Rental Properties – To incorporate or not to incorporate…

…that is the question. Put to me by FT and his request that I try to address the issue.

First, and most importantly, I am not an accountant, tax lawyer, or anyone else who makes money off the misery of others.

Second, my current corporate structure has evolved over time and I do not advocate one way over the other. Smarter people than myself will tell you better ways to do it, but these are my observations.

My Portfolio

I currently own four properties as follows:

  1. My personal property – owned jointly by my wife and I. This is not relevant to the discussion, but just thought you should know.
  2. One mixed-use property – owned in my wife’s name. It is a old house in the downtown that is commercial first floor and has two residential apartments upstairs.
  3. One residential duplex – owned 50% by myself and 50% by my partner. It is a house that I purchased with my buddy when we were in university. At the time, we squeezed 7 guys into the place over three years and pretty much demolished it. Subsequent to graduation, we converted it into a duplex (basement apartment) and now rent to a grad student and a nice family who take care of it for us. Not the most efficient use financially, but definitely the best use from a PITA (Pain in the A**) factor. There is an identical house across the street and the landlord gets 8 girls in the place and takes in almost triple the rent we take in. However, he is there almost every other day and that is his full time job.
  4. One mixed-use property – owned by a corporation which in turn is owned 25% by myself, 25% by my wife, 25% by my partner and 25% by his wife. This is a multi-unit complex with 5 commercial units and 3 low-income apartments.

Our Structure

As you can see, I don’t have just one solution for any model.  Each scenario was dictated by the circumstances at the time of purchase. For example, the first property I bought in partnership with my university friend just began as joint owners on the deed. At the time (we were 18 and 19), the house was our only asset, and we were using the cash flow from 7 guys to pay the mortgage. We had accelerated the payments and paid the thing off in 12 years. Neither my buddy or I required the income from the house after we graduated, so we ploughed every dollar it made back into paying off the mortgage as soon as possible.

Once the house was paid off, we started looking at other opportunities together.  The last property on my list was discovered by my friend in my hometown.  We looked at the potential and decided to go for it. The decision to create a corporation was made purely from an organizational point of view, as opposed to any specific tax benefit.  We were able to set up a shareholders agreement and loan the money to the corporation to purchase the building.

Using a corporation like this, we are not eligible for the capital gains allowance on this corporation and we would be subject to the capital cost allowance recapture when we sell the property. However, we have plans to tear the building down and redevelop.  For us, the corporate model worked.  We have even discussed including the other house in the corporate structure and establishing ourselves as a REIT (real estate income trust), but that is long term planning.

Finally, putting the other property in my wife’s name was based on the fact that she had some money saved up and wanted to invest.  After our kids were born, she did not want to go back to work, so this allowed us to use her savings to create cash flow for her, and let’s us legitimately income split.

Property Management Company

We did create a second corporation to act as a property management company. The property management company creates active income and can be eligible for the capital gains allowance. There is a caveat to this. If a property management company makes its money solely from one source which would be related, it can be deemed ineligible.  There are a series of rules about this and this comment is only based on conversations I have had with my accountant on an informal level, so do your own homework.

Pros and Cons

It used to be that a corporation would protect you from liability in the case of claims.  However, that is proving to be less and less the case as directors and officers are drawn into lawsuits. The key is having the right amount of insurance.

The corporation has additional costs with the annual filings, but we also have an annual shareholders meeting (which we can deduct) and get a chance to have dinner and discuss the corporate plans with our friends.

While the corporation is financially strong, no bank is loaning on the basis of the corporation alone and thus any future loans/mortgages would still require personal guarantees from the shareholders.

Conclusion

Perhaps there is nothing to be concluded by how I have things set up. It does appear to be a bit of a hodge-podge of systems and can be a bit of a nightmare from an accounting point of view. The property management company basically handles all the transactions for all the properties and thus simplifies things. It also leads to some confusion as to when some properties may be in deficit verses surplus, but I try to keep a handle on cash flow on a monthly basis.

For the real estate investor readers out there, how do you have your business structured?

QCash is a young retiree and self made millionaire. He has built his net worth up to $1.5 million by the ripe age of 36.  QCash writes the occasional article for Million Dollar Journey to share in his experience of obtaining a large net worth at a young age.

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QCashMan

QCash is a young retiree and self made millionaire. He has built his net worth up to $1.5 million by the ripe age of 36. QCash writes the occasional article for Million Dollar Journey to share in his experience of obtaining a large net worth at a young age. You can read our interview with him here.
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Paul L.
5 years ago

Hi! My Wife and I own some Income Propertys in Ontario .now we would like to include our Sons, which will trigger Capital Gains. would it be better if we incorporated the Partnership before transfering into a Trust with our Boys to lower C. G.?
I appreciate any little Help!
Paul L.

Jason
6 years ago

Hey FT, I really love your blog. You keep me motivated to keep making my own progress.

I’m wondering if incorporating provides any advantages that are not available to standard co-ownerships or partnerships.

For instance, you cannot claim mortgage payments as a deductible in a co-ownership or partnership, but couldn’t a corporation claim them as an expense? Doesn’t it show up on the P&L of a corporation?

In my case my expense deductions don’t offset my income and so I’m stuck with taxable income on my personal return. If I count my mortgage payments, I’m incurring a loss.

Maybe it makes more sense for me to setup a corporation to avoid false net profit or even reduce tax burden by taking dividends from the corporation if it really is profitable.

Am I on to something or am I missing something important?

Dan
7 years ago

FT, do you have any updates on QCash? I’m curious as to what his current financial situation is and what he thinks of the current markets

FT
7 years ago
Reply to  Dan

Good question Dan. I’ll ping him to see if he’ll post an update.

Mike
7 years ago

Hey Guys,

Just trying to revive this post as it has some great information. I just have a question. My partner and I have started personally buying investment properties. We are reaching the LTV ceiling and could probably squeeze out another 200k or so before the bank stops giving us money. Would setting up a corporation help us to move forward? I know it was mentioned that we would have to guarantee every property we hold in the corp. but does that mean we would need to get approved the same way if we personally purchased each property?

Basically, I’m just wondering if setting up a corp. is the way to keep moving forward when we hit the LTV road block.

Any other ideas are greatly appreciated.

Thanks,

Mike

MStar
9 years ago

Great discussion guys….I have a few rental properties…and I am on the hunt for an accountant that deals with Real Estate Investors…Any recommendations guys??? Thanks!

qmanrei
11 years ago

Talk to good accountant that works with real estate investors. They should be able to help you with the income gained from the property. Especially if you are in that tax bracket. If the CRA comes knocking nobody on the internet will be sitting down with you at the audit.

Mark in Nepean
11 years ago

Thanks FT!

If I understand what you’re saying correctly, I can claim a percentage (although small) of my TOTAL car expenses (loan interest, gas, maintenance, insurance etc.) for the year, as “business” for the rental unit.

That correct?

I’m keeping a log this year of my travel to and from the rental unit, so that should help me.

Mark in Nepean
11 years ago

Question…for QCash and others:

What “value” do you claim on your tax return when travelling to and from the rental unit? I know you can claim mileage for a tax deduction, but how?

Do you put a fraction of the gas amount paid? Line # 9281 for Motor Vehicle?

e.g., 200 city-km in one calendar year = 1/2 tank of gas @ $ 0.90/L??

Thanks in advance,
Mark

FT
11 years ago
Reply to  Mark in Nepean

Mark, I believe you can claim the car for rental properties only if you own more than 1 (maybe 2) units. Having said that, if you use the car for personal uses as well (as most do), you’ll have to keep a log of your km’s. So basically, you take the amount used for business vs the total amount for the year as a %. Add up all your car expenses (interest, gas, maintenance etc) for the year, then multiply it by the %.

Tory in Markham
11 years ago

I’m looking to become a landlord pretty soon, renting out a whole house that I inherited. I have been running some numbers and it seems that if you declare the rent as income, it’s hardly worth it! In my tax bracket, the government will take half. :(

I was curious….if you feel comfortable sharing….how many of you declare rent income as income?

If you do declare rent as income, are there any deductions that can be made to offset this?

Thank you!!

FT
11 years ago

Tory, Check out this post on rental property income and tax deductions.

qmanrei
11 years ago

You can also depreciate the property to negate the cash flow, but you would be taxed differently on sale. Build a good team first, to advise you appropriately. And again talk to your accountant.