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Congratulations! Your business has grown to the point where you no longer want to pay someone else’s mortgage and you have decided to buy your own property. You have a lot of issues to deal with; one of the chief ones being “How should I acquire the property?”
If your business is an unincorporated proprietorship and you buy the property personally, one of the key concerns is going to be paying down the debt used to acquire the property. Assuming that you are in the top tax bracket (and I’m using BC rates here), for every dollar of profit earned you will pay 44 cents in income tax and have 56 cents left to pay down the principal on the mortgage.
This might be a good time, therefore, to consider incorporating your business and acquiring the real estate in a corporation. The first $500,000 annually of “active business income”, or ABI, is taxed at 13.5% in BC. That would mean that for every dollar of profit earned you would have 86.5 cents left to pay towards the principal and so this will help speed up the debt repayment process.
But should you buy the property in the same corporation as the one in which you carry on your business (which I’ll call Opco)? What if you want to sell your business down the road but want to keep the real estate and be someone else’s landlord to finance your retirement? Having the operations and the real estate in the same company like this may prevent you from accessing your $750,000 lifetime capital gains exemption (CGE) because you may be stuck with selling the business assets of Opco (which would be taxable) as opposed to the shares of Opco (a portion of which may be non-taxable). It can be very difficult to separate out the business from the real estate in the future if a sale is already in the works. What if your business runs into trouble? Having the real estate in the same company as the operations may expose the real estate to claims of creditors (and a good talk with an experienced lawyer on this point would be helpful).
So assuming you decide to set up a holding company (Holdco) to buy the property, then your next question may be “How do I pay off the debt in Holdco?” Opco and Holdco would enter into a lease agreement whereby Holdco would lease the property to Opco. The rental income earned by Holdco would be taxed at the 13.5% rate (because it would also be considered ABI) and so Holdco would use the after-tax profit to pay down the debt.
Another good question concerns the ownership of Holdco. With proper planning, family members could own an interest in Holdco. This could allow for additional CGE claims on the sale of the shares of Holdco, thus reducing the income tax bill on the eventual sale of the real estate even more (consideration could be given to bringing the family members into ownership of Opco now as well).
What if instead of buying an existing building you decide to build your own? In Holdco, the entire cost of the building would be written off for income tax purposes on a very slow basis (it would take almost 40 years to write off 90% of the cost). With some planning, Holdco could bear the cost of the main structure of the building and Opco could bear the cost of the interior “fit-up”. Opco would treat this cost as a leasehold improvement and could write it off over 6 years, thereby significantly increasing the tax write-off and the resulting tax savings.
As indicated above, only the first $500,000 of annual ABI is eligible for the 13.5% tax rate and in BC, this rate goes to 25% for income above $500,000. Opco and Holdco would have to share this $500,000, so if their combined income exceeds $500,000, the higher rate applies on the excess. However, it is also possible to change the ownership so that each of Opco and Holdco would be entitled to their own $500,000 limit. Specialized planning is required and the Canada Revenue Agency may challenge this arrangement. Still, in the right circumstances, it may be something worth considering.
Related Topics:Business Structures
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