Cherry Chan Your Real Estate Accountant

Become Best Friends with Your Accountant (And Happy Halloween!)

Robin was invited to her very first Halloween party this year.

It is that time of the year, happy Halloween!

Leaves are falling and temperature is dropping.

Raptors just started their season!

As an accountant, fall is considered down-time and I was using this as the perfect opportunity to attend various professional update courses.

Last week, I was at this 2014 income tax update course.

It was an informative session, covering changes on taxation at death (yes, you still got to pay taxes after you die. In some cases, it can be as many as a few years.), increase in the children fitness credit and new taxes implemented by Ontario government.

The Ontario government added a new tax bracket for income level between $150K to $220K in 2014.

Before the new tax bracket was implemented, marginal tax rate for income between $150K to $220K was 46.41% in 2013. Now it is taxed at 47.97%. Extra tax of $1,092.

Ontario government also lowered the tax bracket that is charged the highest tax rate of 49.53%. In the past, only income over $509K was taxed at 49.53%. In 2014, income over $220K is taxed at 49.53%.

This is an equivalent of an increase of $9K in tax for this spread of income.

All tax brackets, both federal and provincial, are indexed to inflation every year, meaning the tax bracket increase slightly based on inflation.

This newly added tax bracket by Ontario government is not indexed every year.

This means that when your salary is increased based on index, more and more people are subjected to this tax bracket and Ontario government is getting more tax revenue every year.

I have presented and blogged multiple times how real estate corporations allow the tax planning flexibility with your children and lower income family members.

For the children who go to post secondary school and pay about $7K of tuition without any other income, they can receive up to $44,733 dividends without incurring any tax liability.

For family members who have no other income, they can receive up to $35,547 dividend without paying any tax.

These are huge tax savings if you use Real Estate Corporations to own your real estate holding portfolio!

Some clients have asked me if these tax savings are available to small business – Of course they are!

Real Estate Corporations are just one type of small businesses. If you operate your own business and you are incorporated, these tax savings are available to you provided that you structure your company shareholding accordingly.

Another common strategy is to split income with the lower income family member provided that they work for you. If you are self-employed, paying the lower income spouse can help you save thousands of dollars in taxes.

I have been busy setting up tax planning meetings with clients for 2014.

If you have not setup a meeting with your accountant yet, it is time to do so. There are tax planning opportunities that you can get done before the year-end.

Become best friends with your accountant, tell him/her about everything that happens during the year.

Whether you bought a rental property, a new car, have a new kid, your kid starts joining these new after school hockey programs, your parents start living with you, or your significant other quits, share them with your accountant.

This is the only way your professional advisor can provide advice for you an all the available tax credit you are eligible for, and how much you can reduce your tax liability.

Until next time,

Cherry Chan, 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.

/0 Comments/by Cherry

Real estate corporations

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?”

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 Comments/by Cherry

Real estate rant, Realtors/real estate agents

Building Your Real Estate Team: What I Learned From Finding a Live-In Nanny

Hello to all you real estate investors and real estate professionals,

I hope everyone had a wonderful Thanksgiving with their families this past weekend.

Robin and I were at the Rock Star Inner Circle Member Event this past Saturday learning about real estate investing with the other 400 + hardcore real estate investors who attended.

The event was amazing and informative as usual.

It was also announced that I will be hosting some free real estate accounting and taxation classes for Rock Star Inner Circle members very soon! Stay tuned for those dates and more details!

We started our week with a lot of excitement as we were preparing for Robin’s nanny to arrive on Tuesday from half way across the globe. We made the decision to take over our friend’s nanny from overseas a few months back.

All of us were cautiously excited. After all, we had never lived with anyone before! We didn’t know if she would even like us. Our agent advised us not to notify the nanny ahead of time so she didn’t know she would be working for a different employer!

As Tuesday came, I was at a real estate taxation seminar with another 350 accounting professionals getting the latest tips on real estate taxation in the morning (I will publish these materials in a different post). Erwin and Robin were given the responsibility to pick up Carolyn, the nanny, at the airport.

She had no idea that we were taking over from our friend before her arrival. She was shocked to see Erwin and Robin. She insisted on talking to her cousin, who’s also a live-in nanny in Toronto, before coming home with us.

Upon completion of the morning seminar, I rushed over to the airport to meet up with them hoping to make Carolyn feel better. We had lunch together and like most people, Carolyn immediately adored Robin. But she was still scared.

We finally got a hold of her cousin. She spoke to Carolyn briefly and advised her to leave us immediately because Burlington was too far from her and she believed that she could find Carolyn another employer closer to Toronto. We did not expect this at all! I somehow managed to persuade Carolyn to come to our house, check out our place and stay until the end of the week, hoping that she would change her mind.

We showed Carolyn our lovely home and our friendly neighborhood. None of which seemed to impress her. She was waiting to talk to her cousin again later that night. I guess Erwin and I didn’t have the warm and fuzzy feeling that we were expecting to give off. I was devastated because we planned our whole schedule around Carolyn’s arrival. And yet, she didn’t want to stay with us! There is no ‘plan B’!

Being someone who wants to have everything done yesterday, I immediately started researching for a new nanny who was already in Canada to replace Carolyn. Little did we know that there was high demand for live-in nannies in GTA. People are willing to pay a premium to hire someone immediately. Some people were offering 80% premiums just to get a line-in nanny as soon as possible. I was getting worried and started emailing everyone that had a posting online. After twenty emails and a few phone calls later, we were able to secure a nanny interview the next afternoon at our house.

We had a candid conversation with Carolyn the next morning. She expressed that Burlington was too far away from her cousin and she preferred to live closer to her cousin. There was no way of convincing her at this point. She was leaving us without even giving it a try.

It’s well within her right to choose who she wanted to work for. It was just sad for us that it didn’t work out with her. We took another morning off to take her to her cousin.

We interviewed Sharmein that same afternoon. She arrived with her aunt, checked out the neighborhood, toured around the house and her potential bedroom, met Robin and sat down with us to have a discussion. Erwin and I found Sharmein to be bubbly and easy going.

Within a few minutes after she had left, Erwin and I made the decision to hire her! We knew that the market for live-in nannies is tough and we needed someone right away. We like her because of her easygoing personality. She adores Robin and couldn’t stop talking about how cute she was, so Sharmein started this Tuesday.

What went wrong? What kind of lessons can we learn from this stressful situation?

We listened to the wrong advisor. The original agent that we worked with advised us not to notify Carolyn in advance. The agent repeatedly expressed that she didn’t have any experience dealing with situations whereby the original employer decided not to take on the nanny. We ignored that comment and have now learned to always be open and honest with the people that you work with. If she chose not to work with us, we would have had a lot more time to prepare for a Plan B.

Make sure you find an informed and professional real estate accountant for advice! Many accountants or bookkeepers can do your tax returns, only few can do the tax planning, and even fewer specialize in the real estate industry.

We didn’t have a Plan B. It didn’t even dawn on me that I needed a Plan B because we put so much reliance on one option.

Be aware of the risks and benefits of any tax planning or strategies you are getting yourself into. Ask as many questions as possible. Prepare for a Plan B.

We didn’t know the market well enough. We didn’t even know that live-in nannies are in high demand.

Whenever we decide to make any new purchases, real estate or any other products, make sure you do your research, check your references with anyone on your team, meet with them and see if they can provide any valued tax planning opportunities to your situation.

Luckily enough, Sharmein, our new nanny, has now started and life can continue on as planned. It had been a stressful week but we finally got the right person on our team. Have you selected the right real estate accountant on your team yet?

Until next time, your real estate tax advisor,

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.

/0 Comments/by Cherry

Real estate corporations

Real Estate Corporations: Examining the Numbers and Seeing the Long-Term Benefits

Hello fellow real estate investors and real estate professionals,

In the last blog post, I provided an analysis on the benefits and pitfalls of the common corporate structures used by real estate investors who own their own real estate portfolio. In this post, I will provide a calculation on when it makes sense financially to own the portfolio within these structures. You’ll notice that your long-term goal you wish to achieve through real estate investing, which I’ve been referring to as your Big Why, is a crucial aspect to how and when you incorporate your real estate investing business. Keep that long-term goal in mind and you’ll be able to see where the benefits lie down the road.

One corporation, multiple properties

As I mentioned in my last post, the legal costs to set up would be about $1,000 – $1,600 and annual filing costs would be a few thousand dollars. Your rental income would be considered passive income and therefore be taxed at 46.17% in the corporation. Of that 46.17% being taxed, 26.66% is refundable to the corporation when a taxable dividend is declared, eventually and essentially, the corporation is paying roughly 20% tax on your rental income.

When the taxable dividend is declared, it is considered as non-eligible dividends and a different tax rate is applied to non-eligible dividends compared to regular income.

Say you want the cash flow immediately and setup only one corporation– if your marginal tax rate for your rental income is between $136K and $150K, you are paying 46.41% on the rental income if you own the property personally. If you own the property in one corporation and declare a taxable dividend to yourself immediately, the combined corporate and personal tax rate is 49%.

If your marginal tax rate for your rental income is between $150K and $220K, you are paying 47.97% on the rental income if you own the property personally. If you own the property in one corporation and declare a taxable dividend to yourself immediately, the combined corporate and personal tax rate is 50%.

Essentially, there are no tax benefits if you need the cash immediately.

But, say you want to declare the dividend to yourself when you are earning less money personally, perhaps later in life when you’re unable to work as long or as often. The combined tax rate can be significantly lower.

Or, here’s another example, say in the future your child goes to university and you want to pay for their tuition through the corporation– rental income is taxed at roughly 20% after a taxable dividend is declared

Assuming your child is not making any other income, you can declare a taxable dividend of about $44K paying close to nothing in tax. The combined corporate and personal tax rate is then 20%.

In other words, if your rental income is taxed at more than 20% in your personal name, it is worthwhile to consider incorporating, particularly when you have income tax splitting opportunities with your adult family members.

To put this into perspective, if you make more than $40K of employment income, tax rate on your rental income is already higher than 20%.

Three-tiered corporations

Note that the above points are all applicable to the three tiered corporation structure because the Real Estate Holding Co still earns passive income from the corporation.

The only difference is that a management corporation is managing the properties, and therefore, earning some amount of active business income in the corporation at 15.5%, of which zero percent is deductible in this management corp

Now let’s dive deeper into when the break-even point is to setup this three tiered-structure.

The objective of this structure is that the corporations can accumulate capital faster and allow the higher after tax profit to be reinvested and purchase more properties.

The assumption again is that you do not need the cash flow now and you are making profit from your rental portfolio.

The cost of annual filing of 3 corporations is roughly $3K and after tax costs are roughly $2K.

If we can defer more than $2K of tax, we can consider incorporating.

Say your marginal tax rate on your rental income is 46% but a portion of this rental income is taxed at 15.5% in the corporations when you use the three tiered corporation structure, as long as the tax deferral can be greater than the cost of the annual filing cost, you are ahead of the game

Based on a 10% management fees, depending on the marginal tax rate on your rental income, the break even amount of rental income is roughly $60K to $75K for the top four tax brackets in Ontario

This is roughly equivalent to 2 student rentals (6 bedrooms in each house with $2,700 monthly rent) or 3 rent-to-own properties.

Keep in mind the same tax planning opportunities are still available in this 3 tiered structure. If you make more than $40K and have adult family members available for income splitting, you should consider incorporating.

The above illustration just demonstrates when you will start seeing an advantage, purely from the tax perspective, if you setup the three tiered corporations.

There are other significant benefits for incorporating, such as limited liability, that a lot of investors would choose to pay the extra filing cost to have peace of mind.

Again, these structures are not for everyone. The calculation above merely demonstrates the cost and benefits from the tax perspective.

Owning properties are not for everyone. It depends on your personal situation and your Big Why.

Talk to your professional advisor, or contact me, to make an informed decision about your real estate holdings.

Until next time this is your Real Estate Taxation Advisor and friend,

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.

/0 Comments/by Cherry