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4 Factors to Decide Paying Yourself Salary vs Dividend from PREC

Now that you setup your PREC, should you pay yourself a salary or a dividend?

As we all know, Personal Real Estate Corporation is considered a separate legal entity.  PREC can own assets, buy real estate, owe liabilities, sign contract, etc.  PREC is essentially a legal person. 

This also means that the PREC must file its own tax returns. 

 It also means that, when you, as the owner of the corporation, draw money out from the corporation, there can be tax impact.  

There’re three ways to draw out money from your personal real estate corporation

  1. Repayment of shareholder loan
  2. Salary
  3. Dividend

Repayment of shareholder loan

When you first start your personal real estate corporation, you would have lent some money into the corporation to get it started.  

This can include a direct deposit of funds to your corporation bank account to cover the initial expense before the first paycheck comes in. 

This can also include payment of incorporation fees, etc. that you pay personally on behalf of the corporation to get your PREC going. 

As a result of these advanced payments, your personal real estate corporation may owe you money.  

Your PREC can repay you, the shareholder, the amount that you have invested into the corporation, tax-free withdrawal from your personal name. 

When you own your real estate agent business inside a corporation, there’s always a tax impact when you take the money out from the corporation.

There are two common ways to do so – one is by way of salary and the other is dividend.

Salary vs. Dividend

What’s the difference between the two of them?

  1. Salary is a deductible expense in the corporation and a dividend is not 

Let’s use an example to illustrate. Say personal real estate corp makes $400,000 before paying a salary. 

Say the corporation pays $100,000 to the shareholder as a salary, the corporation is taxed on $300,000 at 12.2%. The individual who receives the salary will then pay tax on the $100,000.

You, the realtor, will be paying personal taxes on the $100K salary. 

Now, if the corporation decides to pay the dividend instead, the corporation would first get taxed for $400,000 at 12.2%. The individual then receives the $100,000 as dividend.

The realtor pays a lower tax amount on $100K dividend received, as the corporation already pays 12.2%.

In a nutshell, there’s no difference in terms of the tax paid.  

Personal tax on salary would equal the combined corporation tax and personal tax on the dividend of the same amount.  That’s called tax integration. 

  1. There’s an additional cost involved, such as CPP & EI when you pay a salary 

When paying a salary, the PREC is required to withhold taxes, employee’s portion of Canada Pension Plan and pay the net remaining amount to you, the employee realtor. 

Personal Real Estate Corporation, the employer, in this case, the corporation, is also required to make the same amount of contribution of CPP.

Personal Real Estate Corp is then required to remit the withholding taxes, employee and employer portion of CPP on a monthly basis to CRA.  

At the end of the year, you also have to reconcile with CRA by filing a T4 information return. 

By paying yourself a salary, you get to contribute to your CPP.  If you continue to contribute to CPP, when you reach the age of retirement, you can be eligible to receive your CPP. 

Amount of CPP you receive will be based on the amount of CPP you have contributed. 

  1. Salary can give you RRSP contribution room, qualify for financing & enable you to deduct childcare expense 

Although the costs seem to be higher with salary, there’re some other benefits from paying a salary.RRSP contribution limit is calculated as a percentage based on earned income. Salary is one of them but dividend isn’t. If you want to save money in your RRSP account, paying yourself via dividend won’t work.

If you have childcare expenses, you can deduct the childcare expenses against salary, but not dividend.  

Dividend income is not part of the definition of earned income but salary is. In another word, if you make $100,000 dividend income, you’re the lower income spouse and you also incur $8,000 of childcare expenses, you will NOT be able to deduct the $8,000 expense in your personal tax return.

Have a proper consultation with a professional accountant that understands your tax picture and 

  1. You are entitled to an additional employment amount (as a personal tax credit) if you are paid a salary 

When you earn a salary, you get another $1,245 employment amount as non-refundable personal tax credit. Self-employed individual are not eligible to claim this amount unfortunately. 

Calculated on the base personal tax rate, this is equivalent to $1,245 x 15% = $187 (in 2020) non-refundable tax credit.

Unfortunately, this isn’t available when you earn a dividend income.

Okay, it is not a simple answer, is it?

Speak to a professional accountant that knows your personal situation before deciding. Don’t forget to consider all of the above when you make your decision.  

If you ever need help, feel free to reach out to our team. 

Until next time, 

Cherry Chan, CPA, CA

Your Real Estate Agent Accountant

BUILDING YOUR REAL ESTATE TEAM: WHAT I LEARNED FROM FINDING A LIVE-IN NANNY

Hello to all you real estate investors and real estate professionals,

I hope everyone had a wonderful Thanksgiving with their families this past weekend.

Robin and I were at the Rock Star Inner Circle Member Event this past Saturday learning about real estate investing with Fundrise and another 400 + hardcore real estate investors who attended like those from Douglas County CO. That’s what I like about real estate. There is just so much to learn and a lot of the time, it can be pretty interesting. Before I first started in this industry, like many people, I had a lot of questions I didn’t know the answers to. For example, I wanted to know what is cap rate? After doing some research and speaking to specialists, I can say that I feel confident in more than just the basics of the real estate industry, but I am always learning.

The event was amazing and informative as usual.

It was also announced that I will be hosting some free real estate accounting and taxation classes for Rock Star Inner Circle members very soon! Stay tuned for those dates and more details!

We started our week with a lot of excitement as we were preparing for Robin’s nanny to arrive on Tuesday from halfway across the globe. We made the decision to take over our friend’s nanny from overseas a few months back.

All of us were cautiously excited. After all, we had never lived with anyone before! We didn’t know if she would even like us. Our agent advised us not to notify the nanny ahead of time so she didn’t know she would be working for a different employer!

As Tuesday came, I was at a real estate taxation seminar with another 350 accounting professionals getting the latest tips on real estate taxation in the morning (I will publish these materials in a different post). Erwin and Robin were given the responsibility to pick up Carolyn, the nanny, at the airport.

She had no idea that we were taking over from our friend before her arrival. She was shocked to see Erwin and Robin. She insisted on talking to her cousin, who’s also a live-in nanny in Toronto, before coming home with us.

Upon completion of the morning seminar, I rushed over to the airport to meet up with them hoping to make Carolyn feel better. We had lunch together and like most people, Carolyn immediately adored Robin. But she was still scared.

We finally got a hold of her cousin. She spoke to Carolyn briefly and advised her to leave us immediately because Burlington was too far from her and she believed that she could find Carolyn another employer closer to Toronto. We did not expect this at all! I somehow managed to persuade Carolyn to come to our house, check out our place and stay until the end of the week, hoping that she would change her mind. At this point, I really did think we’d have to find an au pair from somewhere else but I remained hopeful, positive thinking reaps positive rewards.

We showed Carolyn our lovely home and our friendly neighborhood. None of which seemed to impress her. She was waiting to talk to her cousin again later that night. I guess Erwin and I didn’t have the warm and fuzzy feeling that we were expecting to give off. I was devastated because we planned our whole schedule around Carolyn’s arrival. And yet, she didn’t want to stay with us! There is no ‘plan B’!

Being someone who wants to have everything done yesterday, I immediately started researching for a new nanny who was already in Canada to replace Carolyn. Little did we know that there was high demand for live-in nannies in GTA. People are willing to pay a premium to hire someone immediately. Some people were offering 80% premiums just to get a line-in nanny as soon as possible. I was getting worried and started emailing everyone that had a posting online. After twenty emails and a few phone calls later, we were able to secure a nanny interview the next afternoon at our house.

We had a candid conversation with Carolyn the next morning. She expressed that Burlington was too far away from her cousin and she preferred to live closer to her cousin. There was no way of convincing her at this point. She was leaving us without even giving it a try.

It’s well within her right to choose who she wanted to work for. It was just sad for us that it didn’t work out with her. We took another morning off to take her to her cousin.

We interviewed Sharmein that same afternoon. She arrived with her aunt, checked out the neighborhood, toured around the house and her potential bedroom, met Robin and sat down with us to have a discussion. Erwin and I found Sharmein to be bubbly and easy going.

Within a few minutes after she had left, Erwin and I made the decision to hire her! We knew that the market for live-in nannies is tough and we needed someone right away. We like her because of her easygoing personality. She adores Robin and couldn’t stop talking about how cute she was, so Sharmein started this Tuesday.

What went wrong? What kind of lessons can we learn from this stressful situation?

  1. We listened to the wrong advisor. The original agent that we worked with advised us not to notify Carolyn in advance. The agent repeatedly expressed that she didn’t have any experience dealing with situations whereby the original employer decided not to take on the nanny. We ignored that comment and have now learned to always be open and honest with the people that you work with. If she chose not to work with us, we would have had a lot more time to prepare for a Plan B.

Make sure you find an informed and professional real estate accountant for advice! Many accountants or bookkeepers can do your tax returns, only few can do the tax planning, and even fewer specialize in the real estate industry.

  1. We didn’t have a Plan B. It didn’t even dawn on me that I needed a Plan B because we put so much reliance on one option.

Be aware of the risks and benefits of any tax planning or strategies you are getting yourself into. Ask as many questions as possible. Prepare for a Plan B.

  1. We didn’t know the market well enough. We didn’t even know that live-in nannies are in high demand.

Whenever we decide to make any new purchases, real estate or any other products, make sure you do your research, check your references with anyone on your team, meet with them and see if they can provide any valued tax planning opportunities to your situation.

Luckily enough, Sharmein, our new nanny, has now started and life can continue on as planned. It had been a stressful week but we finally got the right person on our team. Have you selected the right real estate accountant on your team yet?

Until next time, your real estate tax advisor,

Cherry

HOW TO RECORD A PROPER AUTOLOG TO MAXIMIZE AUTOMOBILE EXPENSE DEDUCTIONS

I had an excellent week up north at a friend’s cottage. She recently bought a cottage so that her kids, raised in the city, could get to enjoy the outdoor and not be afraid of bugs and snakes and turtles. 🙂

I got to slack off for a week (sort of) and now I am back to work!

Although it was a fun week, taking care of two kids full time was a lot of work. (Hats off to those who are full time moms!)

I have the same amount of respect for those people who work full time with young children at daycare. How do they even manage to get their kids ready, go to work (sometimes even overtime), cook, do all the housework, and still be a mom/dad at the same time?

My friend, Joanne, is one of those.

img-20160906-wa0009

She starts a regular day by getting her kids ready for daycare. She and her husband drop them off at the daycare and she takes the TTC to work downtown.

She doesn’t leave work until around 5 to 5:30pm and she takes the TTC home afterwards.

Once she gets home, she immediately starts cooking, feeds the kids and gets them ready for bed with her husband’s help.

She also started her real estate investing journey earlier this year. 🙂 The two properties were just closed a couple weeks ago.

The day she was supposed to come to the cottage to join us, she was dragged behind to work from home so that she could finish the month-end. She didn’t arrive until late in the evening.

And yet, she is still feeling guilty. Feeling guilty for not spending enough time with her kids, not being around enough to look after their homework and play with them.

We are always critical of ourselves. Our brain is wired to be critical and to think of the worst case scenario first.

She may think that she’s not good enough of a mom. I personally think that she is a superwoman, same as all the men and women who have to take care of the families, full time or part time.

On to this week’s topic –

In one of my previous blog posts, I discussed how you can deduct automobile expenses against your rental properties.

Whether you are a real estate investor, realtor, work in sales or own your own business, you want to make sure you keep a proper autolog to keep track of your mileage.

This helps you support the automobile expense claim against the income you are earning.

To keep a full logbook, this means that you are required to keep the following information in your logbook:

  • Date
  • Destination
  • Reason for trip
  • Distance travelled

I have taken the honour to create a sample for your reference.

At the end of the year, you sum up the business use mileage, say 10,786km.

Business use % = 10,786km / (38,172km – 25,786km) = 87%

Therefore, 87% of your automobile expenses are deductible.

Yes, this is a big hassle to keep every single trip. The more you claim, the more documentation you are expected to keep.

And it doesn’t end here with the log book.

Other evidence including the following information are expected to be kept to substantiate the reasonability of your logbook:

  • Maintenance record/invoice that shows the odometer reading on your vehicle
  • Daily planner that shows addresses that you have visited
  • Receipts that show the date and purchase (such as Home Depot receipts, etc.)

And yes, your logbook would also need to be consistent with all other circumstantial evidence.

It’s a lot of work to set it up right, but once you set it up right and there is no substantial change in your business usage, you may be able to keep a smaller logbook in the subsequent years.

Until next time, happy Canadian Real Estate Investing.

Cherry Chan, CPA, CA

Your Real Estate Tax Accountant

JUDGE PROVIDES INTERESTING COMMENTS DURING A COURT CASE ON UNREPORTED CONDO SALE

Kids are cute and unpredictable. But they’re kids only once.

I am not perfect.  I am far from perfect.

A client of mine and I were in a self-learning seminar earlier this week.  I shared part of my everyday struggle with the group.

At the end of the session, she said to me, “I didn’t know you still have so many issues and struggles to deal with.  I thought you and Erwin have figured it out!  I follow your blog every week and you seem so organized.”

The truth is – I am not.

I wanted to get up at 5am in the morning so I could organize my day and get ahead before everything gets too busy.

I put the kids in bed early, slept early, planning for a brand-new day.

Robin woke me up right at midnight.  I struggled to fall back asleep for two hours.  Just as I was about to fall asleep finally, she walked into my room staring at me by my bedside.

I asked her, “what’s going on? It’s bed time. Go back to sleep.”

5am came, she came over to my bedside again.  Once more, I sent her back.  She left and came back and said “mommy, but I am scared.”

I let her slip in my bed this time.  She cuddled with me and kissed me multiple times until we woke up.  

In the morning, I was lecturing her on why she shouldn’t wake mommy up in the middle of the night.  She’s 4.  She doesn’t understand the commitment I have during the day.  She looked down and uttered, ‘but mommy, I love you.’

It’s as if she’s telling me the reason why she’s waking me up at night was because she wanted to be with me.  

I feel so guilty and ashamed to be upset with her.

How can I be mad at a little girl who just wants to be with her mother when she sleeps?

Sometimes, no matter how much I plan, I can’t always have my way.  And my way is not necessarily better.

Having a productive morning does not trump cuddling with my daughter.

I didn’t have the most productive morning that day.  I didn’t have the most productive mornings for the next four days. Laziness and excuses kicked in.

Today, I woke up at 5:30am to write this blog.  I don’t have everything down.  I have something done, and I am striving to put everything in my life on autopilot.  

It takes time.  It’s a continuous improvement.  I have the vision and I am working toward it.  But please do not mistake me or Erwin as “perfect” or as “model” examples.  

We are just struggling the same way everybody else does.  

Everyone starts somewhere. 😊

Onto this week’s topic.

Another court case (DaCosta et al. v. The Queen. Tax Court of Canada, November 24, 2017) came out late 2017 regarding unreported income on the sale of two condo units.

Two taxpayers, a grandmother, Cynthia, and a minor granddaughter, Denise, each purchased a condo unit under construction.

Cynthia, a real estate agent, sold her unit the same month as closing.

Denise sold hers the month after.

They didn’t report any of the income on their tax returns.  

If you’ve follow my blog long enough, you would have known that sale of a real estate property can be taxed either on the income account or capital account.

If it is taxed on the income account, it means 100% of the profit must be reported as income.

If it is taxed on the capital account, it means 50% of the profit are subject to tax.

Now, how do you determine whether the sale of a property is on income account or capital account?  CRA follows a bunch of criteria to make such conclusions. The duration of ownership, taxpayer’s profession, financing arrangement, etc. are all taken into consideration when such a decision must be made.

  • Both taxpayers owned the properties for barely a month or two.
  • Cynthia had been a real estate agent for 23 years at the time when the tax returns were filed.
  • Cynthia reported only $20,000 net income in her 2010 tax returns.  She had significant line of credits.  Denise made $7,000 income at the time.  They both showed that they had no financial capabilities to afford these units.

The judge ruled that the sale should be on income account.

It also didn’t help that the taxpayers did not hire any professional help.

Because they didn’t seek a legal representative, the judge felt that he should point out potential issues that were not addressed by the taxpayers.

  1. Denise was a minor at the time and 21 now.  The judge found that Denise relied heavily on her grandmother and her father (both are real estate agents) to guide her through the entire process.
    The judge pointed out that Denise could have raised the issue that Cynthia was truly the beneficial owner of the condo unit under Denise’s name.Hence, the tax would not have been imposed on Denise’s tax return.
    Cynthia, technically, would have been required to report the sale of Denise’s unit in her tax return, on top of the one in her own name.
    But the judge has no power to increase Cynthia’s taxable income.
    The Unit held in Denise’s title would not have been taxed at all.
    Interesting a judge would provide such comment. 😊
     
  2. We mentioned earlier that Cynthia and Denise were in no position to qualify for mortgages.
    The judge raised a second issue that the beneficial ownership of the condos was not even disposed in 2010.  “The legal titles were merely transferred to close family friends in order to fool a bank into indirectly providing financing to Cynthia.”
    If the beneficial ownership was never disposed of, Cynthia and Denise were under no obligations to report the so called “sale”.  It would have been considered merely a legal title transfer.I thought these two points mentioned at the end of the judgement was very interesting.  These are not loopholes but rather comments based on the case evidence provided.

Lessons learned?

  • Hire a professional to represent you
  • Proper documentation must be kept substantiating your claim
  • Report your income!

Until next time, happy Canadian Real Estate Investing.

Cherry Chan, CPA, CA

Your Real Estate Accountant

7 BOOKKEEPING MISTAKES A REAL ESTATE AGENT (AND ALL TAXPAYERS) SHOULD AVOID

7 bookkeeping mistakes

Many people asked me how I did it – writing blog posts every single week for the last 3.5 years, accumulating over 150 blog posts today.  Trust me, it hasn’t been easy.

I look everywhere for materials that can be relevant to my followers, so I can provide valuable information for them.

One of my favourite source of material is the recent court cases – YIU-CHO NGAI and HER MAJESTY THE QUEEN.

Earlier this week, I stumbled across this court case relating to a real estate broker in Toronto. He’s disputing in court about certain deductions he took in 2005 and 2006 that Canada Revenue Agency disallowed.

The court case ended January 26, 2018. ☹️

It’s over a decade ago and he finally got a ruling from the judge last month!

1. Cash gifts won’t cut it

The taxpayer, Mr Ngai, claimed deductions with respect to cash gifts he made to his clients and referral source against his realtor income.If you are thinking of giving cash gifts to anyone, think again!

He could only provide names of the people who received the gifts but other than that he couldn’t provide any evidence to prove his claim.

He didn’t invite recipients of these cash gifts to corroborate in court.

He couldn’t even provide cash withdrawal support from his bank.  In theory, he would have got the cash gift from somewhere, likely his bank account, to gift them to the referral source.

Lessons learned?  Do not give cash gifts.  If you are giving a gift, make sure you have it properly documented.  From the bank withdrawal, to the name of the person who received it, contact number and the address.

If you want to make sure you get the deduction, get an invoice or receipt, tie it to a specific deal that you are working on.

If you are unsure you can get a receipt, you may even want to avoid cash gifts altogether.

2. Documentation matters

Yep. You’re right. We are in 2018. We are talking about a case related to the taxation years of 2005 and 2006.I graduated from University of Waterloo with my Master of Accountancy in 2006 and wrote my Chartered Accountant Uniform Final Exam that year!

That’s a LONG TIME AGO!

How are you supposed to remember everything that happened that far back? You can’t!

That’s why documentation matters.

In the court case, Mr. Ngai, the taxpayer had stated that a Louis Vuitton designer purse was given to a client’s wife as a gift for purchasing an industrial building with him. He also made an inconsistent comment that the purse was given to thank the client to let him use their BMW for business purposes.

The judge disallowed the deduction, on the basis that Mr. Ngai provided conflicting reasonings for the deduction.

Lessons learned?  Write down what the gifts are for specifically when you are spending the money!  Don’t wait until 10 years later.  Write it down directly on the receipts.  You may even want to take one step further.  Write down how this is related to earning your commission income/rental income!  This will help you in court 10 years down the road!

3. Follow KISS principle

For those of you who don’t know this principle, it means Keep It Simple and Stupid.A taxpayer is entitled to claim any deductions that he incurs to earn the specific source of income, subject to a bunch of exceptions.

The easier it is for you to tie a specific expense to income, the easier it is for the judge/CRA to allow the deduction.

For example, if you buy a Louis Vuitton designer purse for a client who just closed a property that’s worth $1million, it is worthwhile for you to write down on the receipt that this is for Mr. XYZ’s wife and Mr. XYZ just closed a deal on ABC street.

When you get audited by CRA, you already establish how the expense is related to the income earned.

I am not saying that by writing down the name and the deal, you are able to deduct a Louis Vuitton designer purse.  But making it simple and stupid surely make your position a lot stronger.

4. Corroboration matters

In this court case, the taxpayer didn’t invite any witness to substantiate his claim.The judge even offered to hold off the case to allow the taxpayer to invite some of the people who he claimed to provide cash gifts to stand in court.

Mr. Ngai turned down the opportunity citing cultural differences.

Going back to the cash gift example above, Mr. Ngai couldn’t provide any paper documentation as to how he got the cash to issue payment to the referral source.

Should Mr. Ngai asked some of these recipients to appear in court, he likely would have got the deduction allowed.  Even a written statement from these recipients would have made the case stronger for Mr. Ngai.

On the flip side, I do understand why Mr. Ngai is reluctant to call these recipients to court.  If they were to appear in court, they probably would be questioned as to whether they reported the gifts in their income tax return.  What if they didn’t?

Lessons learned?  Make sure that when you are providing gifts to referral source, you have them properly documented. Certain gifts are tax-free from the recipient’s point of view, but certain “gifts” such as rebates of commission can be taxable, depending on what you are buying.

Talk to your accountant to recognize the risk of deducting cash gifts without proper documentation.  Maybe it’s not worth it to take the risk?  Maybe getting a receipt from them is sufficient.

5. Gifts to a clients’ son’s wedding likely can’t be deductible

Mr. Ngai also deducted cash gifts for a wedding that he attended.The wedding gifts $1,000 was written as a cheque.  It was the wedding of the son of an important business contact.

The judge cited two previous court cases before they made the decision to disallow it.

In the judge’s point of view after reviewing the two court cases, a wedding is considered a social event, not a business event.  Just because there could be an element that the taxpayer could hand out business cards, “(b)ut it could not be argued (except under possibly the most extreme circumstances that are not easily evident to me) that going for a cup of coffee, mowing the lawn, or attending the wedding was for the “purpose of gaining or producing income from the salvage business”.  (comment from the court case Ace Salvage)

Lessons learned?  If you are attending a social event, costs of wine, wedding gifts, etc. cannot be deductible.

6. Referral fees are deductible

I mentioned in previous blog posts that referral fees could be deductible.Technically speaking, referral fees are tax deductible.  But remember the general guideline, reasonable expenses are deductible if you incur them to earn the specific income.

It’s worthwhile to note that the Real Estate Council of Ontario may not allow you, as a real estate professional, to pay referral fees to anyone outside of the deal itself. But that’s beyond the scope of a tax court case.

Mr. Ngai was able to deduct referral fees paid to various referral sources, with proper documentation provided.

Lessons learned?  Write down the name of the referral, write down the deal that the referral fees are related to and ideally mark it on top of the cheque, also keep a copy of the cheque for deduction.

7. Rebates are also deductible

Many realtors give a rebate to their clients, in the form of cash, cheque, gift cards, or an exhaust fan in this court case!Seller or buyer rebates are fully deductible with proper documentation provided.

Mr. Ngai was required to provide the listing documents (MLS Listing) to the court for him to get the deduction that he made on a $1,500 rebate to one of his clients.

Mr. Ngai also bought an exhaust fan for one of his other clients after closing.  The court treated this expense as a buyer rebate.  He was able to establish in court that the buyer would not purchase the house because of the exhaust fan and Mr. Ngai agreed to pay for the replacement of this exhaust fan to complete the deal.

Lessons learned? Documentation matters.  Follow the KISS principle above.

Hopefully, all of us can take away something from Mr. Ngai’s case.  

Until next time, happy Canadian Real Estate Investing.

Cherry Chan, CPA, CA

Real Estate Investment Tips for Canadian Investors

3 Investment Tips Every Real Estate Investor Can Benefit From

I’ve learned a few real estate investment tips from my mum that I would like to share with you, whether you’re working in property development finance in Melbourne, or if you’re based up here in chilly Canada!

My mom is my superhero. She’s inspired me to be a real estate investor and entrepreneur. Thanks to her, I had little fear when I bought my first condo. It was a real boost to the confidence I had at the time, and she continues to be a great supporter of my efforts.

So, here are 3 real estate investment tips every real estate investor can benefit from:

    1. Cash rebate received on new mortgage and renewal

In Canada, when you sign up for a new mortgage after going to someone like Mortgages For Less for the best rates, or when you renew a mortgage, you simply sign, and that’s the end of the story.

In Hong Kong, the banks are so competitive that they will offer you incentives/rebates if you sign up.

For example, my mom would get a 1% rebate on the mortgage amount, essentially lowering her effective interest rate to just above 1%. (Rates in Hong Kong are slightly lower than ours.)

One of her property’s mortgage renewal just came up. Her bank offered the same rebate again!

In Canada, some bank still offers this type of rebate. However, the mortgage rate will go up.

From a tax perspective, this type of rebate is taxable in the investors’ hands. The only way for you to know whether or not you can get a rebate is to look into your mortgage before renewal. If you want to do this, see when your renewal time is coming and check your mortgage.

    2. No capital gain tax in Hong Kong (and many other countries)

We often talk about tax when you sell your properties.

My mom still owns a rental property in Canada, and I explained to her how she would be taxed when she sells the property eventually.

She’s a bit shocked to find out that she needs to pay tax. There’s no such thing as the capital gain tax in Hong Kong, and in many other countries such as New Zealand and Switzerland.

According to Fraser Institute, zero tax on capital gain increases savings and discourages entrepreneurs/investors from making more investments.

Mom dressing up at Pirate Show

Imagine Canada has no capital gain tax? Imagine what it will do to our property pricing? Just imagine the type of economic growth we will get?

Mom thought that because she had one property only, she could be exempted from paying capital gain tax.

That’s a myth!

She would still need to report the sale of her rental property as an investment, pay capital gain tax on it. I went through the quick calculation I have here to prepare her for the amount she needs to pay.

    3. A will is necessary, even if you own one property.

My grandparents were farmers. They were ranked bottom under the communist form of China. This meant that they received minimal resources from the government.

Thankfully, my mom and one of my aunts decided to “move to” Hong Kong, which was a British colony back then.

They both worked hard and saved some money.

Eventually, they together provided the money for my grandparents to buy a place closer to the border.

Fast forward to 20 years later today, this same condo unit is old and a bit out of shape. But this same unit is in the centre of the town. Rumor is that it will be taken back by the Chinese government for redevelopment.

Instead of buying you out, the Chinese government will give you a unit in the brand-new building when the redevelopment has finished. They will also reimburse you for the rent you incur during this inconvenience. Crazy, isn’t it?

Rumor is that the new unit will be worth a lot more than the old one.

When there’s money to be made, there’s conflict inflicted. One of my aunts wanted to make sure that the property will be split up properly when my grandparents pass away.

This also stirred up the pot causing the rest of the siblings to ask for some. ? My mom is one of 7 children.

It was an uncomfortable conversation to have, but they finally reached a conclusion how this fortune will be split up.

CN Tower With Mom

They will sign a piece of paper specifying the arrangement. In Canadian terms, it’s the will.

Erwin and I are in the process of drafting up our wills as well. Certain conversations are difficult to have, but you still need to have them to clear things up.

Without the will and the conversations ahead to explain why you allocate your asset the way it is, this can trigger conflict among siblings and family members.

Be sure to set this up ahead of time. 

I hope you found my 3 real estate investment tips useful!

Until next time, happy Canadian Real Estate Investing.

Cherry Chan, CPA, CA

Your Real Estate Accountant

5 Lessons learned from $600 million unpaid Real Estate taxes

UNPAID TAXES

Canada Revenue Agency recently released its latest statistics on their effort cracking down on unreported tax liability in the real estate sector (unpaid real estate taxes).

We have been following this data since 2015 when it was first introduced.

I figured that it’s a good time to remind all real estate investors, flippers, land developers about a few quick facts about unpaid real estate taxes.

5 Quick Facts…

1. Property flipping is considered business income. It is legally allowed, but you are required to report it accordingly. Most mistakes are made when the sale is reported as capital gain.


2. Selling pre-construction condos/homes before closing is called an assignment. In the past, assignors’ names were not readily accessible by CRA. CRA has since obtained court orders successfully to require builders to the assignors and assignee’s information. You cannot get away from not reporting the income. Big Brother is always watching!


3. Assignment deals are subject to HST. Assignment deals are also considered flipping in the previous point and must be recorded as income, 100% taxable. You may think you can make a killing in selling assignment deals; there may be very little left after HST and business income tax.


4. When you flip a house, it usually involves renovation. If you have renovated substantially, you will have HST exposure. This means that when you sell, you must consider the HST impact on the sale price. One reader of my blog didn’t include HST in his calculation and was shocked to find out how much he must give up.


5. Tearing down an existing house and building new ones are considered selling new homes. Even though you don’t have to pay HST on the purchase of the existing home, you must charge HST on the sale of the new homes. The entire projection of profit can be substantially different.

Make sure you speak to a qualified accountant with a real estate background to consult on your financial matters.

Until next time, happy Canadian Real Estate Investing.

Cherry Chan, CPA, CA

Your Real Estate Accountant

Setting up a new Corporation? Take these 7 steps

7 Steps You Must Take When Setting Up a New Corporation

Setting up a new corporation has many benefits but can also be complicated. Here are 7 steps you need to take to simplify this process.

1. Open a bank account:

A corporation is a separate legal entity. When you conduct business in your corporation’s name, the corporation earns money, not you personally.

If you receive money in your personal bank accounts, shareholder benefits might have been conferred to you instead.

In simple terms, you will have to pay personal taxes in your name.

And your corporation may still have to pay taxes on this earned income!

Double the taxes!

The best way to go around this is to ensure all corporate income earned is deposited directly into the bank account.

2. Open a credit card, if that’s an option:

When you first set up a corporation, it’s often advisable to have a credit card as well.

Credit cards are used for the day to day business expense incurred to earn the income.

Sometimes, the bank may not allow a brand-new corporation to have its own credit card.

A dedicated credit card in your name can be sufficient.

The idea is that only corporate business expenses can go through this credit card, making accounting, bookkeeping and reconciliation a lot easier.

It also helps to establish the deductibility of fees and interest on this credit card.

3. Purchase shares:

Many business owners simply go online to set up the corporation themselves.

Shares are often set up as a journal entry at year-end by the accountant.

The truth is, to have the corporation established, a share must be purchased. (Trust me, a few court cases have mentioned the validity of the corporation before!)

To establish that, the shareholder should deposit a cheque to subscribe for the shares at the beginning.

4. Register for your HST account

You may be in the residential rental business – most residential rental companies are not subject to HST, and you may not be required to register for HST.

If you are a builder building new homes, your business is subject to HST. Registering for HST earlier guarantees that you get the benefits of getting a refund from the HST you paid.

If you are a flipper, depending on whether you are renovating substantially or not, you may have an HST exposure still.

If you are a real estate brokerage, you don’t really have a choice but to register for HST. Chances are, you won’t even get paid if you are not registered for HST.

If you have HST exposure, be sure to register for an HST account early to avoid any future surprise.

5. Select an accounting software and all related apps:

Whether you have a real estate investment business, realtor business, flipping houses or building houses, you would need to select an accounting software initially.

Or alternatively hire a company for your accounting needs, from payroll to making sure there are never any errors on your bank statements.

In the marketplace, there are tons of apps that keep everything smooth and straightforward for you.

For example, if you’re handling many customers then it is important to get a powerful CMS system that suits your needs. Two of the main ones to compare when making this choice is freshdesk vs zendesk, as they are major players in the market and each can help with certain niches.

Apps for real estate professionals:

General contractors – specific apps are available for progress billings.

Regular business owners – I suggest using credit card collection, which makes collection much more manageable.

Rental investors – I’m personally using an app for collecting rent and making payments to my subcontractors at $1 each. The app syncs with my accounting software, performing my accounts payable, and receivable function automatically and seamlessly.

I looked into this app after a friend of mine recommended that I look into a way to manage my rent collection and my accounts. She stated that she used a Xero accountant, a financial advisor who was adept at using the Xero accounting system, which is a cloud-based account software for small businesses.

There are also apps out there helping you to track your mileage and fetching bills and bank statements for you.

It would be advisable to also get yourself some documentation management software, this will help you get everything on your computer organised and anything that you have as a physical copy can be scanned into it too, this will reduce paper in your organisation.

Look at software on FilecenterDMS.com to see how it can help you.

Be sure to speak to your accountant regarding the apps available that suit your specific need.

6. Select a year-end for your corporation

As an individual, we’re so accustomed to having December 31 as a year-end. Calendar year-end means our year-end.

We are required to file our personal tax return on April 30 if you’re not self-employed or by June 15 if you’re self-employed.

One year-end is December 31, which is one filing deadline.

Your corporation is a separate legal entity. Your corporation has the flexibility to select its year-end. And it does not have to be December 31!

Sometimes, a year-end of January 1 can be advisable for tax deferral purposes. Sometimes, a July 31 year-end may be more appropriate.

The filing deadline for a Canadian Controlled Private Corporation (for the majority of my audience here) is six months after year-end. Corporate taxes, however, are due only three months after year-end.

HST filing requirements can be different, depending on the filing frequency requirement.

7. Make money and talk to your accountant early

After spending so much money on the initial setup, it’s time to make some money!

Tax planning should be accomplished ahead of time and it is also highly personal.

The strategy should start before setting up the corporation, with your goal in mind, the proper corporate structure should be set up.

Once you start earning income, you should have a conversation with your accountant on how much money you should set aside in preparation for tax owing.

Believe it or not, making money is essential, but keeping a portion for the taxman can avoid much grief in the long run.

Until next time, happy Canadian Real Estate Investing.

Cherry Chan, CPA, CA

Your Real Estate Accountant

Taxation of Rental income: How to pay 13.5% Small Business Tax

taxation of rental income

Taxation of Rental income is not the same as how regular income is taxed.

But before I go into more details, did you see this headline – “Liberal government writes off $1.1B US loan, plus interest, docs show” on MSN.com?

Federal government wrote off a loan made to Chrysler during the 2009 global economic meltdown.

I believe in making progress in life: Failure is fine, as long as we learn from it and never make the same mistake again.

It sucks to lose $1.1B, but it doesn’t mean that we can’t learn a thing or two from this loss.

I’m a small business owner and real estate investor. Billion seems to be a big number to grasp.

To give you some perspective, Toronto Transit Commission (TTC) subway extension to York University costs about $3.2 billion. The federal government only contributed $697million; the rest was funded by the province, the city of Toronto and York region. This $1.1B could have been used to build 1/3 of our subway line[i].

The cost to build UP Express, which provides train service connecting Pearson airport to Union Station downtown, cost $456 million to build[ii].

This $1.1B loan can allow us to build two UP Express.

In 2012, the automotive section employed 115,000 persons in Canada as per Statistics Canada[iii]. Compared to the 2007 to 2009 employment level, a total of 43,500 jobs were lost.

Could we have spent this $1.1B in better places making a greater impact on our lives?

Should we have been so willingly giving away our hard-earned Canadian dollars to bail out big corporations?

Could we have created a program to re-educate these 158,500 auto-workers to work in a different industry instead?

I’m not a politician.  Politicians are difficult business.

As an entrepreneur, I’ve learned that reflection is part of the key to success. Hopefully, our Federal government learned from this mistake, instead of purposely hiding the write off from the public, and not to make the same mistake again.

Now, back to this week’s topic…

Taxation of Rental Income in the Corporation.

In Ontario, small businesses can pay as little as 13.5% corporation tax.  If you earn $100,000, you would only need to pay $13,500 tax.

With proper planning and structure, small business owners can pay personal taxes to close to nil when they withdraw the money from the corporation.

If you were to earn the same amount in your personal name, you would have to pay close to $35K tax.

Unfortunately, Income Tax Act (ITA) and CRA do not look at rental income the same way as regular income.

Rental income, together with dividend income, interest income and royalty income, are all considered Specified Investment Business income (SIB).  They’re taxed differently in the corporation.

SIB is taxed at 50% with 30% refundable upon the distribution of taxable dividend.  If you want to find out more about how this works, please refer to this blog post.

Many investors ask, ‘is there a way to get away from paying 50% taxes?

Yes, the key is to hire more than 5 full-time employees.  Most of us know, it would take a lot to build up a portfolio that would require more than 5 full time employees.

(For the record, if you hire more than 5 full time employees, you would pay 13.5% tax instead.)

Once in a while, I would also take over real estate investor clients’ and their prior year tax returns were erroneously claiming small business deduction rate at 13.5%.

From time to time, I would see taxpayers challenging this “more than 5 full time employees” exception.

Check out this example:

In Huntly Investments Ltd. V. The Queen, the taxpayer claimed a small business deduction on rental income received from residential properties.

The taxpayer owned and leased 5 buildings in downtown Vancouver. One of them is a 40-unit building, and the other four were adjacent to each other and had 40 dwellings combined.

This taxpayer didn’t have 5 full time employees.

Instead, the taxpayer used arm’s length property management company and services provided by other related corporations (which are owned mostly within the same family) to manage the rental portfolio.

The taxpayer challenged that the tax court and CRA cannot simply use the definition of “more than 5 full time employees” to determine whether the rental business should be considered a SIB.  She argued that business owners could outsource the work, and have other associated companies providing the service, rather than hiring.

I, as an accountant, 100% agree with that!

Rather, tax court should determine the services required to run the operation would have needed the taxpayer acted alone.  From there, they could determine the number of full-time employees required to provide the services on a reasonable basis.

The judge went into prior court cases to determine the definition of “full time employees” and how several “part time employees” cannot be “added” together as one full time employee.

The judge also went into depth in analyzing the services provided by the associated companies and found that the taxpayer did not substantiate why and how she needed a chief executive officer, an executive assistant, a chief financial officer and a full-time accountant if the associated companies did not provide their services.

These services would have been required if the taxpayer started the redevelopment proposal during the taxation years in question.

The judge concluded that the regular day to day rental operation would not have required these many employees.

The judge sided with CRA, concluded that the taxpayer did not require more than 5 full time employees to run the operation.

As such, the taxpayer cannot claim the small business tax rate. ☹️

How do we do this properly?

If you don’t have more than five full time employees providing services to your business, but use related companies to provide services, the key to success is to document, document and document!

Job description, list of services provided, # of hours these staff work in your rental business.  You may even want a timesheet showing that these staffs are working consistently in the rental business (this can include redevelopment!).

Claiming a small business tax rate on your rental property isn’t a walk in the park.  Be prepared for the challenge from CRA.

Until next time, happy Canadian Real Estate Investing.

Cherry Chan, CPA, CA

Your Real Estate Accountant

Reporting losses from Rental business? These are the dangers…

deducting losses from rental business

There are many dangers of reporting losses from the rental business… I’ll explain with this story.

A couple of years back, I advised a real estate investor not to take the entire apartment renovation as a one-time deduction.

The renovation was done in between tenancies. He didn’t put much improvement except giving the unit a fresh look.

Technically speaking, he could deduct it as repairs.

I looked at it differently.

He reported multiple years of losses.  His other rental property also had a huge expense creating a bigger overall rental loss of over $50K.

He’s self-employed as well, which means that he was at a higher risk of being audited.

He disagreed with my judgement…

People generally underestimated the amount of work involved in handling an audit and the stress it would add to your life.

This recent court case in Hamilton reminded me of this client. The taxpayer owned a few rental properties in Hamilton and Stoney Creek area.

He reported rental losses from 2005 to 2011 (see below for a summary).

He rented out two properties, detached bungalows, at significantly below market rent.

He rented out these properties for $450 per month for the most part, during the questioned period. He rented one of these properties to his lease for $200 per month.

CRA presented in court that market rent as per CMHC, which we all know as real estate investors are way low, is around $850 per month during the period.

The taxpayer simply argued that his rent was charged on a net basis with the intention that the tenants are responsible for utilities, snow removal and day to day maintenance of the properties.

He stated in court that his objective for these rentals was to “recover property taxes, mortgage interest and insurance”.

As a result, he reported significant losses in multiple years.

CRA audited his tax returns and challenged that he did not intend to carry on the rental with the intention to profit.

If you’re not intending on carrying the rental activities in a commercial manner, this means that you cannot deduct the rental losses incurred.

Losses offset against his income. If these losses are disallowed, that means he must pay back all the taxes he would otherwise be liable if he didn’t have these losses.

Judge didn’t think that he was carrying out his rental activities in a business-like manner.

  • He didn’t have any actual leases signed.
  • He didn’t make any attempt to determine comparable rent being charged in the Hamilton area.
  • He also failed to increase rent even though he’s incurring a loss every year.
  • He rented out one property to his niece for $200, significantly lower than what other tenants are paying, much lower than the fair market value rent.
  • The judge concluded that the taxpayer did not provide any proof that he was conducting his rental activities in a commercial manner.

The judge dismissed the taxpayer’s appeal and sided with CRA.

Next time when you are reporting multiple years of losses – whether it is rental or business, think again.

Next time when you are renting your properties to family members and reporting losses, think again.

Until next time, happy Canadian Real Estate Investing.

Cherry Chan, CPA, CA

Your Real Estate Accountant