How to Make More Money by Paying Higher Interest Rates on Your Incorporated Rental Portfolio

One of the main complaints about owning your rental portfolio in a corporation is the increased interest rate, as compared to owning them in your own name.

Of course, there are a few ways to get around this problem.

If you work with a bank that is willing to let you put the title in the corporation like us and still offers competitive rates, you don’t really have much of a problem here.

We recently closed on the house we purchased for our son. We were able to put it in our corporation and we are able to get retail rates. We did qualify under a different program, which requires us to have a certain level of liquid asset outside of the real estate portfolio and sufficient rent from the property to cover all the expenses.

Some of the investors get around this issue with a trust agreement. There’re certain pros and cons of using trust agreements. Speak to a real estate lawyer to understand the risks involved in using the trust agreement.

If you are not comfortable using trust agreement and you don’t qualify to work with the lenders that I worked with—so now you have two options: (1) own them in the corporation with high interest rates or (2) own them personally with retail rates.

Now you wonder, is it worthwhile to pay the higher interest rate in the corporation or is it better to simply own them personally with lower interest rates?

Honestly, there’s no one size fits all answer. I am going to go through an example on the analysis, but you would need to analyze this based on your own situation as well.

Let’s make some assumptions here:

Five year fixed interest rate right now is below 3% right now. For the sake of this example, let’s use 3% as the interest rate.

Say the target property is $350,000, with 80% loan to value. This is equivalent to $280,000 mortgage.

You are planning to hold the property for roughly ten years.

With 30 year amortization, interest cost for ten years $74,029.

Say the interest rate offered to your corporation is about 4%.

Interest cost for ten years is $100,123.63.

If you simply look at the interest rate differential, the additional cost is close to $26K! That’s a lot of money!

Here are a few variables that can affect your decision–

1. What’s your expected profit before deducting the mortgage interest?
2. What’s your personal marginal tax rate on the rental income?
3. Do you have anyone in your life that you can split income within the corporation?
4. Do you have any other reasons to put the properties in the corporation, such as owning a small business?

For a student rental earning $2,700 per month resulting in about $1,700 before debt servicing on a monthly basis, if you were to own the same property in personal name, the net income would be $128K.

Depending on your marginal tax rates on your personal tax returns, the after tax cash available from the net rental income is

• If your marginal tax rate = 43%, after tax net income = $73K
• If your marginal tax rate = 46%, after tax net income = $69K
• If your marginal tax rate is the highest at 54%, after tax net income = $60K

Now if you were to own the same property in the corporation, the net income after deducting interest in the corporation for ten years would be $102K.

Over the long run after declaring a taxable dividend, the corporation truly would pay 20% tax on this $102K, meaning that $82K after tax net income available.

If you have someone that’s making no money to share this income with, he/she will pay 0% tax for the first $30K dividend income declared in his/her personal tax return.

Best case scenario in a corporation, you have $82K after tax net income available between the corporation tax and the individual personal tax level.

Compared to owning them in your personal name, you are only able to retain $73K with a marginal tax rate of 43% (basically when your job income gives you $90K, your rental income is then taxed at 43%).

So even with 1% interest rate differential (4% in the corporation versus 3% owning it personally), it looks like a better choice to own the property into the corporation.

This comparison is based on the assumption that you can extract cash out from the corporation paying no personal tax (other than the Ontario Health Premium).

Of course, if you are a small business owner and are simply paying 15% small business rate in your corporation, the above calculation may not even apply to you in your decision process. You have so much advantage to purchase in a corporation than not.

At the end, there are always other ways to put the properties into your corporation and pay retail interest rate too. 🙂

Until next time, happy Canadian Real Estate Investing.

Cherry Chan, CPA, CA

Your Real Estate Accountant