This one rule could save you thousands, but only if you know it.
Many people overlook how the system works – corporate rental income can face a 50 percent tax if you’re not careful
If you’ve ever considered buying rental properties through a corporation, the different tax treatment compared to personal ownership might surprise you. And if you don’t understand how it works, you could end up paying more tax than necessary.
Let’s break it down so you can make smart decisions and keep more of your hard-earned money.
Why This Matters
Corporations can be a powerful tool for real estate investors. They offer legal protection, income splitting, and long-term planning flexibility. But they also come with extra costs and a different tax system.
Before you jump in, it’s important to understand:
- What kind of income your corporation earns
- How that income is taxed
- What you can do to reduce the tax bill
Corporations Are Separate Legal Entities
A corporation is considered a separate legal entity. That means:
- It files its own tax return
- It pays its own tax
- It can be sued independently from you
You can’t just take money in and out of the corporation without proper documentation. Every dollar that moves needs to be tracked and may have tax consequences.
Active vs Passive Income
In Canada, corporate income is split into two main types:
- Active Business Income: Income from running a business (like selling widgets or providing services). This qualifies for the Small Business Deduction and is taxed at just 12.2% inside a Canadian Controlled Private Corporation (CCPC) in Ontario.
- Passive Income: Income from property—like rent, interest, dividends, or royalties. This is called Specified Investment Business (SIB) income and is taxed at 54%, with 34% refundable when a taxable dividend is declared.
Rental Income Is Passive (Unless You Hire 5+ Full-Time Employees)
Rental income earned inside a corporation is considered passive income, unless the corporation hires more than five full-time employees to manage the portfolio.
If you don’t meet that threshold, your rental income is taxed at 50%.
That’s a big number. But here’s the good news…
Refundable Dividend Tax On Hand (RDTOH)
About 30% of that 50% tax goes into a CRA account called Refundable Dividend Tax On Hand (RDTOH).
Think of RDTOH as a tax refund bank account. When your corporation pays a taxable dividend to you (or another shareholder), CRA refunds part of that tax.
Example:
- Corporation earns $10,000 in rental income
- Pays $5,000 in tax
- $3,000 goes into RDTOH that CRA owes you
- If a dividend is declared, CRA refunds $3,000
- Net tax = $2,000 (or 20%)
- If no dividend is declared, CRA keeps that $3,000 payable to you.
- If you continue to earn another $10,000 net rental income the following year, your RDTOH goes up by the same amount of $3,000 in year 2. Now CRA “owes” you $6,000.
You can choose to declare a taxable dividend tax to the shareholders to trigger the refund the same year that you pay tax. You can declare a taxable dividend to the shareholders 10 years from now. CRA still owes you the amount in the RDTOH account.
Related Post: How To Calculate Rental Property Capital Gains Tax
Over time, your effective tax rate on rental income drops to 20%, assuming you declare dividends.
But There’s a Catch…
The dividend you receive is taxable in your personal name. So depending on your personal income, you might pay more tax.
If you have no other income, you could receive up to $35,000 in dividends and only pay a small Ontario Health Premium on your personal tax return. That’s a great way to minimise your overall tax.
You can also declare the taxable dividend to the lower income spouse, who would pay lower personal tax rate on the dividend received. Make sure you consult with a professional accountant to avoid any Tax on Split Income (TOSI) rule.
This gives you flexibility in tax planning – to minimize the amount of tax you would have to pay overall.
Real-Life Scenario: Meet Lisa
Lisa owns a rental property in her corporation. It earns $30,000 in net rental income.
- Corporation pays $15,000 in tax
- $9,000 goes into RDTOH
- Lisa declares a $30,000 dividend
- CRA refunds $9,000
- Net corporate tax = $6,000
Lisa pays personal tax on the dividend, but because she has no other income, her total tax bill is low. Her combined tax rate is around 20%.
Selling a Property in a Corporation: Capital Gains & Tax-Free Dividends
When your corporation sells a long-term rental property and makes a profit, that profit is called a capital gain. Just like in your personal tax return, only 50% of the capital gain is taxable. The other 50% is completely tax-free.
Let’s break it down.
How Capital Gains Are Calculated
Capital Gain = Sale Price – Adjusted Cost Base (ACB) – Selling Expenses
- ACB includes your original purchase price, capital improvements, and closing costs.
- Selling expenses include legal fees, commissions, and other costs to sell.
Example:
- Sale Price: $850,000
- ACB: $250,000
- Capital Improvements: $50,000
- Selling Expenses: $25,000
- Capital Gain = $850,000 – ($250,000 + $50,000 + $25,000) = $525,000
- Taxable Capital Gain = $525,000 × 50% = $262,500
- Tax Payable (at 50%) = $131,250
What Happens to the Taxable Portion?
The taxable half of the capital gain ($262,500 in the example above) is treated as passive income. That means it goes through the same Refundable Dividend Tax On Hand (RDTOH) system as rental income.
- The corporation pays 50% tax on the taxable portion.
- About 30% of that tax goes into the RDTOH account.
- When the corporation pays a taxable dividend, CRA refunds part of that tax.
Example:
- Taxable Capital Gain: $262,500
- Tax Paid: $131,250
- RDTOH Refundable Portion: ~$78,750 (Refundable when a taxable dividend is declared)
- Net Corporate Tax: ~$52,500
- Shareholder receives dividend and pays personal tax on it
This system allows you to recover part of the corporate tax when you pay dividends, reducing your overall tax burden.
What Happens to the Non-Taxable Portion?
The non-taxable half of the capital gain ($262,500 in our example) goes into a special account called the Capital Dividend Account (CDA).
The CDA is a notional account that tracks tax-free amounts your corporation can pay out to shareholders.
Your corporation can elect to pay a capital dividend from the CDA, which is completely tax-free to the shareholder.
Example:
- Non-Taxable Capital Gain: $262,500
- CDA Balance: $262,500
- Corporation elects to pay a capital dividend of $262,500
- Shareholder receives the dividend tax-free
This is one of the biggest tax advantages of selling a property through a corporation.
Key Takeaways
- Only 50% of a capital gain is taxable, just like in personal tax.
- The taxable portion goes through the RDTOH system, allowing for partial tax refunds when dividends are paid.
- The non-taxable portion goes into the Capital Dividend Account (CDA) and can be paid out tax-free.
- With proper planning, you can minimise tax and maximise after-tax cash from a property sale.
What If You’re Flipping or Building New Houses?
If you sell a property that wasn’t held for long-term investment—like a flip, land development, or wholesaling—or sell a residential property within 365 days and earn a profit, the tax treatment changes. The CRA typically treats these types of sales as business income, not capital gains.
That means:
- 100% of the profit is taxable
- You don’t get the 50% tax-free portion
- You don’t use the Capital Dividend Account, meaning no tax-free dividend to the shareholders
Example:
- You buy a home for $500,000
- Renovate for $100,000
- Sell for $700,000
- Profit = $100,000
- Taxable income = $100,000
- If taxed at 12.2%, tax = $12.200
- Net after-tax = $87,800
You will have to pay personal tax on the dividends received from your corporation.
Final Thoughts
Setting up a corporation for your real estate investments can be a smart move—but only if you understand how the tax rules work. Corporations face different tax treatments for each type of income, from rental earnings to capital gains to property flips. The good news is, with the right structure and timing, you can use tools like RDTOH and the Capital Dividend Account to reduce your overall tax bill. The key is planning ahead and knowing when to take money out, when to leave it in, and how to report it properly. If you’re unsure, talk to a real estate accountant who can help you build a tax-smart strategy that fits your goals.
Next Steps
We help everyday Canadians navigate the confusing world of taxes—so you can keep more of what you earn. Want to make sure you’re not leaving money on the table? Book a consultation with my team today.
Until next time, happy Canadian Real Estate Investing.
Cherry Chan, CPA, CA
Your Real Estate Accountant
