Tax season is fast approaching! If you’re looking to make real estate moves this year, then now’s the time to think about how best to position yourself tax-wise based on your income situation.
Sole Proprietor
If you’re a sole proprietor and only paying tax on Line 13499 of your return, the lenders will need to consider a two-year average. The lower your declared income, the harder it can be to qualify for a mortgage. In most cases, your gross revenues are not used to calculate the income needed for your mortgage. As a result, you’ll want to pre-plan your income tax claim to best position yourself for a purchase.
Depending on the lending channel, the list of what’s needed can vary but to get started we’ll need:
- Two years of T1 Generals (full tax returns)
- Two years of Notice of Assessments to prove no tax is owed (your previous year’s income tax will need to be paid before closing)
- Potentially a T4A if you’re a commissioned employee (this might include a letter of employment from your sales office and/or a year-to-date commission statement)
- Potentially three to six months of bank statements from your business account (including invoices for jobs completed)
So when it comes to tax planning, someone that makes $50K a year in gross sales commission and expenses themselves down to $25K would pay $2,300 in tax (in Ontario). Another person, who makes $140K annually in gross sales commission but claims the entire amount as their net income will pay $40,300 in tax. Why are we telling you this? It’s the type of math you need to consider when you do a deal and decide to work with different lenders.
We had a client who needed to have a two-year average net income of $75K to purchase a home. They had grossed $50K and claimed $25K in net income the previous year, which means they needed to earn and claim $125K net to achieve the needed average. They ended up earning $140K that year so the next question became which lending channel was best.
Our A Lenders came back with a rate of 5.74% (which would be a monthly payment of $3,300) with a 20% down payment and a 30-year amortization period. At $125K net income, the client would’ve had to pay $34K in tax. If we completed the deal with an alternative lender, the client could’ve actually kept more of that tax payment because their commissions would be treated differently than a regular bank.
The client could expense themselves by almost 50% down to $70K net income and the deal would still work with an alternative lender. The alternative deal was at a rate of 6.74% over a 30-year amortization period with a monthly payment of $3,600 and a one-time 1% fee of $5,700. More expensive on the mortgage, yes but the tax payment was now only $13,400 (a savings of almost $21K). For this client, claiming less income and taking the alternative deal kept more cash in their pocket today.
Corporation
Assuming you pay yourself a combination of income and dividends from the corporation, we will use a two-year average of Line 10100 (how much you pay yourself in salary and what’s on your T4) and the dividends you pay yourself on Line 12000. Again, the lower your declared income, the harder it can be to qualify for your mortgage.
We need to also be conscious of increasing or decreasing either your salary or dividends too much from one year to the next. On a two-year average, lenders use the lower of the most recent year and not the average. Too much of a significant swing one way or the other will prompt further questions and documentation requirements.
To get started, we’ll need:
- Two years of T1 Generals (full tax returns)
- Two years of Notice of Assessments to prove no tax is owed (your previous year’s income tax will need to be paid before closing)
- Two years of T4s from your corporation
- Two years of T5s (dividends paid)
- Potentially a T4A if you’re a commissioned employee (this might include a letter of employment from your sales office and/or a year-to-date commission statement)
- Potentially three to six months of bank statements from your business account (including invoices for jobs completed)
- Incorporation documents including shareholder agreement and minutes
- Corporate tax return
- Corporate Notice of Assessment
- A business license and HST filings
When it comes to tax planning, the owner of a corporation (who pays themselves as an employee) might have paid themselves a $100K salary. That structure can benefit that owner/employee in a certain way. Their accountant might suggest paying themselves via dividends when there’s a specific advantage to paying yourself in that structure. What’s important from the bank’s perspective is consistency.
Going back and forth between certain payment structures puts you at a disadvantage as a borrower. Banks don’t see dividend income the same as they see salary income, even if it’s from your own business. So if you’re planning on making real estate moves, it’s important to plan ahead! isn’t to say Your accountant isn’t wrong by switching you from one to the other, there can obviously be a benefit. The lender sees it differently, which is why planning ahead is key!
Contact the Kyle Miller Mortgage Agent team to learn how to prepare for the tax season if you plan on buying this year!
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