Beyond the Purchase 

By Nathan Hooper, CPA, CA, Partner, Tax, Caroline & Aschaber LLP

The tax considerations every commercial property owner should understand.

Owning real estate can bring many benefits, including financial rewards, lifestyle advantages, and the peace of mind that comes with owning a tangible asset in an increasingly virtual world. While real estate used solely for personal enjoyment is generally straightforward to administer from a tax perspective, the ownership of real estate for commercial purposes can be significantly more complex.

When acquiring real estate for commercial purposes, it is difficult to overstate the importance of seeking professional advice before entering into the agreement of purchase and sale. At a minimum, purchasers should obtain legal, insurance, income tax, and sales tax (GST/ HST) advice.

From an income tax perspective, it is important to understand where, within an existing corporate structure, the new property will be owned. Real estate can be held in a joint venture, partnership, corporation, or trust, each with distinct benefits and drawbacks. Other key considerations—beyond financial or commercial matters—include whether the property will be held as land inventory for future development, used in an active business, or owned as a passive investment.

Another key consideration is whether interest on borrowed funds will be deductible and how to structure the financing to achieve the most favourable tax outcome within the corporate group. In many cases, real estate may initially be owned personally or within an operating corporation but later needs to be transferred to another corporation within the corporate group. These transfers require careful planning to avoid undesirable income tax, sales tax, and land transfer tax consequences. Tax-deferred reorganizations are often achievable when appropriate professional advice is sought.

When acquiring real estate from a third-party seller, GST/HST rules also require careful attention. Even if the purchaser is a GST/HST registrant who would normally self-assess tax on acquisition, this only applies if the sale itself is taxable. It is the seller’s registration status and use of the property—not the purchaser’s that determines whether GST/HST applies. If the sale is taxable, then the purchaser’s registration status and intended use of the property determine how the tax is reported and paid to the CRA. If the sale is exempt under the Excise Tax Act, the purchaser’s registration status will not change the tax outcome.

Once real estate has been acquired, owners should consider how it may affect a future sale of the business. Generally, if a Canadian-controlled private corporation (CCPC) owns real estate that is used in an active business, the corporation’s shares may qualify for the Lifetime Capital Gains Exemption (LCGE). This can create significant tax advantages when selling the shares of both the operating company (“Opco”) and any related real estate companies. To take full advantage of this opportunity, however, planning generally needs to be completed at least 24 months in advance.

Unlike real estate used in an active business, passive real estate investments held in a CCPC are taxed at a rate of approximately 50% corporately, part of which is a refundable tax. This high rate is intended to mimic the tax an individual in the top tax bracket would pay if they owned the same passive investment personally rather than corporately. The concept is often referred to as “integration.” Despite this, it is common for investors to hold passive real estate investments corporately because the funds used to invest often come from prior corporate profits that have not yet been subject to tax at the personal level. Redeploying corporate funds into new passive investments is therefore a common strategy among Canadian investors.

It is particularly important to seek professional advice whenever a corporately
owned real estate investment undergoes a change in use. This is especially true from a sales-tax perspective, where the rules are complex and require careful analysis in advance for both complete and partial changes of use with respect to a property.

Cross-border investments in real estate also require careful consultation with professional advisors to understand tax-compliance obligations. Non-residents who purchase Canadian real estate must meet annual tax-reporting obligations for both rental income during the period of ownership and upon a sale of the Canadian real estate property. Known as “Section 116,” these provisions require that a withholding tax of 25% (or 50% in certain cases) be remitted to the CRA within 10 days of closing. If the non-resident vendor does not comply, the purchaser (often a Canadian) becomes fully liable for the withholding tax. As a result, Canadians purchasing real estate from non-resident sellers must conduct careful due diligence with the assistance of legal and tax advisors.

Canadians investing in real estate outside of Canada should consult with their tax adviser regarding the implications from both Canadian and foreign tax perspectives. Because Canadian residents are taxed on their worldwide income, net income and capital gains earned on real estate investments outside of Canada must be reported in Canada, ideally with any eligible foreign tax credits claimed for taxes paid abroad.

For sales of U.S.-based real estate, Canadians will generally need to comply with the U.S. equivalent to Canada’s “Section 116” rules, known as FIRPTA (Foreign Investment in Real Property Tax Act). This typically requires assistance from U.S. legal counsel and both U.S. and Canadian tax professionals to ensure all foreign tax credits are claimed in connection with the disposal.

From an estate-planning perspective, additional complexity and planning will often arise when a Canadian individual passes away owning shares of a private corporation that holds real estate. Without proper planning, double taxation may occur on both the shares of the private corporation and the assets owned within the corporation. Some of this tax planning is time-sensitive to implement after the passing of the shareholder. These planning techniques, generally referred to as “postmortem pipeline” or “loss carryback” planning, require professional assistance. It is also important to meet with advisors in advance to understand the total amount of potential estate-tax liability and to develop a plan to fund this liability, which can sometimes be a significant challenge if significant portions of wealth are held in illiquid real estate assets.

This article provides only a high level overview of some common issues encountered when investing in real estate. Readers are encouraged to conduct their own due diligence and obtain professional advice based on their specific circumstances. E

Nathan Hooper is a Chartered Professional Accountant with over 15 years of experience providing clients with timely and proactive tax advice. He is a Partner at Caroline & Aschaber LLP, located at 173 Ste Marie St. in Collingwood and at 31 Arthur Street W. in Thornbury. Nathan can be reached at nathan@kcrallp.ca or by phone at (705) 444-9987.

The information contained in this article is intended as a general source of information only and should not be construed as offering specific tax, legal, financial, or investment advice. Readers should consult with their accountant and their financial, insurance, and legal advisors before taking any action based upon the information contained in this document.