Should you incorporate your real estate business?
It depends. However, contrary to the majority’s advice, when considering medium to long-term perspective versus short-term perspective, in most cases, it’s better to incorporate. This idea stems from a couple of different thought processes, one of them being: “I don’t have enough properties, so I’ll set up an incorporation down the road when I have more properties.” While this makes intuitive sense, there’s a consequence of going from personal ownership to corporate because you’re selling our property to the corporation.
While in most cases, you can file for a tax election to defer that tax, this requires tax planning work, completion of the election, and documentation, among other expenses. So one may think: “Why go through that process if I can avoid it?” Although the corporation is underutilized in the first couple of years, this is probably still better than paying the cost of transferring the property. This is incredibly tempting when one is in a territory with a land transfer tax that can get expensive quickly! While different places have different rules for what is exempted, the exemptions don’t apply more often than not, and it becomes the most costly part of the transaction.
From a long-term perspective with regards to last will and testament as well as successions, a real estate investor may be able to save around 25% of his portfolio’s overall value by using a corporation. This is something that can’t be done when on a unique design. There’s also no income splitting in your preferred way. There isn’t any flexibility offered by corporations when it comes to not dealing with land transfer tax and other similar expenses. Therefore, incorporation becomes a more accessible vehicle to jump into a family trust or different types of structuring, which can help minimize tax costs.
However, for a personal investor who, for example, is looking to buy condos at about $100,000 range, and that’s all he has his sights on without legal concerns, corporations are not needed. But when one gets more severe down the road, getting it right the first time will ultimately lead to more tax savings.
What is a substantial portfolio-what does that mean?
This is one of the most common questions investors have. In a dollar value, if an investor has 1.5M worth of property over a 3-5 year period, a corporation most likely makes the most sense. However, with today’s property value, 1.5M is not a significant number to get to for that period. Given the current prices, “substantial” may be anywhere from $5-6M. Meeting with a tax business advisor or real estate accountant to get professional and personalized advice is imperative.
One of the most misunderstood parts of real estate investing is the tax rate. Again, tax rates may vary depending on the investor’s location, but roughly speaking, there may be an initial tax of as much as 50%-almost as bad as one’s tax rate. But in context, in an individual tax rate setting, that 50% tax is as good as gone and the investor can never get it back, whereas, on the corporate side, about 30% out of that 50% is refundable if a dividend is paid at some point in the future. This makes the net tax (corporate) at about 20%. Furthermore, splitting the tax is possible in a corporation. Being in a corporation gives investors options, and you never know when these options may come in handy in the future!
In real estate, where you start can be very different from where you end, and along the way, things will happen. The flexibility and options provided by a corporation can be incredibly beneficial. Why not put yourself in a position where you can enjoy more tax savings?
What is the “three-tier structure”?
The three-tier structure is designed for use by real estate investors and comprises three corporations. There are now different versions of the “three-tier structure,” which is unfortunately used too frequently nowadays. Before tax and finance changes, some investors used the three-tier structure. However, the rules have changed. Back in the day, those with a three-tier design were allowed to pay money from the subsidiary company to the parent company on a tax-free basis. Today, one is required to have a “safe income.” If someone who has a long-term hold rental property refinances a property before, they would pay that up as a dividend to the parent company and then redeploy tax efficiently. Today, this is treated as a capital gain and triggers a double tax.
Remember: It’s alright to have a more significant tax (meaning business is doing great!) provided you don’t pay any extra taxes you could have avoided. It’s not about spending the least tax but paying the right amount of tax. Always remember that structures can change over time. Have that quick conversation with your advisor. Don’t run the risk of missing out on doing something outstanding in the future by sticking with something that was working in the past but may not necessarily be working in today’s market.
If you’re ready to take your investing career to the next level, contact us to find out how we can help!
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