5 Tax Impacts on Real Estate Investors from the Proposed Tax Changes on Private Corporation

We are changing our office number!

I am in the middle of switching my business phone network from a US carrier to a Canadian carrier. Although we can work out the logistics to port the old number over, I’m assigned a new number temporarily before I port everything over smoothly.

It’s funny isn’t it? I’ve never truly considered the importance of having a business phone system that can run efficiently until now. It plays a massive part in our success, as it allows us to speak with management, as well as potential clients.

I think it would be a great idea, but nothing has come from it yet, as we’re still in the middle of changing our office phone number. Luckily, this was a straightforward process.

Then I realize, the new number assigned is indeed a better number than our old one!

So we are changing to this new number: 416-548-4228.

Call me superstitious or silly. Having more 8s in my phone number makes me feel luckier. ?

8 traditionally symbolizes wealth and money in Chinese. 4 represents death, and hence we try to stay away from 4.

Many builders, who target Chinese buyers, would skip any floors than ends with 4 and they know that 4 isn’t welcome in our culture.

If you walk into a downtown Toronto building, you will likely find them skipping the 4th, 13th, 14th, 24th, etc. floor.

And 2 carries the meaning “easy”. So 228 means easy wealth ? Who doesn’t want easy wealth?

It may be a bit of transitional period but yes, we are switching to this number full of 8s! Hopefully these 8s will bring all the luck to us.

And our new number is 416-548-4228.

Now, kidding aside.

Recently, I had a consultation with two 2nd generation real estate investors. I call them 2nd generation because they’re about to inherit a few houses that their elderly parents bought years ago for less than 6 figures in the city of Toronto.

Our goal was to draft up a plan so that they could inherit these properties in the most tax efficient manner. We will detail a few options, calculate the tax impact under each option, and make a decision based on their objectives.

I explained to them that someone has to pay some tax, eventually. You can defer the tax and can potentially minimize it by a small amount but you will never be able to avoid it. (Boo! ?) If they don’t pay the tax now, they will pay a bigger tax bill sometime down the road.

For those of you who are interested in this Estate Planning topic, you can refer to my previous blog post here.

I immediately speak to my tax guy about this new job. His recommendation is that we should wait until the Liberal government makes their conclusion regarding the proposed tax changes on private corporations. No move is a better move.

If you are a real estate investor, you own a business in Canada. If you plan to pass on your portfolio to your future generation in a tax efficient manner, you too are getting affected by this change!

Just because you now have a job and own real estate in your personal names, these proposed tax changes on private corporation can still limit your opportunity to lower your tax when it is time to transition your portfolio to your future generation!

Here are the five-potential effect on you, a real estate investor, by these proposed change:

1. Cancellation or alteration of Refundable Dividend Tax CalculationRental income earned in a corporation is considered Specified Investment Business (SIB) income. SIB is taxed at 50% in the corporation.Out of the 50% paid, 30% sits in a notional account called Refundable Dividend Tax On Hand (RDTOH) that CRA owes you.

   You need to declare a taxable dividend to yourself or any shareholders to trigger this refund.

   In essence, you are paying only 20% tax inside the corporation, plus whatever you would be paying in your personal name.

   The Finance Minster is proposing to remove this refund completely. ?

   Yes, no joke! They can potentially be taking away 30% potential refund from you.

   So if you have a real estate holding company that only holds rental portfolio, all of a sudden you are losing the 30% refund.

2. Cancellation of capital dividend accountIn the proposed change plan, Finance Minister is also talking about eliminating the capital dividend account.For a real estate holding company, when you sell a long term buy and hold, similar to your personally held real estate, 50% of your capital gain is not taxable. This non-taxable portion of your capital gain goes into the capital dividend account.

   Capital dividend account allows shareholders to take out cash in the corporation without getting taxed in their personal names.

   For those people who purchase their life insurance policies inside the corporation, the proceeds also go into the capital dividend account and hence allow the shareholders to access the payout tax free.

   Liberals are proposing to remove capital dividend account.

3. Inability to use bona fide tax planning strategy to pass your real estate portfolio to next generationIf you have a situation similar to my clients mentioned above (i.e. owning all the rental properties in their own names), currently, you are able to do an estate freeze, via a corporation, to pass your portfolio on to the next generation in a tax efficient manner.Once the proposed tax changes implemented, what’s the point given that they’re taking RDTOH and Capital Dividend account and ultimately you are taxed more in a corporation!
4. Highest tax rate imposed on passive income earned using small business rate incomeReason why they are cancelling the RDTOH is because they are trying to prevent small business owners from using income that is taxed at 15% to invest.The Liberals want to tax everyone at the highest rate, assuming that the Small Business Owners, after taking out the excessive earning, are all paying the highest marginal tax rate in their personal names.

   For more details, please refer to my previous blog post here.

5. Small business owners can pay as much as 93% tax under the new proposed rulesAccording to Minden Gross LLP’s recent publication titled “is a 93% Tax Rate Fair to Canadian Small Business Owners?”, a detailed example is given on how a small business owner can end up paying as much as 93%, leaving close to nothing to their next generation.I think all of us can agree that 93% tax rate is not fair!

I had another conversation with one of my favourite mentors, a partner from Deloitte that specializes working with private companies and small businesses.

He said that he’s very frustrated at all the changes being put forth by the Liberals.

Who isn’t frustrated? Liberals are keeping many of the public practice accountants up at night.

And yes, you still have a say.

Contact you local MP (find them using this link to voice you concerns.

If you are still not convinced, you can listen to my podcast with Erwin Szeto using this link.

Until next time, happy Canadian Real Estate Investing and enjoy the rest of your summer.

Cherry Chan, CPA, CA

Your Real Estate Accountant