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Transfer of Real Estate fm Sole Prop to Corp

A partnership owns a large commercial/residential building. They want to incorporate to reduce personal risk of liability and to reduce the tax burden. Any thoughts on the downside? I’m concerned about a capital gains exposure for the partners personally on transfer to the corporation. If we set up the corp as a management company, would the building asset stay an asset of the partners or would it need to transfer to the corp? The lawyer says capital gains will have to be paid. Any thoughts or suggestions?

They might want to rethink this. I doubt if they will save tax. Assuming the building produces rental income, and there are fewer than 5 employees, the income will be passive income, taxed at the highest corporate rate. Assuming the existing partners are individuals and not corporations, personal tax rates are not influenced by having rental income vs salary income, for example. So they will very likely pay higher taxes inside a corp. Tax consequences of transferring property from a partnership to a corp can be avoided by doing a section 85 election. And, consider costs other than tax: deed transfer tax (if the jurisdiction has one), cost to incorporate, annual registration fees, cost of filing T2’s, etc. Personal risk may very well still exist within a corp. If a mortgage exists, the lender may very well require personal guarantees. The partners should think things through before going ahead with this scheme. And go to a tax accountant, not a lawyer. There are those who would say, never, NEVER, put a rental property in a corp.

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Thank you for your insight. I have been trying to think of the downsides, which you have expanded for me. Definitely great idea on the tax accountant!

Harley has given you a good answer. I will not go further on that.
But, note that the transfer of property to a corporation can be done without incurring capital gains for the transferor - per Section 85 of the income tax act. This generally requires a proper valuation (i.e. appraisal) and a legal agreement (by a lawyer), as well as filing a T2057 to report the transfer to CRA. Any decent tax accountant will be familiar with this process.

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Barb,

There is far more to this than meets the eye and a Section 85 rollover. I have worked with numerous clients on this very thing; always with the eye of saving huge accounting and tax bills.

There are a number of other issues that need to be overcome as well as some that have not been included in other’s remarks.

If you wish to discuss, you can contact me at cracctg@shaw.ca

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I would get some professional tax advice if this is a true partnership (as opposed to co-ownership). A partnership transfers property to a corporation using a T2058 (not the T2057). The wind-up of the partnership can also be something to consider. Mistakes made on the wind-up and transfer of property to a corporation by a partnership can be costly for all. As was pointed out already, this will likely not lighten anyone’s tax burden but it will increase some accountant’s fees.

@barbsbookkeeping56

This is a great question. There are various opinions about this subject. In general, it depends upon the nature of the individuals, their partnership, and the current financial portfolio of each individual, and the long term financial goals. Succession planning and the exact nature of the partnership agreement are also factors.

Here are some resources for you to research:-

  1. Tax Tips
    https://www.taxtips.ca/realestate/rentalorbusiness.htm

  2. Money Sense
    https://www.moneysense.ca/save/taxes/rental-properties-corporation-save-taxes/

Q: I have five rental properties in my name. Should I switch them to a numbered company?

–Travis

A: Hi, Travis. Incorporating a holding company to own rental properties has some advantages and disadvantages depending on the objectives you have in mind in both the short and long term. However, you should first speak with a tax accountant about any tax ramifications both personally and corporately to ensure as perfect an integration of the two systems as possible. Then speak with a legal advisor to draft up the appropriate corporate structure before making the transfer.

From a tax point of view, there are two things to consider. While the transfer of real property held personally should qualify for a Section 85 election to rollover the properties at their cost base, you will want to be sure the CRA will not consider your properties to be held as “inventory”; that is property, held primarily for resale rather than rental. If so, they will not qualify for a tax-free rollover or capital gains treatment. Therefore, the transfer could trigger unexpected tax consequences. Your history of receiving rental income from the property will help you avoid this.

Second, you’ll also want to understand the difference in taxation rates both inside and outside of the corporation. Recent tax changes may have made it less desirable to own passive investments inside a corporation, depending on where you live in Canada.

Some advantages of incorporation include limited liability and creditor protection. However, if you are holding mortgages, most financial institutions will still require personal guarantees. Corporate directors and officers can also be held liable on default, so proper insurance protections for these instances is critical.

From a retirement planning point of view, incorporation may provide more flexibility as to when income is taken as dividends. It could help you to avoid personal taxes or spikes into the next tax bracket, and benefit from the recovery of refundable taxes in the corporation.