Federal Budget 2015: Trick, Treats, and What Ifs Affecting Real Estate Investors

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By George E. Dube, CPA, CA

Small- and medium-sized real estate investors have a great deal to contemplate from the 2015 federal budget (presented before the election call). The 528-page budget, and associated documentation, contains more than the normal number of tricks and treats for real estate investors. These changes will provide discussion points with your advisors over the coming months.

Small Business and Dividend Tax Rates (Trick and Treat)

Great fanfare accompanied the recent reduction of the federal small business tax rate from 11% to 9%. This reduction, which will be gradually phased in, will be fully implemented in 2019. This tax rate applies to ?active? business income earned by corporations for the first $500,000 of qualifying taxable income for a corporation or associated group of companies. This rate is phased out beginning where the ?taxable capital? (think mortgages and retained earnings, for example) of an associated group of companies exceeds $10 million and is completely phased out at $15 million. Real estate investors frequently benefit from the reduced rate, in areas such as:

  • profits from flipping property
  • portions of rent-to-owns
  • property management activity (even on your own properties, if properly done)
  • assignment fee income
  • development and sale of properties
  • condo/strata conversions

So, there is even more incentive to incorporate for many, although long-term rental income will typically be considered ?inactive? income and will not qualify for these rules. Furthermore, and even more importantly for quite a number of investors, the reduced tax rate provides additional resources to invest when they are carrying out other business activities. It can also save them some funds, such as realtor/broker activities or completely non real estate related business activities.

To keep the integration of the personal and corporate tax system congruent (because, in theory, someone should be indifferent between earning income personally or through a corporation) the tax rates on dividends are being increased to reflect the drop in corporate rates. But?this increased tax on dividends will also impact most investors with inactive income from real estate. The problem is that the tax rate applicable to inactive income has not decreased in a corresponding fashion, thus effectively increasing the tax rate for individual recipients on dividends?again. While planning with your accountant can mitigate the majority of this problem, clearly it would be nice to have a corresponding decrease in the corporate rate or alternatively, it would be nice to maintain the existing dividend tax rates on applicable inactive income.

Consultations on Active and Inactive income (Trick and/or Treat?)

The budget papers have a very small section indicating that the government wishes to consider whether certain income should generally be considered ?active? or ?inactive?. In particular, as examples, they refer to self-storage facilities and campgrounds. The significance of active versus inactive relates to the lower rates of tax initially applicable to active income. And, as real estate investors, we know that often, particularly with buy and hold investments, the income is treated as inactive.

While the areas for discussion initially seem relatively isolated, who knows where this can truly lead? Although this may seem odd, at times we are looking for one or the other form of income depending on the particular situation. But generally, for businesses which will show profits of less than $500,000, we?d prefer active income. The subjective criteria and court rulings, for example, that already exist for distinguishing between active and inactive income for a minority of business/investment cases (in most cases it is very clear what form of income exists) add to the intrigue. Stay tuned?this may impact you in unknown ways even where you are not involved with self-storage or campgrounds.

Donation of real estate or private company shares (big treat)

Charity-minded real estate investors and the organizations that they support will see some dramatically positive changes beginning in 2017. Correctly done, more money can effectively end up in the hands of a charitable organization where real estate or the shares of private corporations are essentially donated. Now, as you can see on this guide on the best shares to buy now, shares are usually bought and sold for monetary gain. You buy shares to a company like Amazon and make money when the appreciate in value. This means that the person investing is subject to things like taxes. Knowing how to buy shares/hur köper man aktier, is very important in this instance, knowledge is key and is needed to make sure the right decisions are being made. However, thanks to these new provisions, shares in real estate can now be donated for charitable purposes. The changes apply to both individual and corporate investors, effectively mimicking rules related to donating shares of public companies and ecologically sensitive land. This levels the playing field for philanthropy while encouraging real estate investors to continue doing what they are great at AND providing a bigger bang for the buck in helping others.

While the provisions are quite detailed, in their simplest form, donating shares or real estate can be done without triggering a capital gain while still receiving a full donation tax credit for individuals or deduction for corporations. ?Recapture? may still be applicable ? thus share sales may be better and provide further opportunities for other investors. Put another way, it costs less to donate more.

Among other conditions, proceeds from the disposed property/shares must be donated within 30 days. The sale itself must be completed to an arm?s length party and the donor and recipient must similarly be at arm?s length (generally speaking, not related or deemed to be related due to their level of control). Within five years of the donation, the donor cannot reacquire the property or substituted property (in the case of shares).

The changes will provide additional incentive for the philanthropist to control the earmarked capital to help ensure that the ultimate proceeds are used when and how they want them applied. Furthermore, it gives much more reason for the investor to do what they?re really good at and have fun investing while knowing they can now provide more money to their favourite causes.

Budget Real Estate Tidbits ? More Treats than Tricks

  • TFSA increased limits to $10,000 per year beginning in 2015. This means increased ability to create war chests for real estate investing, increased use of the ?TFSA Maximizer? planning, and more overall tax planning.
  • Investments in limited partnerships ? charitable organizations and foundations can now invest in LP?s containing real estate, for example
  • Infrastructure investments ? providing opportunities for the construction industry
  • RRIF minimum withdrawals being reduced ? helps savings last longer while not triggering taxes so quickly due to forced removals from a sheltered investment with a RRIF status
  • Home Accessibility Tax Credit introduced ? providing further opportunities for the construction industry
  • Co-operative and non-profit social housing changes ? eliminating prepayment penalties on CMHC long-term loans
  • Simpler reporting for foreign assets costing less than $250,000
  • Life-time capital gains exemption for qualified farming property increased to $1 million

This budget will impact those in the real estate and construction industries more than the average budget over the past several years. Now it?s time to find out how you can both take advantage of the treats, and protect yourself from potential tricks presented by the 2015 federal budget.

Note: Please exercise extreme caution in reviewing this article in that many exceptions and critical details affecting the provisions are omitted for brevity and understanding. Please ensure that you discuss these points with your qualified real estate accountant.

George E. Dube, CPA, CA is a veteran real estate investor and accountant. He has spoken, written various articles, and co-authored two books on real estate accounting. Reach George at: gdube@bdo.ca or @georgeEdube.

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