It was a busy weekend in our business. Other than the fact that it is tax season, we were also busy meeting real estate investors answering their questions at the 2016 Real Estate Investment Network SOS event.
It has been an amazing 2016 so far. I built up some habits that I would have never thought possible. One of which is the 5 Minute Journal.
It is a journal that you can purchase off Amazon. All it takes is 5 minutes in the morning and at night combined to fill it out.
It starts off each day with an inspirational quote. And we are required to write 3 things that we are grateful for, 3 things that would make today great and daily affirmations.
At the end of the night, we would reflect on 3 amazing things that happened today and the items.
Our brain is wired to focus on the negative aspects of our daily lives. By taking 5 minutes everyday to appreciate what we have in life, it resets my mindset to focus on things that are great in my life.
Believe it or not, happiness can be as simple as getting a full night of uninterrupted sleep when our babies can sleep through the night.
Happiness can even be having a great workout in the morning.
When things are tough sometimes, this simple Five Minute Journal forces me to appreciate my life a lot more!
Now onto this week’s topic.
Many investors are hesitant to incorporate at the beginning. For some, this will be because they don’t want to pay for the costs of incorporation. For others, it will be because they don’t want to pay for the cost of filing their corporation tax returns annually, and for the majority it will be a bit of both.
What can you do?
With the existing properties, you can choose to do nothing with them or you can choose to transfer them into a corporation.
Here are the price tags for transferring the properties to the corporation.
- Land transfer taxWhen you transfer the ownership to the corporation, even though in essence, you are transferring from your right pocket to left pocket, the law does not necessarily look at it the same way. A corporation is considered as a separate legal entity from you, despite the fact that you may be the sole shareholder of the company. As a result, the transfer of the title from you to the corporation will trigger land transfer tax. And the land transfer tax is calculated at the fair market value.One of my clients who is at his retirement age has multiple properties in the heart of Toronto. Most of us know that Toronto has double in land transfer tax.
He would like to minimize his future estate taxes. One strategy is to own these properties in a corporation.
To transfer all his personally owned properties in a corporation, he would have to pay tens of thousands of dollars in land transfer tax.
All of a sudden, the amount of land transfer tax suddenly makes the cost of setting up a corporation and maintaining them for years seem small.
If you are a long-term real estate investor and you are committed, you should consider investing in a corporation from the very beginning.
- Capital gain taxWhen you are transferring the title to the corporation, you are really selling the property to a separate entity. This can potentially trigger capital gain tax.For the people who have incurred large amounts of capital loss from investing in Nortel, selling the property at fair market value to trigger the capital gain can be desirable, as you can utilize the capital loss available to offset against the capital gain.The corporation then has a larger amount of cost base. When it sells to a third party eventually, the capital gain can be lowered.But if you don’t have any capital losses carried forward, there is an election in the Income Tax Act that allows you to defer all the gain until you sell the property to a third party.
These elections are complicated forms that you would have to hire a real estate accountant to complete. A lawyer is also involved in the process to transfer the title.
- Accounting fees & legal feesDepending on the complexity of your portfolio, the cost to file the elections can start from $1,000 and up.To complete the transfer, a lawyer is required to assist you in changing the title.
- Opportunity costs of lost tax benefitsFor real estate investors who own an incorporated business, cost of not incorporating can be substantial.Most small business owners pay 15% corporation tax rate. They can use left over money to invest.If they were to take out the money, report the income in their personal names and purchase the properties in their own name, this can cost them as much as 30% additional tax.For $100,000 profit, we are talking about $30,000 of tax deferral opportunities. In two years, you can accumulate enough in the corporate structure for the downpayment of a property.For real estate investors who don’t own a business, you may still lose the income splitting opportunities that you would otherwise have with a corporation.
When you are thinking about the ownership structure of the corporations, make sure you don’t overlook these four costs before making your decision!
Until next time, happy Canadian Real Estate Investing.
Cherry Chan, CPA, CA
Your Real Estate Accountant