January came and went. So has February.
For those of you who are wondering if I am still sticking with my 4:30am wake up time, it’s getting bigger and better.
March and April are the busiest time of the year as a public accountant. I convinced Erwin to get up to take care of the kids so I can take advantage of the focus work I do from 4:30am all the way to 11am, and some times even to noon.
This is the only time I can put my head down, focus on the work that I have to do and accomplish before starting a day full of interruptions at the office.
Contrary to what most modern businesses are designed encouraging collaboration among employees, I’m most productive when I can be alone, focused, and working on one task at a time.
Over the last weekend, I had the honour to speak at Investor Forum 2017.
Again, the biggest question asked was – should I setup a three tiered corporation? If so, what’s the breakeven number?
This gave me the idea of writing this blog post and hopefully provide some insights to when you should setup a 3 tiered corp structure!
- Do you have a small business?
Having a small business that’s earning active income can get you ahead a lot faster.You earn your income inside a corporation and pay only 15% tax for the first $500,000 net income.If you earn $100,000 salary, you net roughly $75K after paying income tax.
If you earn $100,000 from your business income inside a corporation, you pay $15,000 of tax and you can potentially pay close to zero dollar of taxes in your personal name with proper planning.
If you decide not to take the money out from the corporation, you can invest within your corporate structure. You have so much more after tax money available within your corporation to invest. In our example, we are talking about $10K a year with $100,000 income.
- Do you need all the cash flow from your small business
If you own a small business that’s bringing in cash flow, three tiered corporate structure (or a variation of such) is almost the top advice I give to my clients.But if you need all the money from your business for your personal expense, such as children’s private school tuition fees and finance a boat you enjoy, you probably aren’t in a position to invest in real estate at all.Instead of setting up a corporate structure, I would highly recommend that you sit down and draft out a realistic income and expense statement and have a realistic picture of your financial situation.
Something’s gotta give before having enough money to invest in real estate.
I’ve once had a consultation with a couple who put their two kids in private school, own their own home in Markham/Richmond Hill through a mortgage and they also have a motorcycle to pay for (as a third vehicle).
They both made decent money and the wife is an accountant owning her own practice in a corporation as well.
They came in to see if I had a magic wand, but we, as accountants, only have a few tricks to save you taxes.
And taxes are a part of it but not everything.
Private school tuition for young kids, principal residence mortgage and a third motor vehicle in your family – these are all the expense items that would have to be paid for using your after tax money in your personal name.
These are personal lifestyle choices. I can’t help you to make more money to finance these items.
I can only help you save a few bucks of taxes and invest more efficiently.
- Are you making cash flow from your properties yet?
When you are running a business, it is always a smart idea to lead your business with profit.This means that if your portfolio generates very little cash flow, you may not have the money to pay for the accounting fees.Assuming that you don’t have a small business to begin with, setting up a 3-tiered corporation requires a relatively large amount to set up. You would also need to pay your accountants annually to file the tax returns.
If your portfolio consists of a few cash flow or even negative cash flow properties, you don’t even have enough cash flow from your properties to pay for the accounting fees.
The structure is designed in a way to save you taxes. Negative cash flow properties probably do not have much income to begin with. In turn, it defeats the purpose of using a 3-tiered corporate structure.
- How much time do you have to do all the work?
As with all tax strategies, it takes time and effort to implement.If you have a full-time job and setup a traditional three-tiered corporation to run your rental portfolio, the structure can help you save faster and invest faster.But this comes with a cost.
First and foremost, it is a tax planning strategy. Like all tax planning strategies, it can be subject to CRA’s scrutiny.
Secondly, to implement this strategy, you need to do regular invoicing, money must change hands on a periodic basis, documentation must be kept for all the property management work performed.
An accounting journal entry at year-end just wouldn’t fix everything unfortunately.
How much time in your life do you have to implement this 3 tiered structure properly?
- Do you own 4 properties?
Many investors ask me when it would be a good time to setup a three tiered structure.For small business owners, it’s simple. Pretty much you should set it up as soon as you start your first rental property.For those of you who have full time job, the answer can be tricky.
I did a breakeven analysis and learned that for most people, if you own 3 to 4 rental properties, a three tiered structure likely would pay for itself.
This means that if you own 3 to 4 properties, a 3 tiered structure won’t get you anymore ahead. You, on the other hand, would have spent lots time drafting up invoices and implementing the strategy.
If your goal is to purchase 3 to 4 rental properties, you don’t need the 3 tiered structure.
If you goal is to build a bigger portfolio, yes, by all means, go ahead. Just keep in mind that this will take you a few years to recoup and it is a long term investment.
In summary, if you are a small business owner or a realtor, and would like to purchase a few investment properties, 3 tiered corporate structure is the way to go.
If you work full time and have no intention to leave your job, you may want to own properties in one or two corporations before upsizing it to a three tiered structure.
Until next time, happy Canadian Real Estate Investing.
Cherry Chan, CPA, CA
Your Real Estate Accountant
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.