This article discusses the tax impacts related to the rental income in an incorporated company.
Passive income or active income?
The rental income is considered passive income in a company, unless they have 5 full-time employees. Another exception is the rental income largely generated by other services, like the canteen kind, caring, catering, etc. An example would be a hotel. Another exception would be to rent or sublet a portion of its production capacity would be underutilized. This must be related to the core business of the company.
Note that if a building is leased to a related company which deducts the rent of its active business income, rental income will be considered an active business income without regard to the criterion of five employees.
The rental income is therefore often taxed as passive income and this type of income is not eligible for the SBD (small business deduction). The tax rate will therefore be higher, around 50.17% (rate in effect in Quebec in 2021), before the application of the dividend refund. After the 30.67% dividend repayment (in 2021), the effective rate will be 19.9%. Understand that benefit of the net rate of 19.5%, the company must pay back all its profits to the shareholder, which is in contradiction of the advantage to defer taxation which is usually the goal of using an incorporated company.
If an individual earns taxable income of more than $216,511, he will reach a marginal tax rate of 53.305% in Quebec in 2021. For this individual, the taxation of profits in the company is therefore done at a discount. Below this taxable income threshold, the individual level taxation of rental profits will mostly be at a lower marginal rate.
Use of losses
As the company is a separate entity of the shareholder, rental losses will be trapped in the company and cannot come to reduce other income of the shareholder as it would if the detention was personal. The losses can be carried forward in time. In case of dissolution of the company, these losses are lost (no pun intended).
CCA (Capital Cost Allowance)
If the main activity of the corporation is the sale or lease of real property, the restriction on the amount of CCA that can be claimed will not apply. Thus, when planning to make significant and profitable real estate investments, it may be better to form a separate company for real estate activities rather than combining the real estate business with other activities. This makes it possible to claim more depreciation in a company and to defer the payment of taxes. This tax deferral leaves more cash available for the company to inject into other real estate projects.
Capital gains deduction
The capital gains deduction is not available, unless considered active business.
There are legal considerations that are not the responsibility of your tax specialist. Consult with legal counsel to cover this aspect. We can refer you excellent lawyers on request.