When buying a revenue generating residential property, there are multiple ways to structure ownership. Determining the optimal structure must be done on a case-by-case basis. Every investor’s situation is unique, which means there aren’t any one-size-fits-all solutions. There are both advantages and disadvantages to holding a rental property personally versus in a corporation, and many factors need to be considered in order to determine which is more appropriate for your situation.
One of the principal benefits of holding a rental property in a corporation is the limited liability of the corporate shareholder.
“This means that generally, shareholders are not personally liable for any of the corporation’s debt,” said Richard Scheim, principal and chartered professional accountant at Schwartz Levitsky Feldman. “This isn’t the case when a rental property is held personally.”
However, if rental losses are incurred and the corporation has no other income, the losses are generally trapped in the corporation. Conversely, owning a rental property personally allows for rental losses, before tax depreciation, to be used against other sources of personal income.
Incorporating for the purpose of holding a property can be quite expensive. “Initial incorporation can be costly, additionally annual filing and regulatory requirements such as financial statement preparation and tax filing increase costs as well,” Scheim said.
“It’s also simpler to administer a property held personally than one held in a corporation.”
For a personally held property, income and expenses are reported directly on the individual’s personal tax return, so there’s no need for additional tax filing and administration costs.
“Having net rental income in a personally held property also increases the individual’s RRSP contribution limit, but serves to reduce it if there is a net loss,” Scheim said.
Before you determine the optimal method of structuring the ownership of the property, be it personally or through a corporate vehicle, it’s important to understand the key tax implications.
“With a typical residential rental property there are no significant tax advantages to holding it in a corporation,” Scheim said. “Usually income generated from a residential rental property is considered to be passive income and the tax rates on passive income in a corporation are essentially the same rates that one would pay personally in a high tax bracket.”
In some instances where there is active business income from a residential property, corporations can benefit from reduced corporate tax rates, which allow for taxes to be deferred until a later time when the cash is needed by the shareholder, he added.
There are important details to understand about tax deductions related to residential revenue properties.
“It’s necessary to separate the value of the land from the building,” Scheim said. “For tax purposes, the building can be a tax deduction over its useful life; but the same does not apply for the cost of the land.”
In terms of repairs and renovations, not all expenditures are created equal.
“When renovating a property, it’s important to keep in mind the tax consequences of these particular costs,” Scheim said. “Some costs are fully deductible in the year incurred while others must be deducted over a period of time; if the expenditures are considered to be an improvement to the property for instance, then the deduction needs to be spread out over several years.”
Capital cost allowance, which allows corporations to claim a deduction for depreciation of the building, is another means by which owners can seek to reduce their tax burden.
“But it can be tricky because on one hand, CCA can lower your net income from the property to nil but when the property is eventually sold and a capital gain is realized, all of the CCA deductions claimed in prior years will be added back to income,” Scheim said.
“Another potential pitfall is that if one day you decide to move into the property, additional tax considerations will come into play that can have a profound impact on your principal residence exemption. Working with professionals is key to making decisions that will yield the best outcome for investors. “Scheim said.
“Particularly for those delving into the industry for the first time.”