After years of hard work, you’ve managed to create a successful business and finally have some extra cash built up. You’re now for looking for ways to save and grow your cash in other investment opportunities. Some business owners may connect with a financial advisor and begin to invest in mutual funds, bonds or other securities. Others however, may want to think about buying some real estate.
While it seems pretty straight forward to buy a mutual fund, real estate deals can add another level of complexity. So just how should you purchase your real estate property?
There are two common ways to purchase a property:
If you purchase a property personally, your name will go on the deed. Assuming you rent it out, you’ll need to keep track of your rental profit and loss and include it on your T1 personal tax return on Schedule 776 to be added to your total income for the year.
If you purchase a property through your company, it’s your company’s name that goes on the deed. Any rental income will be added to your total corporation’s profit and loss and become part of the T2 corporate tax return.
Given the two structures, let’s look at a few factors that will determine which one is best for you:
Purchasing a property personally may be your best option if you need a mortgage. Taking out a mortgage personally is a common transaction and you’ll likely have lots of options to choose from in the market.
If you’ve recently incorporated a company, it’s unlikely you’ll be able to negotiate a substantial mortgage. As a company is a separate entity, lenders will likely view a corporation with no credit history a risky business and will want to stay clear.
Pre-tax vs. after tax dollars
If you’ve got lots of dollars built up in a holding company, buying real estate through your company may be the way to go. When you buy an asset within a company, you’re using pre-tax dollars. That means that you haven’t paid any personal tax on that income yet.
For example, suppose your company earns 500K. At a corporate tax rate of 15%, that leaves you with 425K to invest in a property purchased within the company. Since you’ve left that money in the company, it’s considered pre-tax.
On the other hand, if you wanted to purchase a property personally, you’d need to take that money out of the company by way of a salary or dividend. Assuming you’re at the top tax bracket, that would leave you with only 230K of after tax dollars to invest.
If you’ve got the cash in your company, an extra 200K in your pocket may be a pretty good argument for a corporate purchase.
Personal residence exemption
There’s a distinct difference from a tax perspective when buying a rental property versus a second home. If you buy a property and begin to rent it out, when you sell that property in the future you’ll have to pay capital gains tax on the profit you earn from the sale.
However, if you buy a cottage or vacation home that you plan to move into down the road or live in for part of the year, you may be able to shelter those capital gains taxes when you sell. While the rules and formula of the principal residence exemption is a discussion in itself, the gist is that you may get a discount on the amount of capital gains tax you’ll have to pay when you sell in the future if you declare the property a personal residence.
A corporation can’t claim the principal residence exemption so if you’re thinking about buying a second home, you may want to consider buying it personally.
Beyond tax considerations, it may be a good idea to chat to your lawyer before you make a final decision. Buying a rental property within an operating company may expose the corporation to liability if a tenant happens to sue. As well, if the company has other shareholders (or wants to in the future), you’re essentially giving them ownership of the property.
If you’re buying an asset personally, you may be able to shelter yourself from liability by putting it in your spouse’s name.
Each structure will have its own set of legal considerations so it’s important to understand the consequences before going into a deal.
So what’s the best option?
If you’ve got a simple holding company with one shareholder and the cash available, you may want to consider a corporate purchase. On the other hand, if your corporate structure is a bit more complex, you need a mortgage or you’re buying a second home, you may want to consider a personal purchase. Each person’s situation will be different so a careful analysis of the factors above should point you in the right direction.