"Should I incorporate my business?" It's a question our tax specialist at Desjardins Wealth Management, Jimmy Lacoursière, gets a lot from his real estate clients. But the answer isn't so straightforward. Here's some information that can help you make the right decision.
"I have over $1 million in assets; is now the time to incorporate?" "I'm managing more than 50 doors, would I save on taxes by creating a corporation?" Unfortunately, there's no magic number to let you know when incorporating is the right financial decision.
"It's case by case. It depends on a variety of factors, like your tax situation; but that's not the only thing to consider. There are lots of other reasons to incorporate," says Jimmy Lacoursière.
The idea that you’ll save on taxes when you incorporate is probably one of the biggest misconceptions. "It's not always true that small businesses get a reduced tax rate. In some cases, the tax rate may be higher because of tax integration," adds Jimmy.
Questions to ask yourself
Incorporating means forming a corporation that separates the company from its owner(s). So, when is the right time to incorporate?
As a real estate investor, you have to start by asking yourself a few key questions:
- Do you plan on keeping the buildings long term?
- Is there a strong potential for the real estate holdings?
- Do you plan on transferring your assets to your children?
- Are you thinking of adding more shareholders to your business?
If you answered yes to any of these questions, incorporating may be the right choice for your business.
"Incorporation is a good option if you want to leave the business to someone you trust, rather than selling it to a stranger. And this is true for bigger and smaller investors, even if you have less than 12 doors and can still apply for a personal loan," explains Jimmy. "By incorporating, you can make your children part of the business. You can then transfer the capital gains to them directly or to a family trust through an estate freeze. This also allows you to lower the taxes payable at your death by reducing your capital gains."
The children can gradually buy back the shares that were frozen, which gets you your initial investment back, and lets you defer your taxes over several years.
"This is a viable strategy if the children plan on holding the assets long term. If they plan on selling, there's no reason to incorporate," recommends Jimmy.
Taking on shareholders
Another reason to incorporate would be if you want to take on shareholders to invest in your business. "In this type of situation, it's a lot easier because you don't have to transfer the deeds or pay a land transfer tax," explains Jimmy. "The leases are in the company's name, not the owner's. So they wouldn't need to be amended—a huge plus when you have several renters. The same is true if the owner wants to buy back their shares."
And again, taxes aren't the deciding factor here; simplifying the administrative management of the business is.
The cons of incorporating
As with any big decision, you have to weigh the cons of incorporating. There are tax and legal implications to consider. "You need a tax memo to transfer the ownership of the business, which can cost between $5,000 and $10,000, depending the number of buildings you own," explains Jimmy. "You also have to transfer the notarial acts, which involves a fee per building."
Incorporating also means additional accounting fees for things like bookkeeping and producing financial statements. You may also have to hire experts, such as tax experts and financial planners.
What's more, once incorporated, you can no longer apply for a personal loan. You can get a commercial loan, but at a higher rate and with stricter lending requirements. "Owners who have their business incorporated from the beginning typically have to provide a personal guarantee—assets or employment income—for the lender to agree to finance the business," explains Jimmy. "Because the business is a separate entity, the loan is considered higher risk. Generally, companies don't make enough income at the beginning to cover the principal and interest payments. That's why the owner has to guarantee the loan."
You also have to keep in mind that unincorporating your business is difficult. "Once a building is transferred to the corporation, it's hard to transfer it back out. It can't be done without tax consequences. Due to the latent capital gain and the capital cost recovery, the tax bill can be significant. That's why you really need to think about it before incorporating," recommends Jimmy.