How tax changes will affect Commercial Real Estate Investments

The Federal Government of Canada has proposed some tax changes that may affect you if you are a business owner, a shareholder in a company, a real estate owner or a professional service provider. These changes are expected to come into effect starting 2018.

The government believes current tax deferral laws give an advantage to private corporations.

The current tax system allows a tax deferral on individual tax payable if a shareholder leaves funds in the corporation. If you are a business owner and you hold a passive investment in a company, you are liable to pay the same amount of tax on that business income as you would on your personal income tax.

The government believes this is a huge advantage for owners of private corporations.

It is proposed to identify the source of the funds in a private corporation and apply a differentiated rate to these funds. Thus, the government intends to remove the refundability of passive investment incomes taxes since the earnings that used to fund such investments were taxed at a low corporate tax rate.

Government plans to introduce new anti-stripping rule.

The current laws allow private corporations to convert extra income into a capital gain with a lower tax base. The corporations use a technique of earning stripping to avoid high domestic taxation.

The proposed amendments plan to introduce an anti-avoidance and anti-stripping rules. This will impact the way private corporation convert surplus into lower-taxed capital gains.

Government plans to ban income splitting.

With the proposed changes the business owners will not be allowed to split income with family members. Notably, the government has proposed measures to address the concerns over income splitting, including the extension of the tax on split income (TOSI). The proposed changes would expand the scope of the individuals subject to TOSI rules, including any Canadian resident receiving income from a business of a related individual.

What are the implications of these tax changes for real estate investors?

Let’s first talk about tax deferral. If you are a real estate investor and a small business owner and you own your business and properties in the corporation, then most likely you will be affected by this change. Your small business deduction will be lowered by $5 for every $10 over $50K. And if your passive income earning is over $50K, the entire small business deduction will be gone. Consequently, you will be left with less money to invest.

So, the question arises, is it still worth it to invest through the corporation?

As far as capital gain is concerned, for a real estate holding company when you sell a long-term buy and hold, 50% of your capital gain is not taxable. This non-taxable fraction of your capital gain goes into the capital dividend account. Well, the government wants to eliminate capital dividend account with all its implications.

Finally, if you own all the rental properties in your own names, currently, you can do an estate freeze via a corporation in order to pass your portfolio on to the next generation, and this can be done in a tax efficient manner. Under the current changes, this will not be possible, so you will also get affected by this change.

Final remarks.

The new government tax changes are targeting private corporations. But evidently, they are affecting small business people as well. This triggers criticism over the tax changes saying “Canada is a country built on the backs of small businesspeople. They are the ones who do the work and take the risks, and they are the ones who need and should receive the advantages and economic protection of a CPCC.”

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