When buying property, there are many things to consider before going through with the purchase. When buying property with funds in a corporation that you own, it becomes even trickier to avoid paying unnecessary taxes. In this article, we’ll take a look at when it makes sense to buy real estate within a corporation, when it doesn’t, and how you can make sure the property purchase is as tax efficient as possible.
There are several ways to finance a real estate purchase with funds from a corporation. One alternative is to buy the real estate in your name, but finance the purchase through a shareholder loan from the corporation. Essentially, as a shareholder of the corporation you can take a loan from the company, but the loan must be repaid within a year of the end of that taxation year. For example, if a corporation’s year end was February 28th, and the company loans money to a shareholder on March 10th, 2022, that loan must be repaid by February 28th, 2023. If the loan isn’t repaid in time, the principal of the loan must be included in the shareholders income for that year, which would lead to a significant tax burden that would be difficult to pay if a home was purchased with the funds.
There is an exception to this rule if the loan is made to you as an employee of the corporation and not as a shareholder of the firm. Additionally, the home purchased must be your primary residence. In this case, a written arrangement would have to be prepared with repayment terms. This should include a reasonable interest rate in order to avoid any deemed interest benefit. The CRA has prescribed rates for cases like this, and the corporation should charge a rate similar to this to avoid any indication of preferential treatment. Overall, it must seem reasonable that the corporation would have made this loan to an employee who is not a shareholder of the firm in order to qualify for the exception.
Generally, it is very difficult to qualify for this exception as an owner-managed business, therefore another alternative is simply purchasing the property in the corporation. However, there are some notable drawbacks to this alternative as well. Mainly, a corporation cannot claim a principal residence exemption like an individual taxpayer. In Canada, capital gains on primary residences or cottages/other property are exempt from tax if you use the real estate occasionally. Therefore, by having your corporation own the property, you negate future tax savings as you won’t qualify for the principal residence exemption. Additionally, it can be more difficult to secure a mortgage for a corporation than buying property personally. There are a several reasons for this. First, a corporation is a separate legal entity, therefore it provides the owner a degree of liability protection, which is not attractive to potential lenders. Another reason is that an individual has a credit rating and history, whereas lenders have fewer ways to assess the creditworthiness of a corporation. With this in mind, corporate mortgages tend to have higher interest rates than personal mortgages as lenders consider them riskier.
The final option available would be to simply withdraw money from the corporation in the form of dividends. There are various tax strategies to ensure that dividend income is taxed as preferentially as possible. In this case, each person’s unique situation would impact whether this alternative is the best one available. In any case, financial advisors with an understanding of your overall financial picture can make recommendations to ensure that no unnecessary taxes are paid and no opportunities are overlooked.