By: George E. Dube, CPA, CA
We frequently receive requests to set up property management companies for real estate investors, even when they only manage properties that they own. When we receive these requests, we first examine the clients’ reasons for creating the company, and second, ensure that the clients are aware of the advantages and the drawbacks, before we leap head first into creating a new property management company.
7 Potential Advantages of Property Management Corporations
- When properly done with a separate corporation, the property management company can be used by investors to convert “inactive” income into “active” income. The significance of this is that depending on the relevant province, inactive income is typically initially taxed at approximately 45% whereas active income may be taxed at roughly 15% (25% after taxable income of $500,000 for the most part, but as in most areas of tax, exceptions exist). Peeling off some profits and saving 30% in taxes is clearly attractive. That being said, the 45% inactive tax rate has a 26 2/3% refundable tax (RDTOH) which may negate the need to convert the income as the net corporate tax could be approximately 19% depending on the province and the tax planning you have completed with your advisors.
- By talking with your lawyer, you can learn whether your legal advisor believes the company can help isolate legal issues. For example, contracting through a company which owns few if any assets may be better should something go sideways, compared to negotiating deals in an entity which owns a few pieces of real estate.
- Decide how you want to manage expenses and payments. Some investors, such as my wife and I, use the property management company to track our entire portfolio. By having all, or most, of your expenses flow through one company (allocating on a regular basis the activities to the owner of the property) you can quickly compare and note trends in your properties. I’ll allocate the activities for each property on our corporate year-end as I find monthly allocations more of a needless chore. But to each their own. Furthermore, I like using one company for paying most property expenditures in that I always know which entity can pay the bill but not necessarily which company owns the particular property. Much easier to carry a few cheques from one company, and be able to electronically pay from one entity, as compared to a handful of them as the real estate portfolio grows. On the reverse side of things, running all of the revenues and expenditures through one company and then regularly allocating these amounts can create confusion on the bookkeeping side. We have found the majority of our clients get frustrated attempting this.
- You may want to combine a few activities which generate active business income within a single corporation. Over the past several years, we have done this personally and with our clients, where we have seen more hesitation from financial institutions to fund properties where non-real estate revenues are combined in the same entity with rental activities. Putting various revenues in the same corporations can save in reducing the number of corporations needed to conduct all of your activities and thus save costs and confusion. For example, in one company, we see property management, consulting, coaching, asset management fees, assignment fees, acquisition fees or even carried a little further, but subject to financing and legal concerns, flipping properties or RTO’s (rent-to-owns).
- With additional sources of revenue at a corporate level, you may have the opportunity for income splitting with your family. While we would often first use up income generated from inactive sources, this may not be appropriate, sufficient or available in your case or at a certain point in time. Typically, splitting income between family members results in decreased taxes for the family unit. Furthermore, additional opportunities may be created to use corporate tax dollars to fund additional real estate acquisitions when properly structured. Investing with an 85 cent dollar is typically much more effective as compared to investing with what is frequently on the personal side somewhere between a 70 to 50 cent dollar.
- Generating cash flow on joint venture deals is possible. We are seeing an increasing number of our clients charge their co-venturers an acquisition fee up front or an ongoing asset management fee. This helps generate a little cash flow as compared to waiting for a longer period of time to realize the benefits of the improving financial condition of your property, refinancing, or the ultimate sale. A word of caution: ensure an allegation of acquiring an underperforming or mediocre property for a co-venturer just to pick up these additional fees is virtually impossible to make. Charging these fees though can help remind your investors that your time and/or knowledge are worth something.
- If you’re good at managing your properties, perhaps you can help others with their portfolios or otherwise coach them, while earning a little money for yourself at the same time.
4 Potential Drawbacks of Property Management Corporations
- Once revenues in associated activities are over $30,000, GST/HST must be charged on fees such as property management. If you are investing in most residential properties, you are prohibited from charging GST/HST and thus are denied a refund of the input tax credits you pay. Put another way, your company may need to charge you GST/HST on the property management fees yet you cannot claim a refund in the company paying those taxes. While you can deduct these taxes, effectively you’re eating the GST/HST. Not the end of the world if you’re in Alberta for example with their current GST only taxing measures, but in most provinces creating an extra 13% or so of combined taxes will eat into much of the advantage of the spread in active and inactive rates. It can still make sense for higher income earners; it just seems an unfortunate waste of tax money, but it takes money to make money.
- At times, the property management company can create more confusion on the bookkeeping side. That being said, to combat this we frequently see the annual activities for each property simply recorded by the appropriate owner and the property management company charges an annual fee. This is much easier and provides the same tax benefits.
- There can be restrictions in certain provinces as to who is allowed to manage a property, or what properties you are allowed to manage, thus potentially restricting some benefits.
- Creating an extra company means additional accounting and legal fees for the set-up and ongoing maintenance of the entity. Although usually easy to see the net benefit, for smaller operations the additional costs may not make sense for the tax benefits provided. If there are other legal benefits or reasons to have a company, this analysis can be amended. However, there’s still a cost to additional companies.
You may benefit from inserting a property management company into your structure. Engage in a discussion with your tax, legal and financing advisors to determine what is right for you now, and in the future.
George E. Dube, CPA, CA is a veteran real estate investor and accountant. He has spoken, written various articles, and co-authored two books on real estate accounting. Reach George at: firstname.lastname@example.org or @georgeEdube.