# Part Time residential development - incorporate or not?



## nobleea (Oct 11, 2013)

I have an acquaintance that is buying lots in mature areas, splitting them and putting up larger houses. This is something that is essentially a dream job for me, but until now it has seemed daunting. Knowing someone who has/is doing it makes it seem a little more realistic. I am not going to do anything until at least mid-2014, but there's a lot of questions I have, particularly on the corporate set up.

The background is that my wife and I will continue to work our normal, professional jobs. I expect to complete 1-2 houses every 18-24 mo, so it will not be consistent.

If I buy the lot/house jointly with the wife, we do the tear down and rebuild in our names, and then sell, I think the tax situation is pretty straightforward. This should be a capital gain, split evenly between us, with half of our respective gains taxed at our marginal rate (39% in my case, 36% in her case). Given that this would happen at most once a year or less, and the capital gain would be equivalent or less than our incomes, I think CRA would be ok with it being claimed as capital gains rather than income. Getting a mortgage is easy and cheap.

The acquaintance I know has set things up differently, and I'm trying to figure out the benefit. He has a holding co that holds the title and does the development. Then the net gain is passed out to him and his wife in dividends, slowly (they also have regular professional jobs that they keep). But wouldn't the corporation still have to pay capital gains taxes? Is it considered capital gains if that's the only thing the corp does is developments like this? Or would they consider it income, if income would it be passive or active? I've not been able to find the capital gains tax rate for corporations in Alberta, but I thought I read somewhere that it can be similar to personal capital gains taxes. If the capital gains tax for a small corp is half of the income tax rate, which in AB is 13% for small businesses, then I can see a benefit to it.

One thing about a corporation doing this is it would have a tough time getting mortgages as there is nothing in terms of assets or income. I have read that it is possible for an individual (a director or shareholder in this case) to get the mortgage in their name, in trust for the corporation. This would mean the mortgage is based on the individual's income and assets (in this case, me). This avoids the involvement of commercial lenders.

I assume that if a corporation like the one described above were to pay out dividends, they would be non-eligible. A question on dividends - is the dividend tax rate based only on your dividend income? Or on all your income? For example, if you have 120K in regular income and 40K in non-eligible dividends, is the tax rate on the divvies 10.21% or 27.71%? (http://www.taxtips.ca/taxrates/ab.htm for 2013). I've always assumed it would be the 10.21%.

Obviously, if I were to go through with it, I would discuss in detail with an accountant. Lots of questions there I guess!


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## Taraz (Nov 24, 2013)

If you were just building yourself a new house and selling it, you wouldn't have any capital gains due to the principal residence exception. However, if the CRA believes you are doing it as a business, you would be required to report it as employment income (not capital gains). 

If you're just going to build one at a time for yourself, (i.e. less than one a year) and you're going to sell them as used homes (not new homes), you should see if your accountant thinks you could get away with just using the principal residence exemption. After all, I haven't seen a law that says you're not allowed to move every year.

As for your friend, especially if he's doing a lot of development, it probably makes sense to keep the money in a corporation because then he can pay it out as dividends (instead of straight self-employment income).


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## nobleea (Oct 11, 2013)

Yes, that is an option, though it definitely gets in to a grey area. There's no way I would move my family every year, and there's really no declaration necessary to change your primary residence. I know some people don't actually move, just change some addresses on bills and such, but it seems a tad unethical, especially since we wouldn't be selling or moving out of our current home.


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## Taraz (Nov 24, 2013)

Then I'd double check on the capital gains. I think you'd end up having to pay ordinary income tax, not capital gains, since you're actually doing work on the property (not buying and holding). Another alternative would be to buy rental properties, rent them for a while to people with pets (since you can charge more rent that way) until they're pretty much trashed, then do your house flip. That's a lot more work, but then you'd probably be more likely to get away with claiming it as capital gains instead of employment income, since it would be more of a long-term investment.

At any rate, a corporation is probably the most simple solution.


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## nobleea (Oct 11, 2013)

My friend is renting the houses out before demoing them. Just for 2-8 months while the rezoning application and home design goes through the motions. Would that kind of rental income change the capital gains equation if it was held personally? Or would it have to be longer than that


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## OptsyEagle (Nov 29, 2009)

One consideration, which is not pertaining to your tax question, is the issue of how viable of business these developments really are. When house prices are rising, many people who bought fixer uppers and made improvements and then sold them at a much higher price, tend to believe that the profit was mostly derived from their hard work and entrepreneurial efforts...when really it was just the fact that the developments took a considerable amount of time and the real estate prices magically rose during that time frame.

The question would then arise; what would have happened to those same developments during a general decline in real estate prices. Most developers would not see anywhere near the profits they did in the past. Now this can not only become very dissappointing, since a tremendous amount of work can go into them that doesn't get paid for, but since they usually require excessive bank leverage, they can quickly turn into a personal bankruptcy long before the markets turn back in your favour.

Just keep that in mind while you are considering this. I am positive 1000s of American's sure wish someone told them this story before they ventured into the same game, 5 or 6 years ago, that you are considering now.


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## nobleea (Oct 11, 2013)

OptsyEagle said:


> One consideration, which is not pertaining to your tax question, is the issue of how viable of business these developments really are. When house prices are rising, many people who bought fixer uppers and made improvements and then sold them at a much higher price, tend to believe that the profit was mostly derived from their hard work and entrepreneurial efforts...when really it was just the fact that the developments took a considerable amount of time and the real estate prices magically rose during that time frame.
> 
> The question would then arise; what would have happened to those same developments during a general decline in real estate prices. Most developers would not see anywhere near the profits they did in the past. Now this can not only become very dissappointing, since a tremendous amount of work can go into them that doesn't get paid for, but since they usually require excessive bank leverage, they can quickly turn into a personal bankruptcy long before the markets turn back in your favour.
> 
> Just keep that in mind while you are considering this. I am positive 1000s of American's sure wish someone told them this story before they ventured into the same game, 5 or 6 years ago, that you are considering now.


Thanks. I'm quite comfortable with the costs side of the equation and relatively comfortable with the selling side of the equation. To be clear, this isn't fixer upper/flips. This would be tear down and either subdivide and build, or just build new. In specific, desireable neighbourhoods that already have million dollar homes in them (as well as 400K fixer uppers). Many people can't be bothered to do a tear down/rebuild or live through a renovation, but will pay extra to live in a centrally located, desireable neighbourhood. In Edmonton, where I live, we have the most affordable housing of any major centre in Canada. And some of the highest incomes to boot with massive growth in population. Our purchase to income ratio is around 3.5 right now, compared to Vancouver's 9. 3.5 is still on the high side mind you. Given that a lot could be purchased, house demo'd, new one rebuilt in about a year, the market would have to decline double digits in a year before the economics would start to get dicey.

Worst case scenario is that we carry the new house (or move in to it) as our current house will be mortgage free at this time. Not an ideal scenario, but would not put a crimp in our lifestyle one bit.


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## Taraz (Nov 24, 2013)

I suspect you couldn't get away with capital gains on that time frame, but check with an accountant to be sure.

Here's my accountant (also in Edmonton) if you're looking for one: http://www.christianthut.com/


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## wendi1 (Oct 2, 2013)

You incorporate to put a fire wall between your business and your personal assets. This doesn't always work, though. Banks might not lend a brand new corporation with no assets the kind of money it will need. If things go wrong, your BUSINESS goes bankrupt, instead of you, personally.


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