Real Estate Corporations: The Advantages of Holding Companies

Hello real estate investors and fellow real estate professionals,

I was presenting the cost and benefit of incorporating rent to own real estate to a group of investors last night in Thornhill. One investor asked the question “why couldn’t we eliminate the holding company in the three tiered structure to save money?”

RealEstateCorporationStructure4

Great question! Business Vancouver had a great article talking about advantages of using a holding company. I’ll share a link with that article here.

Let’s see how these advantages apply in the context of the three tiered corporation and the one structure without one.

Defer and save tax

I talked about the advantage of the three tiered corporation in my previous blog post. One of the major advantages of using the holding company is to defer and save tax. In the context of the real estate three tiered corporation, this is no different.

When the Property Management Company (PM Co) and the Real Estate Corp (RE Co) earn income, the dividend can be declared to the shareholder, in this case, the Holding Company (Hold Co) on a tax free basis. You can save the money in Hold Co, wait until you need the cash and declare the dividend to the shareholders at the appropriate time.

In the two corporation structure, the PM Co and the RE Co will both keep the money in their corporations, again, you can achieve the same benefit to defer and save tax by retaining the cash in the RE Co and PM Co.

Now, in the article it also mentioned that the holding company allows the dividend to be accumulated for reinvestment in other assets. This can be done in both structures.

In the three tiered corporation structure, after the dividend is declared to the Hold Co, the cash is kept and accumulated until it is enough for another downpayment.   It can then be loaned back to the Real Co for future investment.

In the context of the two corporations, after tax income is accumulated in the respective companies. There are two ways to reinvest the cash in the PM Co. One, you can declare a dividend to yourself, report tax in your personal tax return and reinvest the after tax money into RE Co.

Two, PM Co can lend the after tax money directly to RE Co for reinvestment with no tax effect. This way, the two corp structure basically achieves the same result as what the three tiered structure does. The full after tax money at the corporate level can be preserved similar to what the three tiered corp structure does.

Protect your assets from creditors

With the three tiered corporation, our clients usually distribute the retained earnings to Hold Co on a periodic basis. This strategy eliminates all of the cash available in both PM Co and RE Co.

If any accidents or any third party liability arise in the RE Co, there is very limited amount of equity left in the company.   If any claims against PM Co happen, there is again very limited amount of money left in PM Co.

On the other hand, with the two corporations, if any creditors are going after the asset in RE Co, unfortunately there is less protection given that all cash is retained at the corporation. Although it is rare, if something happens to the PM Co, where all the cash is on loan to RE Co, theoretically the loan can be called upon and RE Co may have to repay it immediately.

This is where the Hold Co makes a difference in the structure.

Other points mentioned in the article

The article also mentioned the advantage of capital gains tax exemption. Only small businesses that qualify for small business deduction are eligible for capital gains tax exemption. In our case, it is very unlikely there is any buyer interested in the PM Co, which is the only company that qualifies for the small business deduction. Having a Hold Co would not affect the status of being a specified investment business, which cannot qualify for the capital gains tax exemption.

The article also speaks to the opportunity to split income to minimize tax. With proper planning, both structures allow you to split income to minimize tax.

Your real estate tax accountant,

Cherry

 

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.
5 replies
  1. Cheryl Boch
    Cheryl Boch says:

    I am curious, if you have a property in mind that you would like to make an offer, is it possible to give an offer without having the corporation in place. Then if the buyer & seller agree on a price, to THEN contact your lawyer & set up this structure? Or do you need to have this in place prior to making the offer? If it’s possible to make the offer prior to having the structure in place, how do you sign your offer?

    Reply
    • Cherry Chan, the Real Estate Accountant
      Cherry Chan, the Real Estate Accountant says:

      Yes it’s definitely doeable. You will have to contact the lawyer who knows about setting this structure up and make sure everything is done properly. Coming out from a real estate background, some sellers can be offended if you purchase the property in the corporations. You have to proceed carefully Cheryl. Speak to someone that knows how to set this up before proceeding.

      Reply
  2. Claudia Espindola
    Claudia Espindola says:

    Hello, I’m thinking of buying an investment property, so the best way is to setup the 3tired Corp first and have the Corp buy the property?, can I be employed by either the prop mgmt?, to own a real estate Corp do u need to fulfill some requirements?, thank you

    Reply
  3. Cherry
    Cherry says:

    There’re no specific requirement to own a real estate corp.

    But depending on your situation, if this is the first property you are buying, I would not start with a 3 tiered structure.

    Reply

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