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Should your business property be owned personally, by your operating company or through a separate corporation? Review the key Canadian tax, HST and planning considerations before you buy.
For an established business, buying the office, clinic, warehouse, retail unit or other commercial property it operates from can be an attractive long-term investment. Instead of paying rent to an unrelated landlord, the business owner builds equity in a property that may appreciate over time.
However, one of the most important decisions is not simply whether to buy. It is how the property should be owned. For business owners in Mississauga and across the GTA, the main choices are usually personal ownership, ownership in the operating corporation, or ownership through a separate corporation.
Option 1: Own the Property Personally
An owner can purchase the commercial property personally and lease it to their corporation. The corporation generally pays reasonable market rent and deducts the rent as a business expense. The owner reports the rental income personally and may deduct eligible expenses such as mortgage interest, property taxes, insurance and repairs.
This can keep the property outside the operating corporation and may provide flexibility if the operating business is eventually sold while the owner wants to retain the real estate.
The main disadvantage is funding. If the down payment is sitting inside the corporation, the shareholder generally has to extract those funds personally before using them for a personal purchase. Depending on how the funds are withdrawn, that can create a significant personal tax cost.
Option 2: Buy the Property in the Operating Corporation
The operating corporation can purchase the property directly and use it for its own business. One major advantage is that retained corporate funds can potentially be used toward the down payment without first paying those funds to the shareholder personally.
The corporation may deduct eligible operating costs and may claim capital cost allowance (CCA) on the depreciable portion of the building. Land itself is not depreciable.
The drawback is that the real estate sits in the same legal entity as the operating business. This concentrates valuable assets and operating risk in one corporation. It may also reduce flexibility if a future buyer wants the business but not the building, or if the seller wants to retain the real estate after selling the business.
Option 3: Use a Separate Property Corporation
A common structure is for one corporation to operate the business and another corporation to own the commercial property. The property corporation then leases the premises to the operating corporation.
This can provide useful separation between the operating business and the real estate, and can make it easier to sell the operating company later while retaining the property as a long-term investment.
Rental income earned by a corporation is generally income from property. However, special rules can apply where rent is received from an associated operating corporation and the rent is deductible in computing that corporation's active business income. Subsection 129(6) can deem the corresponding amount to be active business income in the property corporation, subject to the broader small-business-deduction rules and the specific facts.
What Happens When the Property Is Sold?
Commercial real estate can create more than one tax consequence when it is eventually sold. If the property has appreciated above its tax cost, there may be a capital gain. If CCA has been claimed on the building, some of those previous deductions may also be brought back into income as CCA recapture.
This is why claiming the maximum available CCA every year is not automatically the best strategy. The current tax deduction should be considered together with the owner's longer-term plans and the possibility of recapture on a future sale.
Do Not Forget HST
HST is particularly important when purchasing commercial real estate in Ontario. A sale of commercial real property is generally taxable unless a specific exemption applies.
For a normal taxable sale to a GST/HST-registered purchaser, the vendor will generally not collect the HST from the purchaser. Instead, the purchaser accounts for the tax directly to CRA. This treatment comes from the real-property collection rules, generally subsection 221(2) of the Excise Tax Act. It is not the section 167 sale-of-business election.
Example: $1 Million Commercial Property
Assume a corporation buys a taxable commercial property for $1,000,000 and is GST/HST registered. The HST is $130,000.
- The purchaser pays the $1,000,000 purchase price to the vendor.
- The vendor generally does not collect the $130,000 HST, assuming the registered-purchaser rule applies.
- The purchaser reports the $130,000 tax directly to CRA, generally on line 205 of its GST/HST return where the property is for use primarily in commercial activities.
- If the purchaser is entitled to a full input tax credit, it may claim the corresponding $130,000 ITC on line 106, which flows into line 108.
In that situation, the $130,000 tax payable and the $130,000 ITC may offset each other on the return. The transaction is not HST-free. The reporting and payment obligation has simply shifted from the vendor to the purchaser.
If the purchaser is not entitled to a full ITC, the unrecoverable portion becomes a real cost. This is especially important for businesses making exempt supplies, including many medical and health-care practices.
What About Form GST44?
Form GST44 is different. It is used for the joint election under subsection 167(1) when a purchaser acquires a business or part of a business and acquires all or substantially all, generally at least 90%, of the property reasonably necessary to carry on that business or part of the business.
For example, GST44 may be relevant when someone buys an operating restaurant together with the assets required to continue the business. It would not normally apply merely because someone purchases an isolated commercial building from a landlord.
A Simple Ownership Example
Assume an incorporated business wants to purchase a $1.5 million commercial unit and has substantial cash accumulated inside the corporation.
Buying personally may require the owner to first withdraw a significant amount from the corporation to fund the down payment, potentially creating personal tax. Buying in the operating company avoids that immediate personal withdrawal but places the property together with the operating business. Using a separate property corporation may provide greater long-term flexibility, particularly if the owner expects to eventually sell the operating business while retaining the real estate.
There is no universally superior structure. The answer depends on where the purchase funds are located, the nature of the business, financing requirements, creditor-risk considerations, HST recovery, future sale plans and the owner's broader corporate structure.
Plan Before Signing the Purchase Agreement
Changing the ownership of commercial real estate after it has appreciated can be considerably more complicated than choosing the appropriate structure at the beginning. A later transfer can raise income-tax, HST, land-transfer-tax and financing issues, even where an income-tax rollover may be available.
Before making an offer, business owners should therefore review both the immediate purchase and their longer-term corporate plan.
How Source Accounting Can Help
Source Accounting Professional Corporation helps incorporated businesses and professionals evaluate the tax implications of major business decisions, including commercial real estate purchases, corporate ownership structures and related tax planning. We work with clients in Mississauga, Toronto, Brampton, Oakville, Milton and surrounding GTA communities to assess the structure before the transaction is completed.
This article provides general information only and is not intended as tax, legal, financing or investment advice. Commercial real estate ownership can involve income tax, GST/HST, corporate, land transfer tax, financing and legal considerations that depend on the specific circumstances. Professional advice should be obtained before completing a transaction.
