Happy belated Valentine’s Day to all of you.
Erwin and I had a very uneventful Valentine’s day. We spent the day resting at home, trying to rest and recover from our illnesses.
I got a very nice present from him – a MUSE headband to help me meditate.
Admittedly meditation is not my strong suit. For those of you who don’t know, meditation is basically an exercise where you focus on your breath.
I don’t know about you, but my mind is constantly running faster than an airplane. It jumps from one idea to another to the next one in less than a second.
I have used Headspace, which is an app that provides guided meditation. So someone is guiding you through what you need to do, breath in and out, focus on your breath, occasionally reminds you to bring your wandering mind back to the breath, etc.
It started out great but recently I’ve found myself tuning out to these narratives.
Then Erwin got me MUSE, a headband that can dictate my brain signal and notify me if I’m distracted.
I know, we’re so weird! LOL!
But for real, meditation for 10 minutes allow you to clear your mind, create mental space that you would need to carry out the rest of the day more effectively. It also makes you more present when you are working on something.
Okay, enough about our weird habit, now on to this week’s topic!
If you are small business owners, this blog post is a great one for you.
If you are earning active business income in the corporation, chances are you are subject to the small business tax rate of 15%.
If you make $500,000 net income every single year and qualifies to pay 15% tax rate every year, and you spend within your budget, chances are, you can have a large amount of retained earnings left inside the corporation.
What do you do with it?
Some people use the money to invest in shares. Some people buy mutual funds.
Some people reinvest in the business and fund bigger and better expansion.
You may just want to take out money to buy yourself a sailboat.
Whether you take out dividend or salary, there’re still tax implications.
I previously wrote a blog post about how you can extract money out from your corporation.
Recently I’ve completed a transaction for my client to take advantage of his existing capital losses in the corporation.
My clients had incurred significant amount of losses inside their operating companies from years of investing excess retained earnings inside the corporation.
When they first started out investing in real estate, they were properly advised to setup a separate corporation to own their real estate.
This way, their business risk would not be mixed in with their real estate portfolio.
But because of that, they now had over $300K of capital losses available in a different company.
Capital losses can be carried forward indefinitely. Even if you lost money trading in a stock, you still should file it accordingly.
For one, you are required by law to report the transactions in your tax returns.
For two, you can carry forward the losses indefinitely and apply them into future gains.
When you make any capital gain in the future, these unapplied capital losses can be offset against the capital gain, effectively lowering your tax liability.
As part of tax planning, we’ve concluded it’s the best to move one of the properties in his personal names into this operating company.
The property was purchased a few years back, it has since doubled in value.
There are two ways to transfer the property over:
- Sell it at fair market value
- Roll the property over on a tax deferred basis
Selling at fair market value
Selling at fair market value means that the taxpayer has to pay taxes on the accrued gain on the property.
It is best suited when you are selling your principal residence and turning it into rental property. There’s no tax impact on you when you sell your own home.
It can also be used when you have a large amount of capital losses carried forward in your personal name. Selling at fair market value allows you to utilize some of these losses.
Adjusted cost base to the corporation is increased to the fair market value.
You still own the property and the corporation can pay you back your money using the excess cash.
Land transfer tax would still be triggered at fair market value.
Of course, you would still need to pay your lawyer to change the title and close the deal.
Rolling property on a tax deferred basis
The Income Tax Act does allow you to “transfer” property into your corporation on a tax-free basis.
You have to file an election form, calculate how much you can get back and what the adjusted cost base is.
The corporation assumes the cost that you paid to acquire the property.
The cost to do this election form can vary.
You can potentially take out what you have put into the property back without triggering any tax liability.
This way, you don’t need to pay any income tax on the accrued gain. The corporation assumes the cost that you pay. You get some $$$ in your own pocket without paying taxes. Win Win!
When the property is eventually sold, it can utilize the capital losses available inside the corporation. Save on taxes! More win!
Note that, even though the corporation is getting the property at cost base that you paid for, you are still paying the land transfer tax on the fair market value.
Of course, this is highly technical stuff and a professional accountant should be consulted when you implement any of these plans.
But it is pretty cool, isn’t it? You can do so much with your corporation and save some taxes!
Until next time, happy Canadian Real Estate Investing.
Cherry Chan, CPA, CA
Your Real Estate Accountant