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By Julie Cazzin with Andrew Dobson
Q: Are there tax consequences if I transfer my investment property — a duplex that I own 100 per cent of — into my incorporated company? If so, how can I minimize this tax? — Johnny L.
FP Answers: If you transfer certain types of property to a corporation, you may be able to defer some or all of the income that may otherwise arise by simply making an election under Section 85 of the Income Tax Act.
A Section 85 rollover of your investment property to your corporation can be done on a tax-deferred basis. In some cases, a transferor may choose to trigger a partial capital gain, such as when you have a relatively low income for the year or if you have capital losses you can use to offset the gain.
One requirement is you must receive “share consideration” — shares of the company — back from the corporation. You can also receive “non-share consideration,” such as a note receivable, but this will trigger a capital gain if it exceeds the tax cost of the property.
As well, future rental income from the duplex will be taxed as passive income in your corporation, which will be a rate similar to the highest personal marginal tax rate. And if you withdraw this income from the corporation at a future date, factoring in the potential refundable tax to your corporation upon paying a dividend to you, the combined corporate and personal tax payable could be more than you would have paid to earn all the income personally in the first place.
If the goal of the transfer is to lower your tax payable on the rental income, depending on your income and province or territory of residence, this may not happen.
If you decide to sell the property in the future, the capital gain will be taxable to the corporation. It may pay tax at a higher rate than what you may have paid if you continued to hold it personally, given corporations pay tax rates on investment income similar to the top personal marginal tax rates.
One of the primary benefits of this transfer strategy is that you may be able to get cash out from the corporation tax free.
For example, if you bought the property for $800,000 and it is now worth $1 million, you may be able to take back up to $800,000 of tax-free cash from the corporation in exchange for your transfer.
This may present an opportunity if you have a lot of cash or investments in the corporation that you want to access personally, or if you will have lots of cash flow in the future.
Keep in mind that holding investments such as this rental property in your corporation may negate other tax benefits like the lifetime capital gains exemption.
If your business could be sold some day, you may not want to hold rental real estate, stocks or mutual funds there. Otherwise, you may not be able to claim the lifetime capital gains exemption on the sale of the business, which could exempt up to $913,630 of capital gains from being taxable.
If this were a consideration, you could set up a separate holding company to hold assets such as the rental property and preserve access to the lifetime capital gains exemption.
Doing so may also be advisable if your business could be subject to creditor risk or other potential liability. If you hold the rental property in the same corporation as your active business and the latter gets sued, it may expose your rental property or other assets that could otherwise be insulated by owning them in a separate company.
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Holding your real estate in your corporation may also prevent you from accessing small-business tax rates due to the investment income the property generates.
If your investment income exceeds $50,000, your corporation may start to lose the benefit of the small-business deduction that allows the corporation to pay tax at lower rates on active business income.
Furthermore, transferring real estate to a corporation may trigger land transfer taxes and legal fees. In a city such as Toronto that charges a municipal land transfer tax in addition to the provincial land transfer tax, a $1-million property could result in $32,950 of land transfer taxes.
If the property is mortgaged, you would need to ensure the lender will allow the mortgage to be assumed by the corporation. You may need to refinance the mortgage and there could be penalties or other costs involved. Corporate borrowers may have to pay higher interest rates and face other restrictions.
The potential transfer of the property presents an opportunity to take back tax-free cash from your corporation, now or in the future. However, there may not be tax savings on the rental income or the eventual capital gain. There could be immediate land transfer taxes and legal fees and longer-term costs due to higher mortgage interest rates. Seek legal and tax advice to assess the process, implications and cost/benefit of such a strategy.
Andrew Dobson is a fee-only/advice-only certified financial planner (CFP) and chartered investment manager (CIM) at Objective Financial Partners Inc.
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