Purchase and sale of commercial real estate by a medical professional

Introduction

What makes Medical Professionals different from many other professionals or business owners is that most Medical Professionals are HST exempt. That means that they pay HST on their purchases and do not get it back. So the cost of HST is very important to consider when structuring any part of their practice.

When a doctor decides it is time to purchase their own office there is more than just HST to consider. They must also consider income tax, creditor protection; Accounting and reporting requirements; and the eventual sale of their practice or the sale of the building. They must also be aware that they must ensure that their corporation continues to qualify as a Medical Professional Corporation.

  • Income Tax – Corporate or personal ownership
  • HST
  • The purchase
  • Daily operations
  • Eventual Sale of your practice
  • Creditor protection
  • Accounting and reporting
  • Qualification as a Professional Corporation

Income tax – Corporate or personal ownership

The first question I would like to discuss is how income tax will affect how the purchase is going to be funded. Generally the money to purchase comes from two sources, your savings are used for the down payment and the balance is provided by your bank as a mortgage.

If your practice is not incorporated and you purchase the property personally you are using after tax dollars to provide the down payment. That means to come up with a down payment of $100,000 you will need to earn $185,185 based on a 46% tax rate. If you were incorporated, the corporation would need to only earn $117,647 based on a tax rate of 15% to come up with $100,000. You can see that there is a significant savings to using a corporation. If your practice is not incorporated you should reviewing the benefits of incorporation on our website.

The benefit of using corporate funds to pay down the mortgage increases the savings by again allowing you to use after tax earnings at the corporate tax rate.

Income Tax – Corporate or personal ownership
Income Earned Personally
Income $185,000
Personal Tax $85,185
After-tax Funds $100,000
Income Earned by a Corporation
Taxable Income $117,647
Corporate Tax -$17,647
After-tax Funds $100,000

HST

HST is an issue at the time of the purchase, throughout the ownership of the property, and again on the eventual sale of the property. In almost all cases a doctor is an exempt supplier and is therefore not registered for HST. That means they do not get the HST paid back.

The purchase and eventual sale

Where a doctor is buying a residential property to convert to commercial use, there is no HST payable at the time of the purchase. Where a doctor is buying a commercial property in Ontario, HST of 13% must be paid by the purchaser at the time of the purchase. If you are buying a unit in an office condominium or a store front building, it is pretty easy to determine that you are buying a commercial property. If however you are buying a single family house to use as your office it can be a little more of an issue.

The determination of whether a house is residential or commercial for HST purposes depends on the use of the property at the time of its sale. If the vendor or a tenant is living in the house, generally it will be residential; if the house is being used as an office, it is commercial. Often the agreement of purchase and sale will indicate what the property is used for; however you need to be careful. Simply saying a property is used for residential purposes, so as to avoid immediate HST does not make it so.

It is your responsibility to ensure you know what the property was used for. If the vendor has represented it was residential and it turns out it is actually commercial CRA will still ask you to pay HST. If CRA comes in a few years after the sale, interest and penalties could be assessed as well. At that point you need to speak to your lawyer to see if you can chase the vendor for damages.

A way to avoid this risk is to include the following comment in your purchase and sale agreement: “HST if applicable is included in the price”. If in fact there is no HST on the sale then, no problem. If there is HST on the sale the Vendor will need to deal with it.

Where the property is commercial and HST is being paid, there are two ways for the HST to be dealt with, depending on the registration status of the purchaser. Where the purchaser is registered, the purchaser self assesses. This could be the case if a doctor used a registered holding company to complete the sale. The purchaser would pay the vendor just the net purchase price and then file an HST return that shows 13% owing on the purchase and claim an Input Tax Credit of 13% to offset the liability to zero. If the purchaser is not registered, like most doctors, the vendor of a commercial property is required to collect the HST from the purchaser at the time of the sale. The vendor then remits the HST to the CRA.

Where the purchaser was not registered and actually pays HST on the purchase the purchaser will get this HST back when it sells the property. So it is important that the purchaser is able to show that HST was in fact charged. Where the HST is paid in addition to the purchase price it is easy to support the payment of HST, however where the agreement of purchase and sale said “HST if applicable is included in the price,” then you must show that HST was in fact applicable. If there is nothing else in the agreement, the onus will be on the purchaser to show that HST was in fact chargeable.

Let’s work through an example, if the purchase price of the building was $1,130,000 and the contract says that “HST is included in the price if applicable.”

If HST was applicable the price would be considered to be $1,000,000 and the vendor would remit $130,000 to the CRA as HST on the sale. The unregistered purchaser would pay the full $1,130,000 however they would get credit for the $130,000 on the eventual sale of the property. When claiming the Input Tax Credit, it is very important that you are able to show that HST was included in the price, as well as that HST should have been charged on the sale. As noted above, the best proof is the vendor acknowledgment. If you are unable to get this acknowledgment, you should at least get support for the fact that the building is in fact a commercial property. You want to ensure that the vendor cannot claim that someone was living in the building. I would also ensure that the lawyer completes the closing statement to show the net purchase price plus the HST.

On the eventual sale of the property, that you have been using for commercial purposes, your medical practice, you will need to charge HST on the new sale price. This will of course affect how much you can sell the property for. Where you originally purchased the property and paid HST, you will be able to claim back the HST paid on the purchase. Where you did not actually pay HST, such as in a case where you purchased a residential house and converted it to commercial, you will not get a refund of any HST.

If we use as an example a sale price of $1,500,000 plus HST you can see how you can recover the HST paid on the purchase assuming a purchase price of $1,000,000 plus HST.

Sale of Property – HST Included
Corporation
Sale Price Inclusive of HST $1,695,000
HST on sale -$195,000
Net Proceeds $1,500,000
Individual
HST to Remit – where no HST paid on purchase $ 195,000
HST to Remit – HST paid on purchase -$130,000
Net payment $65,000

The HST rules will apply in the same way regardless of whether your practice is incorporated or not.

A twist on the rules would be if you used a holding company to purchase the property and then rented the property to your medical practice, whether incorporated or not. The benefit of using a holding company is that it would be registered and if HST was applicable at the time of the purchase you would not need to pay it. The HST would be paid on the eventual sale by your holding company to a new owner. The downside of using this structure is that the practice using the building would end up paying HST on the monthly rent. This is discussed below.

Daily operation

Where you decide to use a holding company to own the property and you get the immediate benefit from claiming the HST on the purchase, you will now need to charge the medical corporations rent. Each corporation is a separate legal entity and transactions between them must be at fair market value. That means if the medical corporation uses the property owned by the holding corporation, the medical corporation must pay rent at fair market value. When rent is charged, HST will be payable.

The rent charged must cover the gross operating cost of the building, including property taxes and insurance. It should also provide an amount for base rent. You could ask your real estate agent for estimate of fair market value (FMV) rent.

If we assume rent of $ 4,000 per month, or $ 48,000 per year, plus other expenses of $ 24,000, that means a total rent of $ 72,000. This represents expenses that would not normally be subject to HST; however, you would now be paying HST of $ 9,360 per year as part of your rent.

Where you hold the property directly in the medical corporation or personally as part of your practice you would save the HST.

Creditor protection

Creditor protection should also be considered. If the property is owned by the medical corporation or by you personally as part of your practice, it would be exposed to the creditors of the medical practice.

Where we are not dealing with a medical professional, i.e. businesses that are registered for HST, we often use a separate holding company to own the real estate to provide some amount of creditor protection.

The problem that medical professionals have is that they now must pay HST on their monthly rental amount as discussed above. Most doctors consider the extra cost for creditor protection to be too high.

Eventual sale of your practice

Another issue to consider is what happens on the eventual sale of your practice. If your practice is incorporated and it is the owner of the building, a sale of the Medical Professional Corporation shares would include the building.

It is possible to split the ownership of the building and the practice; however it would be a complicated and expensive process.

One of the benefits of selling the building and the business together on a share transaction is that the gain might be sheltered from tax by using the $800,000 capital gains exemption.

This is an area you should speak to your accountant about before starting the sales process.

Qualification of your Professional Corporation

Another question I get asked is, how will the ownership of a building affect the qualification of my corporation as a Medical Professional Corporation?

If you will be renting the building to other businesses or professionals outside of your practice your Professional Corporation may be offside under your college’s requirements. Under the legislation a Medical Professional Corporation may only provide services of your profession.

To answer this question, you should look at both the Business Corporations Act (“OBCA”) and the Regulated Health Professions Act (“RHPA”).

The OBCA states that:

5. The articles of incorporation of a professional corporation shall provide that the
corporation may not carry on a business other than the practice of the profession but
this paragraph shall not be construed to prevent the corporation from carrying on
activities related to or ancillary to the practice of the profession, including the
investment of surplus funds earned by the corporation.

Where you intend on using the building to rent to someone outside your practice and you will need to borrow to make the purchase you should consult your lawyer before making the purchase.

Accounting and reporting

Each additional land holding corporation will add about $1,500 to your annual compliance costs.

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