Best Practices When Setting Up Real Estate Investments
Kelowna accountant, Ken Davidson, offers a few best practices when setting up new real estate investments.
Are you a real estate investor who wants to be sure that you set up your investments the right way? It is essential that your plan involves ensuring you are protected personally, your investments are protected, and you are taking advantage of all possible tax savings and advantages?
For many real estate investors that are purchasing apartments, commercial properties and multi-family homes I suggest a high level of protection from liability in a three tier system.
A three tier system would consist of:
- Operating Company – Business operation
- Holding Company – To building your family wealth
- Property Company – To hold each Complex
The operating company is where you have your day-to-day project management, and property management group – all your active business components are within this company. This is where your risk lies…if you do something wrong, it’s going to cost you. That’s why I often call this the risk company.
The holding company owns the operating company and the reason why we have this is so we can strip residual income up into the holding company on a tax-deferred basis through dividends and then allow the holding company to acquire assets.
Depending on the type of assets you are acquiring, that holding company is probably going to setup a “Property” company that is then going to be acquiring real estate on behalf of the holding company. Each property with a significant amount of risk may need its own company so that it does not put the others at risk.
The advantage of this particular structure is that you make sure there is never any risk in the holding company because it holds shares of companies with no direct assets. The “Property” company and the operating company are the risk companies, meaning if something went sideways, a tenant falls and sues the property, you could lose the assets that are left in those companies. In general all the value is kept in the Holding company and safe.
At this point, there are various ownership structures of the holding company but that is on a whole other article.
If you’re acquiring one 10-unit apartment complex, than you only need one operating or property company.
However, if you buy a 10-unit apartment complex and also buy some commercial real estate, like a strip mall, my recommendation would be to have those in separate companies. I suggest this for a couple reasons:
- Risk – If something goes wrong at one property, you don’t want to risk the other property.
- HST Benefits – The commercial unit is likely to be HST registered already and you have to charge your HST on your rent and recover it in your expenses. With the apartment complex, it cannot be registered for HST so if you combine them in one company it becomes more difficult for reporting as the HST paid for the residential expenses are not refundable.
Always seek advice from your Kelowna accountant or a trusted advisor before setting up a corporate structure. Be sure to ask your advisor if they have a background in real estate investments. You’ll greatly benefit from having people on your team that have similar passions and can offer advice from firsthand experience.
What challenges do you have when deciding on a real estate investment plan?
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