When buying real estate today, think about what your situation will be in 10, 20 and more years? Will you have adequate resources available after taxes are paid? If all goes according to plan, you will age along with your investments. Discussing the appropriate ownership structure for your family, and how it will change over time, can save untold grief and taxes.
In the early stages, having the higher income spouse own properties and receive the deductions common to the early years of investment property ownership provides some tax advantages. As you earn additional income and sell properties, splitting properties between spouses may lower rates of tax within the family. But, changing property ownership can produce expensive tax consequences.
Considering alternative forms of ownership now, such as corporations and family trusts, is prudent. While alternative ownership may be completely inappropriate now, from a tax perspective it may be far more effective to allow for the benefits of a structure to accrue over time. For example, creating a family trust for real estate ownership while your children are five years old may provide an excellent vehicle to pay for post-secondary education while potentially protecting assets. The more time you have to plan and implement, the more benefits are available. You just don’t want to go overboard in setting up an elaborate structure that generates additional costs and complexity to operate.
However, this is not a do-it-yourself project. While splitting income between family members is generally a good thing from a tax perspective, the CRA restrains certain activities with, for example, the ‘attribution’ rules. In essence, in some situations the CRA believes that income earned by a family member truly belongs to another who contributed the funds for the investment, or previously owned the investment.
We like to discuss structuring real estate investments within a framework of five major categories. Your priorities within the framework mean you can make the best decision for today, and tomorrow. Often, we provide completely different recommendations for very similar situations.
Ultimately you must decide what is best for you and your family, but you need the input from your advisors to appreciate the choices and ramifications. Unfortunately your advisors may have differences of opinion and so get them to explain why they believe in one course of action over another. Armed with this information you can make more knowledgeable decisions. Ideally, your advisors can have a brief discussion with each other and with your to highlight areas of agreement and disagreement. Then you can weigh the choices.
Generally, we consider our recommendations in the following order, allowing that priorities may differ. A quick overview of of these priorities is provided.
1. Flexibility
Personally, we like having as many choices as possible. Choices of how to remunerate owners, how to structure investments with co-investors without negatively affecting the co-investors, when to remunerate owners, who amongst the owners can be remunerated, how much owners should be remunerated, how properties within the portfolio may be disposed and changing the specific investors in a particular property. Corporations with joint ventures tend to provide more choices as compared to personal ownership or partnerships, for example.
2. Legal issues
While this is the domain of lawyers and their advice is paramount, liability concerns are often critical for many investors so we offer some general comments. From our perspective, we don’t believe that anything approaching a universal opinion exists amongst the legal profession with well respected lawyers on both sides of the “should I incorporate?” question. While not generally an initial concern for investors, discussions of using family trusts in the legal context often takes place for some purchases once you own a base level of real estate. Advisors often talk about limited partnerships in the context of attracting multiple investors.
3. Taxation impact
From a tax perspective no one answer exists concerning forms of ownership with accountants in a similar position to lawyers regarding universality. This is further exasperated by the fact that a structure may be better or worse for you in different cases. For example, your timeline for investment, objectives of your investments, nature of your investments, other business and financial activities currently and in the future, plus family situation, all play a role. For someone unconcerned with flexibility and legal issues, who earns reasonable employment income and who is interested in a “buy and hold” strategy there is little tax incentive to incorporate. Alternatively someone who wants to flip or develop properties, has more family members interested in owning real estate, or currently earns business income through a corporation may be more inclined to incorporate. Further, someone wanting to attract multiple investors may prefer to remain more neutral from a tax perspective. This can be accomplished using the “flow-through” capabilities of a limited partnership because the investors can themselves decide how they prefer to own their partnership units (for example, personally or through a corporation).
4. Financing considerations
With the guidance of your mortgage broker or financial institution representative, consider the impact of the potential structure on receiving financing for current and future properties. Various financing programs are often restricted to personal ownership, for example. Again, we’ve encountered a wide range of opinions from financing professionals but wish to emphasize that many legal and ethical ways exist to attract financing.
5. Professionalism and organizational issues
Generally speaking, we think a corporation provides a more professional image and an ability to segregate personal from corporate activities. This level of professionalism may, however, scare off potential vendors or co-investors.
Similarly some people find it much easier to understand and track their real estate portfolio when everything is basically in the same pot, or owned personally as compared to having separate little “shelves” with one or more entities. This brief synopsis shows that many choices exist, and in fact many more considerations and combinations are available, for ownership. But don’t get taken in by the sexiness of a fancy structure that you don’t understand and fails to meet your needs. You can grow into a structure when you’re ready. Changing your structure in the future may cost a little more, but you will have additional assets and cash flow to address these costs.
