Real estate has been hot in the GTA for many years. Investors have been looking at Real Estate as a lucrative investment to include in their portfolio. The average investor makes the first time investment personally or through a corporation and acquiring property for rental purposes.
When rental properties are held personally, the rent is reported right away on the investors personal tax return. Also, if rental property is held in a corporation, the passive income is taxed at the highest tax rate in Canada. However, there are some strategies and businesses that can be started alongside your real estate investment to help reduce some of the taxes on passive income.
Holding Real Estate in a Corporation
Having a company hold real estate can protect an investor from legal liability as a corporation is a separate legal entity. However, property income or passive income such a rents, royalty, interest, etc. is taxed in a private corporation at the highest tax rate at about 47% right away. This makes holding real estate less appealing in a corporation.
How to Set up a 3 Tier Real Estate Corporate Structure
A 3 tier corporate structure is ideal for an investor who is thinking about investing in many Real Estate properties. They may not have many employees working for them on managing their real estate and would not have be able to fall out of the specified investment business classification which means the passive income earned will be taxed at the highest rate for tax purpose in Canada. If a corporation employs 6 or more employees, the rental income earned will be treated as active business income for tax purposes and will access the small business deduction for a lower tax rate of 15.5%.
To set up the 3 Tier Corporate Structure, there are essentially 3 Corporations needed at a minimum as follows: 1) Holding Company 2) Property Management Company and 3) Real Estate Companies.
The Holding company will be an inactive company. It will not generate any income and will only hold 100% of the shares of the Property Management Company and the Real Estate Companies needed for the 3 Tier corporate structure. The purpose of the Holding Company is to hold the cash earned from the rental properties.
As it owns more than 10% of the shares and value of the Property Management Company and the Real Estate Company it is considered connected corporations for tax purposes and as such, dividends can be declared and paid upwards to the holding company. This allows the holding company to "pool" more after tax dollars to reinvest in other projects or subsequently pay a dividend to the shareholders.
Another benefit of the holding company is that it allows for income splitting opportunities. The real estate investor can issue another class of shares to their spouse or adult children over 18 years of age to allow for issuing dividends to them and income split.
Real Estate Company
This corporation will own the respective rental properties. It is best to have one property held in a corporation to protect the investor from legal liability and expose other assets. The real estate corporation will hold title to the real estate property.
There can be multiple Real Estate Companies set up depending on how many properties an investor may have. Also, the holding company will hold 100% of the shares of the Real Estate Companies or if there are other investors, the holding company can hold its share of the company respectively.
Property Management Company
The property management company is an operating company that is an active business. It will manage the properties by collecting all the rental cheques, pay all the maintenance and repairs expenses, etc. It will also charge a management fee to the Real Estate companies for its services which can be between 8% to 12%.
The remaining portion of the rents will be transferred to the Real Estate Companies. This now allows for the income that will be earned in the Real Estate Companies alone to be earned by the Property Management Company for its management fees and access the lower rate of 15.5% as it is an active business. It will also result in an expense or deduction to the Real estate companies whereby reducing taxes.
As such, there are many benefits of having a 3 Tier Real Estate Corporate structure set up for tax purposes. It allows for moving a portion of the rental income to the property management company as management fees, etc. to access the 15.5% tax rate for active businesses. It also protects investors from legal liability and also channel funds to their holding company that would allow for income splitting opportunities.