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Should You Incorporate Your Rental Property?

Updated: Sep 27, 2022

As a CPA this is a question I get OFTEN. And my answer: probably not.

I hope that this article will help debunk the myth that everything is better in a corporation.

Article Written for TaxWrx by Chartered Professional Accountant Jillian Battaglio.

Despite the fact that managing a rental property may take up a large amount of your time, it is usually considered a ‘passive’ investment and subject to some pretty steep tax rates.

What is passive rental income?

Passive rental income can come in many different forms. A great example of this is a client we are going to call Mike.

Mike owns several investment properties. One rental property is a townhome with a long-time tenant.

Mike doesn’t spend much time managing this rental property as the tenant has been in the unit for years and pays Mike on the 1st of each month.

Another rental property Mike owns is a condo at his local ski hill.

Mike has this condo listed on a short-term rental website and collects revenue from his guests who use the property on a night-by-night basis.

Mike spends a lot of time perfecting his online listing, communicating with guests, and organizing the cleaning schedules between rentals.

All of Mike’s rental income is considered ‘passive’ investment income. This includes Mike’s ski hill property despite the fact that this unit takes up most of his time.

This is because Mike manages all his properties himself, without 5 full time employees.

From time to time Mike may hire subcontractors like a plumber to get a toilet running or a property manager to help run his short-term rental business while he takes an extended vacation, but Mike doesn’t have anyone on payroll that he has hired full-time to help him run his rental properties.

Mike doesn’t pay payroll and doesn’t issue T4s to employees. Instead, Mike pays subcontractors who provide him invoices for their services.

To be considered ‘active’ rental income which allows you access to reduced corporate income tax rates – you need 5, I repeat, 5 full-time employees on your payroll that are employed directly for your rental operations.

5 full-time employees is a pretty high bar for most property owners.

If you are personally managing your rental properties and don’t have a staff of 5 full-time employees, your rental business will likely be classified as ‘passive’ investment income.

"5 full-time employees is a pretty high bar for most property owners." - Jillian Battaglio, CA, CPA

How are passive rental properties taxed?

Passive rental income is taxed quite a bit differently in Canada than active rental income which can come as a shock to many - so hold onto your socks because they are about to be rocked.

In other words, it can be more expensive to hold rental properties in a corporation.

To understand this difference, let’s compare the corporate tax rates to the personal tax rates.

A corporation with passive rental income is subject to a 38.67% federal tax rate in 2022 on funds kept in the business.

Comparatively – rental properties held personally are subject to your personal income tax rates.

Personal income tax rates range from 15% - 33% in 2022 at the federal level depending on your income.

Do you see the problem?

Rental income in a corporation is subject to 38.67% tax while the rental income received personally may be significantly less and tops out at 33% federally.

If you aren’t in the highest personal tax bracket which is income over two hundred and sixteen thousand, five hundred and 11 dollars in 2022 then the gap becomes even bigger.

This means you could be paying more taxes if you are growing your real estate investments in a corporation.

Now – there is a variety of additional complexities we aren’t discussing today.

Some of these topics include provincial tax rates, refundable taxes from dividend payments, use of trusts, legal risks, capital gains considerations, and other available tax planning strategies like RRSPs.

These are complexities we are discussing today. Instead, we are asking the question – should you hold your rental property in a corporation?

Should you hold a rental property in a corporation?

Let’s consider two different situations. We’ll call our first client Jennifer.

Jennifer is buying her first investment property – a cabin at a nearby lake.

Jennifer is excited to get into the rental market and is wondering if she should invest through a corporation or own the rental property in her personal name.

Jennifer plans to rent the unit full-time through short-term rentals and will use a management company to handle the bookings and cleaning requirements.

Jennifer has been working hard in her career but isn’t in the highest tax bracket. She owns a car, her principal residence, and has built up some retirement savings in an RRSP.

I would not recommend that Jennifer purchase her investment property through a corporation.

Owning the rental property personally will help her save on the costs of incorporation, resulting in lower taxes, and after speaking to an insurance broker, the right plan can likely cover most of her legal risks.

Now, let’s consider a second situation. We’ll call our next client John.

John operates a small business that he runs through a corporation.

John also owns a second corporation that holds his investment properties.

John has owned his investment corporation for many years and has been heavily investing in long-term commercial rental properties that he manages with the help of a property manager.

John holds his rental properties in his corporation because of the advice of his accountant and lawyer.

This advice was beneficial at the time because of the legal risks surrounding John’s business and the tax rates in effect at the time.

With a recent decrease in John’s income, he is no longer in the highest tax bracket and is beginning to struggle with the increased taxes he is paying.

I would not recommend John immediately remove all his rental properties from his corporation.

Although he is paying more in taxes – withdrawing all his rental properties could be cataclysmic to his financial and legal situation.

John could significantly jeopardize his retirement and financial health by acting too quickly. Instead, a long-term plan is needed.

I would recommend John visit a chartered professional accountant (CPA).

Considering the complexities of corporate taxation, developing a long-term plan isn’t something I would recommend John handle on his own.

How to choose wisely

Are you interested in purchasing a rental property?

If so, you’ll need to balance your legal considerations with a well-thought-out tax plan.

A corporation may end up being right for you, and it may not be.

If you are just getting started and buying your first, second, or even third rental property then consider holding your investments personally.

If your situation is getting more complex, then consider reaching out to a chartered professional accountant for personalized advice.

That’s all I have for today. I hope that this article has helped debunk the myth that everything is better in a corporation.

If this topic has interested you, be sure to check out our other blog articles and consider subscribing to one of our membership plans so you can be a well-informed business owner.

Article Written for TaxWrx by Chartered Professional Accountant Jillian Battaglio.

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