As a Real Estate Investor: Should you incorporate (or just keep investing personally)?
The decision whether to incorporate really encompasses an investigation of a whole range of factors: assessing potential tax savings, liability protection, creditor protection, and even the nature of your assets and other business endeavours. So there is no an easy answer. Couple that with the corresponding and sometimes off-setting disadvantages (such as added legal and accounting costs and complexity of your paperwork), and it becomes even more difficult.
So for the sake of simplicity, I’d like to boil it down to four considerations: tax benefits, mortgage qualifying, liability protection, and size/nature of portfolio.
Taxation: On the tax side, I will leave it to my accountant friends to dive in – but there are several really fun things to study here: claiming expenses, capital gains exemptions, taxable supplies, tax deferral and income splitting. My goodness I’m glad we have accountants!
Mortgage Qualifying: On the mortgage qualifying front, I would just say that banks have become extremely cautious about corporate lending (from “holding corporation” requirements to asset liability tests). So using a corporation to directly qualify for a mortgage loan these days is not as easy as it once was.
Liability Protection: On the liability protection front, incorporating to run a relatively small real estate investment portfolio may not afford the advantages you might expect.
First, a very large portion of third party risk can be managed by typical and relatively inexpensive insurance. Typical property insurance will include general liability coverage. So if a person slips and falls while on your property, for example, you would have coverage to protect you for a personal injury claim. Provided the coverage is sufficient, it would not matter (in that instance) if you owned the property personally or through a corporation. Your personal assets would not then be exposed. Of course insurance has its limits and exclusions – so this is not fool-proof.
Second, most lenders will only provide financing to real estate corporations in exchange for a full set of security. This of course would include a land mortgage – but in all likelihood would also include personal guarantees from the corporation’s Directors and/or Shareholders. So no hiding behind the limited liability benefits of a corporation in that instance. In fact, the individual’s assets may be even more exposed in that situation. If you purchase property personally, and you obtain conventional mortgage financing (i.e. you put more than 20% equity in and borrower less than 80% of value), upon default, the bank’s remedies would typically be limited to the mortgaged land (via foreclosure for example). In situations where a corporation enters into a loan, and the lender takes additional collateral security in the form of personal guarantees, the bank can pursue against the land and the guarantor personally in order to be fully paid.
Size/Nature of Portfolio: This is where, in my experience, most clients end up when processing this issue . . . there are several potential legal and business benefits to using a corporation in certain situations:
MULTIPLE OWNERSHIP: if there are more than three or four owners it might make sense to maintain ownership, management and governance of the business via the well-traveled legal structure of a corporation. A Unanimous Shareholder Agreement can be drafted to deal with contingencies such as death or default or other unhappy circumstance of co-owners. Holding title together as individuals could result in complex, costly, and unwanted legal headaches should those type of events occur. It is much more difficult to add or remove an owner, amend relative ownership positions, and transfer interests when title is held in your personal capacity – and title itself can be exposed to writs, liens and other attachments by creditors should any one of the individuals get into financial trouble.
ANONYMITY: if some owners want a degree of anonymity maintained with respect to the public or tenants then a corporation may assist in that regard;
MARKETING: for marketing purposes, there are those that see a distinct benefit in presenting a ‘professional’ face to the public with respect to trades, tenants, and others. Whether corporations are seen as more professional is a topic of debate – but many of our clients most assuredly consider it so;
DIVESTING: divesting and acquisition options may also be more numerous if your real estate portfolio is held by a corporation. For example, instead of somehow selling a 5% interest to someone and then having to transfer multiple titles, deal with lenders (to address due on sale clauses), or creating proper joint venture agreements, a simple sale of shares in the corporation would be an option. Most lenders consider a sale of a controlling interest or some other percentage threshold as a ‘disposition’ that would trigger the due on sale clause of the loan – so care should be taken in that regard in any event.
There are many other benefits – and disadvantages too. It is one of those stereotypical situations where we must, at the end of the day, simply advise that you contact your lawyer, accountant, and broker to get proper and detailed advice about your particular situation.