How is Rental Income Taxed in a Corporation?

When you purchase a rental property, it’s crucial to understand the tax implications, as they can directly affect your profits. Different tax structures come with their own sets of benefits and challenges.

The real estate market in Toronto and its surrounding areas has seen significant growth in recent years, driven by strong economic conditions and low interest rates. Many individuals have made investments in a wide range of rental properties. Rental income is generated when you lease out a property you own, whether it be a house, apartment, or commercial building. The property could be held in your personal name, within a partnership, in a trust, or by a corporation. The tax consequences vary depending on the ownership structure.

Rental Property – Owned in Your Personal Name

If the property is owned personally, the rental income is reported on your T1 personal income tax return. The taxes owed will depend on your marginal tax rate.

Rental Property – Held in a Partnership

In the case of a partnership, the rental income is divided among the partners, who must report their share of it on their personal tax returns.

Rental Property – Held in a Corporation

Owning a rental property within a corporation involves considering several factors to determine the applicable tax rate. The General Corporate Rate is 38% federally and 11.50% provincially (in Ontario), resulting in a combined rate of 49.50%. However, not all corporations will pay this rate, as there are various tax breaks available. The federal government offers a 10% abatement, lowering the rate to 28%. Additionally, the Small Business Deduction provides a 17% reduction, and there is also a 13% General Rate Reduction. To qualify for these favorable tax rates, the corporation must meet specific criteria.

Small Business Deduction

The Small Business Deduction (SBD) applies to Canadian-Controlled Private Corporations (CCPCs) on Active Business Income (ABI). In Ontario, the SBD is 17% on the first $500,000 of rental income. Any income above that threshold does not qualify for the SBD but may be eligible for the General Rate Reduction (GRR). To receive the 17% SBD, the rental income must qualify as Active Business Income (defined below).

Active Business Income

Active Business Income refers to income earned from a business carried on by a corporation, excluding income derived from property, such as rental income (referred to as a Specified Investment Business). A Personal Services Business (where the corporation’s primary function is to provide services that an individual could otherwise do as an employee) is also excluded. However, if the corporation employs more than five full-time employees, the income is considered Active Business Income and is eligible for tax benefits.

Rental Property Tax Categories

Rental income earned by a CCPC falls into three categories. If the income qualifies as Active Business Income and is eligible for the Small Business Deduction, it is taxed at 15.50%. If it is Active Business Income but does not qualify for the Small Business Deduction, the tax rate is 26.50%. If the income is not considered Active Business Income, the tax rate rises to 46.17%. It’s important to note that this rate can be reduced to 22% if dividends are paid to shareholders, in order to prevent double taxation and to benefit from the favorable tax treatment of dividends.