Is a PREC right for you? A guide to Personal Real Estate Corporations (PRECs) for Realtors
WHAT IS A PREC?
A PREC is a personal real estate corporation. A new Ontario law (TRESSA2020) passed in October 2020 allowing Real Estate brokers and salespersons to perform services to their brokerage through a PREC (Personal Restate Corporation). Real estate professionals in Ontario can now enjoy the financial benefits of incorporation that other professionals have been taking advantage of for years.
IS A PREC RIGHT FOR YOU?
Just because real estate professionals are able to incorporate does not necessarily mean they should. For some a PREC can have significant advantages, whereas it can add no value for others and actually increase taxation for some. Forming a PREC is nuanced.
WHAT YOU SHOULD CONSIDER
1. Will your current brokerage be on board?
Because a PREC is a brand new business entity you will need a new agreement with your current brokerage. If you determine that a PREC is the right choice for you, you should confirm that your brokerage is willing to sign a new agreement with your PREC.
2. Are you self-employed or an employee of your brokerage?
If you are an employee* incorporating can result in your PREC being classified a Personal Service Corporation by the CRA which can have very negative tax implications. Whether or not you are an employee isn’t always clear cut. (Download our 15 page report for more details)
IF YOU ARE SELF-EMPLOYED ASK YOURSELF THESE QUESTIONS
1. Do you spend everything you make?
In other words does your lifestyle require all of the income generated by your business or can some of it be left to reinvest back in your business or in other assets? Two realtors can be making the same amount, but one may be spending it all on personal expenses, and another only half. If you need all of your earnings to live on, a PREC may make little to no difference from a tax perspective (although there may be non-tax reasons to incorporate). It’s not what you make, it’s what you keep. If you don’t spend all of your income there could be significant tax deferral opportunities available to you under the new law.
2. What is your family situation?
Do you have a spouse or common law partner? Are they involved in your business? Grown children? Depending on the answers you have there could be further benefits to you via income-splitting. The opportunities for income splitting with family members enjoyed by business owners in prior years have recently been significantly limited by new CRA rules. However, there could still opportunities to shift some income to a family member in a lower tax bracket, especially if they contribute to your business.(more here)
3. Are you close to retirement or planning to transfer ownership of your real estate business?
If you are thinking of selling or transferring ownership of your practice, incorporating can allow you to save significant capital gains tax through the Lifetime Capital Gains Exemption (LCGE). Not every corporation will qualify but you cannot qualify without a corporation. (More here).
WHAT ARE THE ADVANTAGES OF FORMING A PREC?
If you have self assessed and meet the basic criteria for forming a PREC, there could be significant financial advantages for you and your business. Keep reading.
1. Tax deferral: a case study
Meet Alison. She makes $250, 000 net in commissions from sales in her real estate business. She needs $150,000 of that income before tax to live on. Alison is contemplating putting the rest back into her business, or else investing it.
Option A: Without a PREC
The $100,000 gets taxed at an effective rate of about 50% (rounded for simplicity).
Alison will have some $50, 000 left after tax to invest into a portfolio, rental property, business development, hiring etc…
Option B: With a PREC
The $100,000 is taxed inside the PREC at a low corporate rate of about 12%* (rounded for simplicity). In this case the PREC retains roughly $88,000 - a difference of $38,000. If the extra funds are invested in a portfolio, with cumulative interest, the extra starting capital can yield very noticeable difference in growth and income over time. Similarly, having that much more down payment for the rental property will cut interest costs significantly. And of course, if she is using the extra cash to grow her professional practice, $38,000 per year can really make a difference. A brief word of caution, however: how much investment versus business income you make in a corporation needs to me carefully monitored to avoid trouble with the CRA. (here for more)
2. Options & Flexibility
Operating your business through a PREC can give you greater flexibility in how much money you keep and how much you take out of the corporation personally. This is especially relevant for realtors as earnings can fluctuate from year to year. Let's say Alison decides she wants to take her family on a special vacation. Because she has a PREC she is able to take more of the income out just this year. The next year her partner gets a promotion and her living expenses drop- Alison is then able to keep more in her business and invest as she sees fit.
There are also additional options in HOW you take money out of your business. You can pay yourself a salary or bonus, or declare a dividend, to name just the most common alternatives. As discussed above, there might even be room to distribute some of the income out to family members, although this will depend on your specific circumstances and requires careful planning.
3. Capital Gains Exemptions
Incorporating under a PREC allows you to shield up to $883, 384K (2020 amount) from capital gains tax on a sale or transfer of certain shares in your business through the LCGE. You can only take advantage of this if you are incorporated and meet certain other CRA criteria. This is a very important consideration whether your are planning to sell the practice, transfer it to the next generation, gift it or just leave it behind in your estate. (Here for more).
THINK A PREC IS RIGHT FOR YOU? HERE ARE SOME FURTHER CONSIDERATIONS
- Your PREC must be structured correctly in order to take advantage of the potential benefits. The new law is very specific and a generic pre-packaged incorporation products will not work. You will need legal assistance and the advice of a tax professional, to set up and structure your PREC the right way.
- Additional tax planning may be required to avoid capital gains tax as a result of forming a PREC. You practice may have intangible value that generates a gain on incorporation.
- Your previous HST number needs to be cleared and closed, new CRA numbers (including HST) must be registered, and your PREC’s books need to be set up
Although there are significant financial advantages made possible by the new laws, a PREC is not a one-size-fits-all solution. Tread lightly and with professional help to avoid any tax trouble down the line. If, however you are a right candidate, operating your real estate practice through a PREC can yield significant financial benefits for you and your family.
For a deeper dive into PRECs download our Free 15 page report.
SUMMARY: TOP 3 QUESTIONS TO ASK YOURSELF
1. Are you self employed and will your brokerage be willing to sign a new agreement with your PREC?
2. Do you spend everything you make?
3. What is your family situation? Can you take advantage of further benefits such as income-splitting?
20 page report outlining in detail everything you need to know about PRECs