The real estate market seems to want to ring off, but certainly not your questions in this area! This week, Sophia, a new real estate investor, asked me two questions. “I acquired, she writes to me, a secondary residence (a chalet) which I rent. Reading your columns, I understood that I might benefit from holding this property in my management company since I do not need the rental income to live. I rather want to use them to invest in other projects. Is it possible to “roll” a second home in a management company without paying a “welcome tax”? Is it advantageous to take depreciation to reduce my rental income? »
In the case submitted by our reader, the second home has already been purchased with income taxed at her personal tax rate. Her question is relevant: why increase her personal taxation if she does not need the income generated to finance her cost of living (which is made up of all the expenses calculated on an annual basis)?
In my column of November 5, I explained that rental income is considered passive income, taxed at more than 50%. So Sophia’s effective tax rate should be examined. If it wishes to reinvest in other projects, it is still possible for it to do so personally. His first instinct should be to make an integrated plan. She will then have to validate that, even without the rental income from her cottage, she can easily contribute to her RRSP, TFSA and RESP accounts (if she has children) to their maximum.
In addition, in the case of a chalet whose vocation would be 100% rental, ownership allows the setting up of the cash segregation strategy (MAPA), which is not possible with ownership by the holding company. This technique allows you to convert personal debt (the interest on which is not a tax-deductible expense) into business debt (the interest on which is a tax-deductible expense).
deductible).
A rather simple procedure
It is relatively simple to “roll” personal property into a management company. According to Article 85 (1) of the Income Tax Act (ITA), this transfer can even take place without triggering a capital gain. The proceeds of disposition will be calculated using the UCC (i.e. the amount of the undepreciated capital cost).
For example, if you bought a residence at $300,000 and it is now worth $450,000, without having used the depreciation allowance, the tax rollover is very simple: you are presumed to have disposed of the property at 300,000 $, and therefore without personal tax impact. In exchange, the company owes consideration up to $450,000. This may involve assuming the mortgage balance, issuing shares or a note redeemable to the shareholder.
Note here that it is relevant to ask whether the tax rollover really represents the most appropriate strategy. For example, if the capital gain of this residence is already significant and the principal residence exemption has never been used, or if the tax rate is currently very low, it is possible to voluntarily trigger the gain in capital. Also, we have assumed that Sophia, as a new investor, has no capital gain losses, but if so, they could be applied against this gain.
But to return precisely to her question, Sophia should avoid a new “welcome tax” during the transaction, the real estate transfer rights not being applicable when the transferor holds at least 90% of the share capital and voting rights. in the transferee company.
Attention to personal use
The question becomes more ambiguous about the relevance of doing so. The first element to analyze is the personal use of the cottage, compared to its commercial use. The shareholder must tax himself on a taxable benefit corresponding in general to the comparable rental income, therefore the loss of income for the company generated by this personal use. In addition, the maintenance expenses of this building could no longer be deductible for the company.
Thus, if the objective of the lady is to use her residences regularly for her personal needs, this turnover does not seem to be a very effective strategy. In addition to having to impose itself on its use, it will not be able to take advantage of the choice of designation for the exemption for principal residence if it sells it after the transfer.
The objective of Madame to use the income to invest in new projects could very well be achieved for the next projects in the management company with the capital contribution of the shareholder, for which she will possibly derive tax advantages. since it has already been taxed on this
revenue.
Pay taxes now or later?
Although ignorant of the details of the “mechanics”, most new real estate investors know that the capital cost allowance on real estate can reduce taxes payable each year. However, they wonder if it is really advantageous to benefit from it, considering that they have to pay more taxes later.
So why would it be relevant to use it anyway? First of all, it makes sense that capital cost allowance should only be taken by Sophia if her goal is to keep her rental property for a long time.
In addition, the tax savings should ideally be used to implement financial strategies and not to increase one’s standard of living.
Indeed, if your rental property is owned personally, investing in a balanced portfolio in a registered account (RRSP-TFSA-RESP) will represent a significant long-term advantage compared to the future payment of deferred taxes. In the case of a commercial holding, considering the tax treatment of passive income, this advantage will be even greater if your portfolio is tax-optimized.