# The benefits and cost of incorporation of real estate



## GeniusBoy27

My apologies for the delay in posting this. 

First off, if you're going to do this, get professional advice from both a real estate lawyer and a good chartered accountant. I will also caveat this by saying I'm NOT an expert, and would welcome editorial/clarification help from others. This is how I see how we've structured our family's properties, but I may be biased from the particular way we've set it up.

I think there are a number of different entities for real estate, including partnerships, joint ventures and REITs, but I want to focus on corporations.

This play is for those of you who are starting to have multiple housing properties, and have concerns about a number of issues. Let me highlight some of the benefits and costs of setting up a corporation, and then conclude with an example of our structure.

*Benefits of Setting up a Corporation*

1) *A Corporate Entity:*I think one of the biggest positives is the concept that a company is an "entity", so that it doesn't die when the individuals die. It makes transferring of property easier with different classes of shares.
2) *Ease of Transferability:* This leads to the ease of transferring properties, because shares are more easily moved than a property per se.
3) *Tax Benefits:* A corporation is liable at a lower tax rates. For example, dividend income (at the marginal tax rate of 46%), would be treated at about 31%. This allows shifting of the tax burden to lower income family members to limit the amount of personal tax paid.
4) *Limiting Personal Liability:* The corporation is also important in limiting personal liability, if something happens at a property. This arm's length relationship provides a piece of mind. (Note, that if you do something criminal, you're still personally liable.)
5) *Retained earnings for reinvestment*: I think another benefit is that you don't always have to take money out, and you can target and reinvest for other properties and/or investments.
6) *Ability to claim management costs:* Since you've got to spend time managing all these properties, you can claim the management expenses.


*Costs of the Corporation*

1) It costs money to set up a corporation, both in legal fees (approximately $750), and the annual cost of keeping the books for each company (this figure would vary depending on the number of poperties.).
2) Need to set-up a board of directors and have an annual meeting (for most family corps, it's over dinner), with minutes, etc.
3) If the corporation makes money, it needs to pay tax, and if dividends are paid out, there's tax on that too. In general, the overall tax benefits are better under the corporation structure.

*Structuring of the Corporation*

1) There are many different ways to do this. How we've done it, is 1 property, 1 company, with a holding company overseeing this with differential shares for different members of the family. So that there are a board of directors for each company, and a board of directors of the holding company. 

This allows different dividend "payouts" dependent on the class of shares and can act as a tax efficient income splitting method. However, having each separate building as an entity, means that each building is responsible for the legal responsibility of paying for costs. If the structure is done correctly, it could provide a very efficient passive income, limiting risks, and provide improved tax efficiency within family members and/or friends.

Just a few quick thoughts. Look forward to the comments.


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## Berubeland

What do you think would be the smallest size building that you could hold within a corporation? 

What is the difference for getting the mortgage?


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## FrugalTrader

Is rental income considered "passive" within the corp? As well, if you get an investment mortgage, wouldn't you need to personally guarantee it, thus reducing the benefit of liability protection?


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## Cal

GeniusBoy27 said:


> *Costs of the Corporation*
> 
> 1) It costs money to set up a corporation, both in legal fees (approximately $750), and the annual cost of keeping the books for each company (this figure would vary depending on the number of poperties.).
> 2) Need to set-up a board of directors and have an annual meeting (for most family corps, it's over dinner), with minutes, etc.
> 3) If the corporation makes money, it needs to pay tax, and if dividends are paid out, there's tax on that too. In general, the overall tax benefits are better under the corporation structure.


The costs of the corp are pretty minimal in the big scheme of things.

And you are able to control when/how the dividends are paid, so even though you are taxed on the dividends, there are ways to reduce the tax burden.


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## 72camaross

I would love to know a lot more details about this so I could bring it up over our family dinner and see if it is something we can pursue. Do you have any links or resources you would recommend to look into this?


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## FrugalTrader

This was a guest post on MDJ by a 30 something millionaire who incorporated his rental properites.


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## GeniusBoy27

Berubeland said:


> What do you think would be the smallest size building that you could hold within a corporation?
> 
> What is the difference for getting the mortgage?


I think there's no restriction on the "size" of the building to hold within a corporation. One of my friends owns about 100 units in Winnipeg, and each building has its separate corporation from the small single sized condos to the mutli-unit residential building.

For mortgages, in theory, there should be a higher corporation rate, usually prime + 2-4%. However, in practice, especially with multiple mortgages, this is negotiable. All of these are going to have to be backed by some sort of asset for banks to want to loan, and that usually means, your private residence or the value of your other real estate/other investments. However, with this type of collateral, you can bring it down to residential rates.


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## GeniusBoy27

FrugalTrader said:


> Is rental income considered "passive" within the corp? As well, if you get an investment mortgage, wouldn't you need to personally guarantee it, thus reducing the benefit of liability protection?


You're absolutely right, FT. Rental income isn't "passive" within the corp, but I view it, as passive in the sense that really the corp is a flow through mechanism to provide income in a more tax efficient manner with minimal work.

And as I just said to Berubeland, you're right ... early on the personal guarantee reduces liability protection, but over time, when you leverage off paid-off investment properties, this will increase your liability protection. If structured correctly, eventually these properties will have no mortgages, and you can leverage until other property purchases.


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## GeniusBoy27

I should also add as a cost, if your property is currently owned, the costs of land transfer tax and associated transfer costs to a corporation. So that if you only own 1-2 properties, this idea probably isn't for you, with the additional PITA factor for reporting.

72camaross: what else would you like to know? Most of my knowledge comes from doing it, and learning from my accountants and real estate lawyer. Perhaps, we could discuss this in the forum so others (including myself) could learn?


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## 72camaross

FrugalTrader said:


> This was a guest post on MDJ by a 30 something millionaire who incorporated his rental properites.


Thanks FT. I believe I read that before, great read which always leads to more articles via the links in the comments haha. And that is how I burn an hour... 



GeniusBoy27 said:


> I should also add as a cost, if your property is currently owned, the costs of land transfer tax and associated transfer costs to a corporation. So that if you only own 1-2 properties, this idea probably isn't for you, with the additional PITA factor for reporting.
> 
> 72camaross: what else would you like to know? Most of my knowledge comes from doing it, and learning from my accountants and real estate lawyer. Perhaps, we could discuss this in the forum so others (including myself) could learn?


I guess I am looking to learn if creating a corporation will work for my situation and from there seeing the tax benefits will out weigh the cost of the corporation. It looks like from some of the reading I really need to talk to a real estate lawyer and a good accountant...unfortunately neither really exist in my town. We have lawyers that do everything and we have accountants...well we've been through 3 in less than 2 years so take from that what you will.

My Situation: 
I'm interested in trying to explain the pros and cons of something like this to my family. In the family we have 3 businesses, 4-unit apt house and soon (within a year) a residential house to rent plus we all have our own homes. My brother-in-law and I are toying with the idea of some rental units so I was just looking for our best way to go about everything. 

So if I have this right you have 1 corporation which owns a Holding company. That Holding company owns multiple companies and each of those owns 1 property?


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## GeniusBoy27

That's correct. I think you have to look at how to separate and distribute equity in a tax efficient manner. For me, it's important, because we're high income earners, and we don't necessarily need the money immediately, so that the profits can be kept in the corporation to help purchase future properties.


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## FrugalTrader

At what point can the corporation obtain an investment mortgage without a personal guarantee?


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## GeniusBoy27

FT: 

Well, you need to put down about 35% to get the usual commercial mortgage rates.

But to get personal rates, I would think you'd require some guarantee from equivalent assets.


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## Berubeland

One Owner I was working for had the building for 18 years and he still had to provide a personal guarantee even though it was like half paid off.


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## GeniusBoy27

i'd be interested if he got the preferential interest rate though ...


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## kcowan

They will ask for it whenever they can. But a refusal and some negotation with competitors is your only option.


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## Berubeland

3.75% interest rate 5 yr term around March of last year and 4.50% 10 yr term CMHC Insured


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## ehobah

Thanks for the great post. I would be interested in knowing specifically how you set up that one corporation for one of your house. Corporation terms, types of shares etc. 

I'm currently thinking of buying a property for rental purposes with a partner, but it would be the case of me providing the majority of the finances and him providing the operational experience. What are some of the issues we should be considering while incorporating off the top of your head?





GeniusBoy27 said:


> My apologies for the delay in posting this.
> 
> First off, if you're going to do this, get professional advice from both a real estate lawyer and a good chartered accountant. I will also caveat this by saying I'm NOT an expert, and would welcome editorial/clarification help from others. This is how I see how we've structured our family's properties, but I may be biased from the particular way we've set it up.
> 
> I think there are a number of different entities for real estate, including partnerships, joint ventures and REITs, but I want to focus on corporations.
> 
> This play is for those of you who are starting to have multiple housing properties, and have concerns about a number of issues. Let me highlight some of the benefits and costs of setting up a corporation, and then conclude with an example of our structure.
> 
> *Benefits of Setting up a Corporation*
> 
> 1) *A Corporate Entity:*I think one of the biggest positives is the concept that a company is an "entity", so that it doesn't die when the individuals die. It makes transferring of property easier with different classes of shares.
> 2) *Ease of Transferability:* This leads to the ease of transferring properties, because shares are more easily moved than a property per se.
> 3) *Tax Benefits:* A corporation is liable at a lower tax rates. For example, dividend income (at the marginal tax rate of 46%), would be treated at about 31%. This allows shifting of the tax burden to lower income family members to limit the amount of personal tax paid.
> 4) *Limiting Personal Liability:* The corporation is also important in limiting personal liability, if something happens at a property. This arm's length relationship provides a piece of mind. (Note, that if you do something criminal, you're still personally liable.)
> 5) *Retained earnings for reinvestment*: I think another benefit is that you don't always have to take money out, and you can target and reinvest for other properties and/or investments.
> 6) *Ability to claim management costs:* Since you've got to spend time managing all these properties, you can claim the management expenses.
> 
> 
> *Costs of the Corporation*
> 
> 1) It costs money to set up a corporation, both in legal fees (approximately $750), and the annual cost of keeping the books for each company (this figure would vary depending on the number of poperties.).
> 2) Need to set-up a board of directors and have an annual meeting (for most family corps, it's over dinner), with minutes, etc.
> 3) If the corporation makes money, it needs to pay tax, and if dividends are paid out, there's tax on that too. In general, the overall tax benefits are better under the corporation structure.
> 
> *Structuring of the Corporation*
> 
> 1) There are many different ways to do this. How we've done it, is 1 property, 1 company, with a holding company overseeing this with differential shares for different members of the family. So that there are a board of directors for each company, and a board of directors of the holding company.
> 
> This allows different dividend "payouts" dependent on the class of shares and can act as a tax efficient income splitting method. However, having each separate building as an entity, means that each building is responsible for the legal responsibility of paying for costs. If the structure is done correctly, it could provide a very efficient passive income, limiting risks, and provide improved tax efficiency within family members and/or friends.
> 
> Just a few quick thoughts. Look forward to the comments.


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## GeniusBoy27

Sorry about the delay, but I've been away.

I think the issues I would see with 2 different people setting up a corporation is that I would spend some time on how the payments and dividends will be paid out.

You can set-up different share classes, to allow for differential payments to be paid out, but I think you should really decide that before hand (then after, when arguments can be made). Furthermore, do you want to retain profits to reinvest. What are the buy out clauses for the other partner (if things don't work well).

What are optional areas of payment (so instead of you or your business partner getting the payment), do you want a spouse or someone else getting the revenue (and setting up a share class for these individuals?)

I have a different circumstance, since it's all in the family, so to speak. But I would suggest spending the few thousand and getting good real estate lawyer and CA advise on this matter.

On how it was set-up, we set it up as a numbered company, and we split the share classes to separate share classes for me, my wife, my parents, and my in-law parents. We pay differential amounts to each share class (if it makes sense). i.e. Class A shares to me, Class B to my wife, etc ..., but what the payouts are ... are determined by the class of share.


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## marina628

Berubeland said:


> What do you think would be the smallest size building that you could hold within a corporation?
> 
> What is the difference for getting the mortgage?


We looked into this in summer 2010.Corporations require 35%-50% down payments , you can set up a company with a single residential property.We are husband/wife owning 100% of corporation so we still have to guarantee the mortgage although it does not show on our personal credit.
For us I cannot justify the $3000 a year in accounting plus the start up costs to set up a holding company.Since we are buying for investment and don't need the income we have bought new homes and each year figure out the net revenue then have invested most of it back doing decks,fences A/C etc .
Even with 50% down banks have different rates for commercial mortgages vs residential.When our accountant ran all numbers and took into consideration interest rates and yearly costs we just went ahead and bought the properties personally.


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## marina628

I just wanted to add that my brother in law set up a holding company with about 10 other friends recently where each share was worth $500 investment , they pooled their cash to buy some property .They thought they can get mortgage in the business name but found out very quickly they need business to have 3 years tax filings and they still need personal guarantees.So they went through this process without doing homework .I think there is maximum of 6 or 8 people that can be on title as well.Before you jump into this , meet with the bank and ask them how these things work.

Marina


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## Quotealex

I'm curious as to why you didn't go instead for the three tier investment stucture:
1-Holding Company
2-Management Company
3-Real Estate Company

Where you own the holding company which owns both the management company and the real estate company(ies). By having the management company take care of all your properties affairs which are owned by your real estate companies, you increase your assets protection while reducing your taxes.



GeniusBoy27 said:


> *Structuring of the Corporation*
> 
> 1) There are many different ways to do this. How we've done it, is 1 property, 1 company, with a holding company overseeing this with differential shares for different members of the family. So that there are a board of directors for each company, and a board of directors of the holding company.
> 
> This allows different dividend "payouts" dependent on the class of shares and can act as a tax efficient income splitting method. However, having each separate building as an entity, means that each building is responsible for the legal responsibility of paying for costs. If the structure is done correctly, it could provide a very efficient passive income, limiting risks, and provide improved tax efficiency within family members and/or friends.
> 
> Just a few quick thoughts. Look forward to the comments.


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## GeniusBoy27

Quotealex: Sorry, I've been offline for a few months, because life got crazy. I've put the management and the real-estate companies under 1 entity. What are the tax benefits of your suggestion?


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## Quotealex

A real estate company is considered passive (if you have I beleive less than 3 full time emplyees) and hence are taxes at the highest rate where as a management company is considered and active business and therefore has a lowere taxe rate. The idea is to have the real estate only own the property have the management company run the operation....



GeniusBoy27 said:


> Quotealex: Sorry, I've been offline for a few months, because life got crazy. I've put the management and the real-estate companies under 1 entity. What are the tax benefits of your suggestion?


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