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?”

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. However, many LLC’s and corporations tend to take advantage of the S-corp tax treatment and filing to be taxed under this as S-corps don’t pay a corporate tax! If you would want to know more about how to file form 2553 online for your S-Corp election, you could read up more on the same online.

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 deductions 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.