beneficiary to receive income and capital gain without legal control. The taxable trustee is tax the highest tax bracket for income hasn’t been allocated to beneficiaries. when income is allocated to the beneficiary, it be tax at beneficiary’s hand.
Pros:
- It is a useful estate planning tool to allow you to claim multiple life-time capital gains tax exemptions.
- Certain forms of income can be changed as dividends
Corns:
The income-splitting opportunity is not available for only one beneficiary.
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Resource:
https://www.canada.ca/en/revenue-agency/services/forms-publications/forms/t5013.html
