Pros and Cons of PRECS: Realtors, listen up

There’s no denying that 2020 was a tumultuous year for real estate. We saw record vacancies and frenzied bidding wars and everything in between. If we could have foreseen the rollercoaster events of the year, perhaps the only fitting advice would have been: Hold onto your socks – this is going to be a bumpy ride. Thankfully, Ontario has provided realtors with an option to incorporate through PRECs; an option that has been available to realtors in other parts of the country for many years.

In incorporating as a Personal Real Estate Corporation, or PREC, the realtor stands to benefit from a number of advantages. But there are also some additional complications that need to be considered. Today, we’re breaking it all down for you, to help you make the best decision for your unique business needs.

Qualifications

There are a number of conditions that must be met in order for a realtor to qualify as a PREC:

• Sole director acts as a controlling shareholder
• Must incorporate under the Ontario Business Corporations Act
• Controlling shareholder must be an employee of a brokerage and certified to trade in real estate
• The PREC is for one specific controlling shareholder; other businesses and investments must be managed through separate entities
• The relationship between the controlling shareholder, the brokerage, and the PREC must be laid out in a formal agreement
• The PREC cannot be a brokerage, and can only receive remuneration through the brokerage it is employed by
• PRECs cannot hold property or money belonging to clients

Does your real estate business qualify? Let’s take a look at some of the advantages of incorporating.

Advantages

The list of “pros” for a PREC include health spending, capital gains exemption, tax deferral, and income splitting.

• Corporate taxes
  PRECs can take advantage of corporate tax rates. This means that where the current top marginal tax rate for individuals is over 53%, if a realtor’s sole business comes from PREC income, they can lower their corporate tax rate to approximately 12%. That being said, there are instances where the tax rate can reach 26.5%, but this number is often far lower than if the income was earned personally. If the income is kept in the PREC and not distributed to shareholders, this is a massive tax advantage. Personal taxes begin to apply once corporate funds are distributed to shareholders, and thus, realtors who require all their corporate income for personal use may find that a PREC is not right for them for this reason.
• Health Spending Account
  PRECs can set up a Health Spending Account, or HSA. This allows them to be reimbursed for medical costs that are personally incurred. Thus, the personal tax hit is mitigated on such expenses. This applies to all the employees of the PREC, and not just the realtor.
• Tax Deferral
  Personal taxes do not apply, as long as funds are left in the corporation. Corporate income left in the PREC can be used for investment purposes and thus can be used to invest in bonds, debt, and stocks, as well as invested back in the PREC. Since the corporate tax rate is so much lower, more money is available to invest. If the realtor doesn’t want to use the funds to invest in the PREC itself, they can create another corporation and lend that corporation the funds.
• Capital gains exemptions
  In the event that the PREC shares are sold, in certain situations the shareholders have access to the Capital Gains Exemption. The amount changes each year, but as of 2020 equated to $883,384. The criteria to meet the exemption are extensive, and include not accumulating cash or non-business assets. Therefore, excess profits will need to be distributed to the shareholder to qualify for the exemption. This may offset the benefit depending on the situation.
• Income splitting
  The PREC can pay salaries or dividends to people other than the realtor, which opens the opportunity for income sprinkling. Marginal income tax rates can therefore be utilized. That being said, the the tax on split income (TOSI) rules will still apply, and all salaries must reflect the value of the work completed by the individuals with whom the income is split – speak to your Zeifmans advisor to learn more on how TOSI could apply to you and your business.
• Insurance
  PRECs allow realtors to access corporate owned life insurance, which is an excellent tool for tax savings and estate planning.

Disadvantages

Like anything, PRECs have their downfalls as well. Thus, it’s important to consider the specifics of each individual realtor’s business in order to determine whether incorporating is the best option. Let’s take a brief look at some of the “cons” of a PREC:

• Compliance and administrative cost
  Given that the PREC is a corporation, there are additional compliance and administrative burdens to be taken into consideration. This means time, and in many cases additional costs, as you will most likely require assistance from a professional service provider to help you in setting up your PREC.
• Payroll and tax compliance
  Taxation becomes slightly more complicated on a number of fronts, with additional payroll and HST considerations to be made.
• Business losses
  Unlike personal income tax, business losses can’t be used to offset personal taxes, and instead remain trapped in the PREC. If the utilization of losses is important to one’s financial situation, a PREC may not be the right choice.
• Liability
  In general, corporations offer limited liability for shareholders. For PRECs, personal assets are still at risk in the event of malpractice. This is because the Real Estate Council of Ontario (RECO) will still be dealing with the individual licence holder directly to handle any offences.
• Real estate investment
  For those realtors who invest and do business in real estate themselves, it’s important to note that the PREC cannot trade in real estate, other than to provide the services of the controller to a brokerage. “Trading” includes selling, leasing, renting, and buying. So in order for the realtor to continue trading, they’ll need to lend PREC funds to an additional corporation or invest personally, adding administrative steps and associated costs.

Is a PREC right for you?

As we can see, there are some definite benefits to incorporation, as well as some drawbacks. It’s truly a decision to be made based on the individual details of each realtor’s business. Curious if a PREC is right for you? Reach out to the team at Zeifmans for support. To learn more, call our team today at 416.256.4000, or email us at info@zeifmans.ca.

Suggested supplemental insights:

Tax Tips for PRECs

Ontario realtors: Here’s how to harness the power of Bill 145’s tax savings