Tax code is notoriously challenging to navigate, for businesses and individuals alike. If you’re an individual operating your own real estate investment business, you’re likely to experience even more challenges. It can be a challenge to determine the best way to structure your personal and business finances under the Canadian tax code.
Revenue Canada offers several programs and systems savvy investors can leverage to optimize their tax burden and transfer assets with limited expense and penalty. Section 85 is one tool Canadian investors can use to transfer assets from a sole proprietorship to an incorporated business while limiting tax liability.
Get your footing in Section 85
When you first enter the real estate investing scene, you may begin as a sole proprietor. This means you don’t have your investing business incorporated. While this may seem simpler at the outset, it may also cost you the opportunity to use other tax benefits only available to fully incorporated businesses.
If you’ve been operating as a sole proprietor, you may be wondering how you can transfer assets from your ownership to your newly incorporated business without incurring stiff tax liabilities. This is where Section 85 rollovers are beneficial.
Without a Section 85 rollover, when selling property from your sole proprietorship to your investment business, you’ll have to pay taxes on the appreciation of the asset’s value. This is capital gains tax. And it’s not a small amount!
For example, if you purchased a single-family home for $200,000 in 2008, now worth $600,000, you’d have to pay capital gains taxes as high as 50 percent on the $400,000 worth of appreciated value. The problem is, you’re not attempting to sell your property—you’re simply transferring ownership to your incorporated business venture.
With a Section 85 rollovers, investors defer capital gains taxes by legally transferring assets from a sole proprietorship to an incorporated venture. While Section 85 rollovers don’t negate your tax liability, they allow you to consolidate your assets without erasing your liquidity.
Reasons to transfer property to an incorporated business
You might assume it’s easier to hold your assets under a sole proprietorship, especially if you only have one or two investment assets. But in fact, holding assets as a sole proprietor has significant drawbacks. Transferring ownership of your properties to an incorporated business provides a significant amount of security and helps ensure you’re looking out for your interests as a business owner.
Here are a few of the benefits associated with holding your real estate investments as a corporation, rather than as a sole proprietor:
- Removes liability: If you hold your property directly, you’re opening yourself up to potential legal troubles later on. If a tenant, for instance, is dissatisfied with their rental, they may pursue legal action against the owner of their building. If you own the property through an incorporated business, there’s a fair amount of legal cushioning protecting you personally.
- You’ll receive benefits when selling the property: Operating an investment asset as an incorporated business allows you to sell the property more easily, and claim for certain types of depreciation. Generally, it’s much more advantageous to sell a property as a business rather than as an individual.
- It’s easier to access business finance products: If you need a business loan or a special line of credit to maintain or refurbish your investment property, it’s far easier to get one when you’re operating as an incorporated Canadian business. You can access credit cards, equity loans and other products only available to corporations.
- Incorporated businesses receive tax benefits: There are federal, provincial and local tax benefits you’ll receive when operating as an incorporated business. Taking the time and effort necessary to incorporate your venture will help you optimize your tax burden and improve the positive cash flow coming out of your investment property.
Executing a Section 85 rollover
Transferring an asset from sole proprietorship to incorporated ownership under Section 85 is relatively straightforward. But it’s important to ensure you’re following Revenue Canada’s rules and regulations during the transfer period.
Keep in mind, while many hard assets you own as part of your real estate investment business are transferable, not everything is eligible for a Section 85 rollover. Section 85 allows investors to transfer capital properties, inventory and intellectual property.
Under a Section 85 rollover, you must sell the asset to your incorporated business at the asset’s initial purchase price. If you bought an apartment building for $500,000 under your name 10 years ago, under Section 85, you’ll be required to legally sell the asset to your incorporated business for $500,000 today, regardless of current market valuation.
It’s also worth noting, to take advantage of Section 85, the corporation needs to be a taxable Canadian corporation. You can’t incorporate your business out of another country, and then take advantage of Section 85.
If a Section 85 rollover is performed incorrectly, Revenue Canada will adjust the valuation of the asset and tax it accordingly. Ensure you’ve performed all necessary due diligence before attempting to go through with a Section 85 transaction!
Realize that while Section 85 allows investors and business owners to take advantage of tax deferral, it is not a cancellation of the tax owed. You’ll still have to pay taxes based on the appreciation of the asset’s value when it’s sold.
Consolidate your assets under a corporation
If you’re in the middle of getting an investment corporation set up, get familiar with Section 85 rollovers. They’re one of the smartest ways to collect your assets under a tax-advantaged legal entity.
If you believe a Section 85 rollover will benefit you and your investment business, consider calling for help from a tax professional. While Section 85 rollovers can be tremendously beneficial for your long-term financial outcome, they’re a fairly complex tax maneuver and will require professional assistance. Get it right and you’ll protect yourself and your assets from the pitfalls of excessive taxation when transferring assets.