Real estate owners often ask themselves if they should own investment real estate personally or through a corporation. There are certain tax consequences and factors to consider in transferring real estate to a corporation. Do you know which?
Holding real estate property personally or in a corporation?
Deciding to hold a real property in a corporation depends on many factors. To begin, a corporation offers limited liability protection. This element of ownership is often the main influence to transfer real estate to a corporation. This is particularly true in circumstances where a taxpayer owns a multi-unit residential complex, and the risk of potential litigation may result in excessive debt, or worse, possible bankruptcy.
Furthermore, holding real estate within a corporation may be tax advantageous. Income from real estate property is most often passive income. Corporations earning passive income are taxed at a higher rate than if the income were to be derived form an active business. However, in some cases, it is possible for the income earned to be taxed as active business income. In these cases, a corporation provides the opportunity for tax deferral and tax savings.
In addition, a corporation may be useful in cases where an individual wishes to transfer property to their next of kin. For estate planning purposes, the value of assets of the corporation are often frozen and the shareholder is given fixed value voting preferred shares. The children are then introduced, by means of a trust or by any other means, to provide them with future growth of the assets, while the taxpayer maintains control of the corporation.
If you already own property personally, and decide to transfer your real estate investment to a corporation. The following components should be considered prior to the transfer.
Taxation on Transfer
The general rule under Canadian tax law is that a transfer of property between an individual and a corporation is a sale at fair market value (FMV), which can result in immediate tax on a capital gain. In most cases, the transfer can be achieved on a tax deferred basis provided you meet certain conditions. The tax can be deferred so long as the conditions are met, and both you and the corporation jointly elect using a prescribed form by the imposed deadline. This is commonly referred to as a “rollover”.
Obtaining Creditor Approval for the Transfer of a Mortgage to the Corporation
Often, creditors will allow a transfer of real estate property. However, permission should be received prior to the transfer, and may entail prepayment penalties depending on the agreement with the creditors.
Mutations Tax, Also Known as Land Transfer Tax
Mutations tax generally apply when there is a change in legal ownership of a property between unrelated persons. However, depending on the province the property is situated, there may be an exemption when a transfer is made to a related party.
In Quebec for instance, there is an exemption from mutations tax when a property held by an individual is transferred to a corporation, and the individual owns 90% or more of the voting rights.
Proper advice should be sought out to make such determination as the transfer simply may not be worth it due to the significant transfer tax.
Sales Tax (GST/HST/PST)
Sales tax generally do not apply to the sale of a residential complex if it is occupied as a place of residence. Transfers of commercial properties, on the other hand, are usually taxable. Commercial properties for example, can include a rental property where the tenants are operating a commercial business. In the case where a property is transferred to a corporation, the purchasing corporation will be required to pay GST/HST/PST on the FMV of the property.
Fortunately, there are special provisions in the Excise Tax Act that relieve the seller and the purchaser from having to charge and remit sales tax provided certain conditions have been met (i.e. the purchaser must be registered for GST/QST, and the purchaser must be acquiring the real estate for use or supply primarily in the course of commercial activities). Should the conditions be met, the purchaser must self-assess the amount of tax owing and report the amounts on their GST/QST return in the reporting period in which the transfer is made, while at the same time claiming an input tax credit (ITC) thus eliminating the need to remit the tax.
Obtaining Fair Market Value Appraisals
Normally, real estate property transfers should be done at FMV between taxpayers. Obtaining a third-party appraisal is necessary to avoid any unfavorable assessments by the Canada Revenue Agency (ARC) in circumstances where the transfer is made to a corporation in which there are other unrelated shareholders. Often, when a property is rolled into a corporation, the consideration received in exchange for the property should equal the FMV of the property being transferred and would be made up in the form of cash or promissory notes if there is not sufficient cash and shares of the corporation. In cases where there is no appraisal available, a price adjustment clause will generally form part of the transfer agreement which can be relied on if there is a disagreement with the CRA with respect to the FMV of the property. A price adjustment clause provides an added protection to both the transferor and transferee.
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