By Julie Cazzin with Allan Norman
Q: I have seven rental properties in my name. Should I put them into a corporate structure? What is the benefit (if any) of doing this? Are there any better options? Right now, I’m reporting the income and losses on these on my personal tax return. — Mason, London, Ont.
FP Answers: Mason, you have a lot to consider when deciding if a numbered company makes sense, including creditor protection, estate planning, the capital cost allowance (CCA), cash damming, possible tax advantages and the cost of setting up the corporation ($2,000 or more).
There will also be accounting and legal fees to properly transfer the properties into a corporation, annual corporate tax returns to pay for, a separate bank account to manage, a minute book of important documents to keep, mortgage transfers and land-transfer taxes to consider, as well as other requirements.
Creditor protection is one benefit of transferring your rentals into a numbered company. With seven rental properties — representing, I suspect, a significant portion of your net worth — some additional protection may be a good thing if you’re ever sued personally.
There may be no annual tax savings by adding rentals to a corporation, especially if you are a highly paid employee. Corporations pay a low corporate tax rate on active business income, not passive income, which is most likely what your rental income will be considered.
I recommend you visit your accountant and confirm the tax-rate differential between your personal income and your proposed rental corporation and help identify any tax savings.
Corporate business owners with active business income, on the other hand, are more likely to have rentals in a holding company. They can accumulate the down payment for a new property much faster than you could personally.
For instance, earning a dollar of active income leaves you with about 85 cents to invest after tax, whereas you may be only left with 50 cents after tax if you’re earning that income personally.
As your operating company earns excess money, you can send it as dividends to your holding company for investment purposes, such as investments in rental properties. Estate planning is another reason to consider moving your rentals into a corporation. That is, to defer capital gains tax and avoid probate.
If you’re leaving your rentals to your children, there will be capital gains tax to pay on your death —whether the properties are sold or not. The capital gains tax on the rentals can be deferred if held in a corporation when you pass, but you may face a larger capital gain on the transfer of your corporate shares to your children if the rentals appreciated in value. An added benefit to consider is avoiding probate fees by placing a second will on your corporation.
I’m curious, Mason, what are you doing about the capital cost allowance? If you haven’t yet, explore this with your accountant, even if it’s just for your own knowledge.
Generally, you can deduct four per cent of your building’s value from your taxable income each year, with the first year being an exception. That’s a nice tax saving, but there is a catch, and it’s called “recapture.” Selling a property that hasn’t depreciated, in which you’ve claimed the CCA, means paying back the amount claimed.
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For example, if you deducted $100,000 over 20 years and the property hasn’t depreciated by four per cent each year, you’ll have to pay back the $100,000, but inflation is your friend in this case. Would you rather pay a dollar today or that same dollar 20 years from now? It is often better to defer because the value of a dollar decreases over time.
The CCA can be claimed whether your rentals are owned personally or corporately. If you are going to claim the CCA, which is annually optional, make sure you have a good understanding of how it works over the life of the rental by working with an accountant who can run the numbers for your particular case.
Also consider cash damming, especially now that interest rates are rising. In general, cash damming is a strategy to convert personal debt (the interest on which is not tax deductible) to business debt (interest is deductible). This is only for people with large non-tax-deductible debts such as a mortgage or large car loan.
The basic approach is to use your monthly rental income to pay down the mortgage on your non-tax-deductible debt (that is, your personal mortgage). Then you borrow funds to pay down the mortgage on your rental property. In essence, you are converting a non-tax-deductible debt into a tax-deductible debt.
Mason, I’ve given you some guidelines, but there is no easy answer. Talk to a lawyer, accountant or financial planner experienced in this area to work out the details.
Allan Norman provides fee-only certified financial planning services through Atlantis Financial Inc. He is also registered as an investment adviser with Aligned Capital Partners Inc. He can be reached at www.atlantisfinancial.ca or firstname.lastname@example.org
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