Happy New Year everyone!
I hope everyone got to enjoy the holidays as much as I did. I surely had a great time hosting a large Christmas party for our family this year. Thanks to Tony, my brother-in-law, we were able to enjoy some delicious food.
Of course, we got to bake a cake with our older one, who just turned 2 over the holidays. We value the experience and the time spent together over presents. We decided to celebrate it by baking her birthday cake together.
Having a child provides a new definition for life. I become more mature, more responsible, and wiser. I’ve just become a better person in general. After all, I have to be the role model for this little 2 year old!
Over the holidays, I managed to attend a tax update webinar about the upcoming tax changes in 2016. Some of them are more relevant to real estate investors than others, but that doesn’t mean you should be complacent. In fact, you should be the opposite. Tax changes can be tricky to navigate and might catch you out, so MCA Assessors and other similar financial advisors might be able to help you if you’re in a bit of a pickle. Here are the 6 most important tax changes that you might need to know about this year:
- Middle class tax cut
As many of you are aware, our new Prime Minister is giving the so-called middle class a tax cut of 1.5% on income between $45,282 to $90,563 – this can potentially result in $679 savings.
This means that if you earn income more than $90,563, you can save $679.
If you make less than $45,282, sorry, there are no benefits to you at this time.
- New tax on the rich
Someone has to pay for the tax cut. Our government decided that the rich should be the one responsible for it.
If you make anything over $200K, you are going to pay 4% more.
As real estate investors, you may think that this does not relate to you if you don’t make $200K.
Think about the year you sell one of your properties and you incurred a large capital gain and recapture on them, pushing your income over $200K for the one year.
Because of the new tax hike, it is more important than ever for people to consider incorporating, especially for the investors who do not need the cash from their portfolio.
- Corporation investment tax and refundable dividend tax credit
Many of the experienced real estate investors know that the Income Tax Act considered rental income as passive income. Because it is classified as passive income, it is being taxed at 46.17% within the corporation.
When the corporation declares a taxable dividend, 262/3% is then refundable to the corporation. The net tax you would pay within the corporation is 20% over the long run.
The shareholder who received the dividend is then responsible to report the dividend as income in his personal tax return and pay tax on the income.
With careful planning, you can structure to lower your overall tax liability substantially.
In the past, for any income a real estate investor makes over $139K, it is taxed at 46.41% and more. 46.41% personally is greater than 46.17% in the corporation -> this is tax deferral and it’s a no brainer to incorporate to hold your portfolio.
From 2016 and onwards, a corporation would have to pay 50% tax on the passive income initially. You will then get a refund of 30% when a taxable dividend is declared. That’s still net 20% over the long run.
Although the same flexibility for tax planning is still available, there is no immediate tax deferral for people who earn income more than $139K but below $200K.
- Small business tax rate is going down
For small business owners who incorporated their active businesses, the tax rate is going down gradually from 15.5% in 2015 to 13.5% in 2019. Specifically, the active income is being taxed at 15% in Ontario in 2016.
For real estate investors who have their small business, this means that you can even save faster to grow your real estate portfolio. Lower tax rate means higher after tax cash flow from your active business and more money available for investment!
For real estate investors who don’t have small businesses but with a larger portfolio, this may also mean it is a good time to consider three tiered corporations structure, as active business income is being taxed at lower rate in the coming years and more tax savings can be achieved.
- No more family tax cut $2,000
Family tax cut was introduced by the Harper government for families who have children under the age of 18 to split the income and save tax up to a maximum of $2,000.
Over 90% of my clients benefit from this family tax cut. It may not be the full benefit of $2,000, but they all get to save some tax dollars.
Unfortunately 2015 was the final year we got to enjoy this cut.
- TFSA contribution limit is reduced to $5,500
Yes, you can’t own a property directly in a Tax Free Saving Account, but you can invest in various real estate related products, such as second mortgage product and equity investment in new build projects.
Reduction in contribution limit means that it limits the amount of income you can shelter without paying tax.
If you expect to earn 10% interest on second mortgage, you could earn $1,000 tax free when the contribution limit was $10,000.
Now you can only earn $550 tax free.
This does not simply affect one year, it affects the contribution limit many years to come.
So what’s the take away on these changes? We are all going to pay more tax, one way or another. The good news is that you can still use corporations as a vehicle to lower your overall tax liability, provided that you do not need the cash flow from your properties immediately.
Happy New Year and happy Canadian real estate investing.
Cherry Chan, CPA, CA
Your real estate accountant