Should you buy your investment properties in your personal name or in a company name – with Cherry Chan
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Cherry Chan is a CPA who specializes in working specifically with real estate investors. In this episode Cherry gives her opinion on whether it’s better to buy in your personal name or company name.
CHERRY CHAN INTERVIEW HIGHLIGHTS
1:12 Tell us anything about yourself.
3:15 Were you an accountant before you decided to specialize in real estate accounting?
5:50 Is it better to buy properties, as a corporation or in your personal name?
11:15 Asset freeze.
13:20 From personal to corporation name, how do you coach people in that scenario?
15:37 What would that investor look like or what would their portfolio look like?
16:50 What kind of costs are involved with setting up corporations for investment?
17:33 What are the ongoing costs if you have it in a corporation versus personal?
18:20 What are the most common mistakes that you see from a taxation?
19:45 Speaking of CCA, you mentioned, maybe you could briefly touch on that?
24:05 Capital gains versus income.
Andrew la Fleur: Should you buy your investment properties in your personal name or in your company name? We’ll talk about that on today’s episode.
Speaker 2: Welcome to the True Condos Podcast with Andrew la Fleur. The place to get the truth on the Toronto condo market and condo investing in Toronto.
Andrew la Fleur: Hi and welcome back to the show. Thanks for listening and thanks for your support for this show. On this show we’re going to be talking to Cherry Chan and we’ll get to that interview in just a moment. But just wanted to give a quick disclaimer because Cherry is an accountant and any time we’re talking about accounting or legal things on the show, just wanted to give the quick disclaimer, you should always check with your own accountant, your own lawyer and get your own independent advice before you make any legal or accounting decisions on what is right for you. But with that being said, let’s jump right into the interview with Cherry Chan. Well it’s my pleasure to welcome to the show for the first time Cherry Chan. Cherry is a real estate accountant and welcome to the show.
Cherry Chan: Thank you.
Andrew la Fleur: Good to have you here looking … Hi. Looking forward to chatting with you and looking forward to hearing some great insights into accounting and some of the common questions that investors have when it comes to accounting. But first maybe tell us a little bit about yourself, help us to get to know you a little bit, who you are and how did you get started, how did you get to where you are perhaps as a real estate accountant?
Cherry Chan: It’s a long story, it’s about 35 year long. I actually started way back when I first came to Canada and our family bought our very first home. I guess that’s the part of the inspiration that I got from my family, particularly my mother, working really hard and leveraging, borrowing money, buying the first home. That’s the Canadian dream. Ever since then I’ve always been inspired on to rent any places and I started … Once I graduated and ended my previous relationship I moved out and I got my own place immediately without looking at the real estate market. At the time I had the experience working in public accounting firm handling small business clients but I didn’t really know what real estate accounting was. I was trying to dig up more and more information and find out there were very, very little and limited information out there.
As soon as I bought my first property and after I met my husband who introduced me to the world of investing I found that it’s really hard to find reliable accounting information out there. I started thinking about going into helping people, sharing my idea and sharing my research. That’s how I really started as a real estate accountant. I started writing my blockos and delivering it over a time I have a follower, some following.
Andrew la Fleur: Interesting, that’s great. Were you an accountant before are you decided, “Okay, I’m going to specialize in real estate accounting and working with real estate investors?”
Cherry Chan: Absolutely. I was in Waterloo, I was in the math accounting program. If there is any nerdier program you could find it would be math accounting. Yes, imagine Waterloo math too. I was in Waterloo math accounting, I graduated and got my CAA charter accountant license and now we all merged into something called Charter Professional Accountant CBA. After I got my first investment property, and that’s when I started thinking, “Wow. I wanted to share my research and I don’t want to just use my knowledge on myself, I want to make this a business.” That’s how I started.
Andrew la Fleur: That’s great. You moved from the corporate world and started your own business with your own clients. Is that right?
Cherry Chan: Yeah well I’ve always been an … I’ve always had entrepreneurial spirit now that I look back. My parents both each of them would have their own individual business. But at the time when I was working for corporate world I found myself spending one third of my time having coffee with colleagues, one third of my time surfing the internet looking for properties and then the other one third of time of course I still need to do some work and that’s that last third of the time. So I wasn’t really happy there and making the jump isn’t really that difficult as a decision.
Andrew la Fleur: Right, that’s great that you always had that instinct. We should mention as well your husband is a real estate agent as well working with investors as well so it’s really literally the perfect marriage in that sense. You guys make a dynamic team.
Cherry Chan: Yes, we are a good team for sure. We are a good team. My husband only works in the southern Ontario area. The strategies are very different from what you do.
Andrew la Fleur: Mm-hmm (affirmative), yeah. Obviously your husband Irwin, he does a … My understanding, he does a lot of work in the Hamilton market there. So that’s great. Let’s jump into it here. Probably the most common question as we were talking about before we started recording, one of the most common questions that I get and you probably get as well is the classic question of incorporation. Is it better to buy properties, investment properties as a corporation or in your personal name? Constantly being asked that question, I’m sure you are as well. You’ve created an amazing PDF which people can download on your website and we’ll include a link to that in the show notes for the episode and encourage everybody to go check this PDF out and get it. But the title of the PDF is seven questions to ask yourself when deciding to incorporate.
So you go over these seven questions. I thought maybe it would be good to just share two or three perhaps of the key questions to ask yourself when you’re thinking about incorporating or not.
Cherry Chan: Okay so a couple key questions that I would consider, that’s the top of my list to be honest. Number one is whether you want legal protection. When I say investors, many people don’t look at real estate investing as a business. It is still a business after all and there is a lot of risk. A lot of risk involved, I mean even in the Condo market you would know that my father-in-law was actually talking to me about how these board members were using the condo fund for their own purpose without proper documentation and he was liable to come up with the money in the condo board. Short fall, it would be the condo owners. Even in the condo asset there would be a lot of risk that we cannot foresee. Legal corporation is considered a separate legal entity in Canada so it can be owned by itself and can be named in court by itself.
If worst case scenario, you get into trouble and you want to just shut it down. There is that option out there once you incorporate. But if it isn’t in your own name people can sue all your assets. That includes your primary residence, that includes your RSP, everything. So that’s the number one thing. Number two thing is that … The number two criteria that I look at is I would say whether or not you’re paying more than 20% tax. If you are buying a property and you are generating … You are earning rental income per se not for flipping, if you are generating rental income. Rental income inside a corporation is considered passive income, specified investment income. That’s the tax term of specified investment income is taxed on 50% first. Five zero. All of that 50%, 30% would be refundable.
If I take an example of $10,000 of that rental income, $5,000 immediately goes to the government first. But then all of that $5,000, $3,000 it’s in a notional account up in the air on CIs, on your own record that they owe it to you. If you declare a taxable dividend. What it means is that the corporation will say, “Okay, well I want to declare a dividend to my shareholder.” And so we declare dividend to the shareholder and we can trigger the refund of this $3,000 back. The trick here is that then the shareholder would have to report that in their personal tax return, the dividend income. If someone who has no income receiving that dividend income, assuming that person has no other income, receiving that dividend income they can receive up to 35, 30, $35,000 tax-free. When you pay zero dollar in your personal tax return and pay …
Essentially because you pay 50% if you got a 30% refund, you had 20% in the corporation, 20% plus the 0% in personal tax, combine, 20%.
Andrew la Fleur: 20% total tax in that scenario is what you’re saying.
Cherry Chan: Yeah.
Andrew la Fleur: If you’re able to dividend out that money to somebody with no other income, is that what you’re saying?
Cherry Chan: Yeah, exactly. Some of my clients actually have a full-time job and they still incorporate. For some reason they would treat this as their future retirement fund so when they retire, when they decide to take a year off that when they declare the dividend out, declare out you get to [inaudible 00:10:27] that money back.
Andrew la Fleur: [Crosstalk 00:10:33].
Cherry Chan: So the value is receivable from the CI would be refundable, I carry for it forever.
Andrew la Fleur: What else? You’ve got other questions as well, some other considerations or questions.
Cherry Chan: One aspect of it is … You’re right. One aspect of it is also the long-term view, what you want to do with your portfolio. The reality is that if you are planning o give your asset somehow to your family, to your next generation we often use a strategy called asset freeze. So we freeze the value of your properties and during this process of doing asset freeze we often would do it with inside … Using a corporation as a vehicle to give it to your next generation tax-free on a tax-free basis. To do it you need to transfer the assets into a corporation and if you think about it if you own a condo downtown in Toronto, say 500,000 you would have to pay probably about 20, $25,000 off-lend transfer tax. When the transfer happens if you own everything in your personal name and you want to do an asset freeze using a corporation it is almost impossible because the cost of doing it is the lend transfer tax.
In Toronto you’re paying double lend transfer tax so it makes the future asset planning very difficult and costly.
Andrew la Fleur: Right, okay. What do you recommend to do instead?
Cherry Chan: In that case if your plan is to have a future or plan is to transfer the assets and leave your assets to your sons, your wife … I’m sorry, to your grandchildren, to your child, then maybe it is a good idea to start off leaving it in a corporation’s name.
Andrew la Fleur: Right, to have it in the … If you’re planning on passing the property down to your children or your grandchildren it’s better, you’re saying, to start it right from the beginning in a corporation as opposed to potentially putting it in a corporation later down the road. Is that what you’re saying?
Cherry Chan: Yeah, absolutely.
Andrew la Fleur: And that’s obviously another common question is people who started out buying properties in their own personal name and they later want to switch it into a corporation name, what are other considerations or how do you coach the people in that scenario? What do you tell them in that situation?
Cherry Chan: There are pros and cons, sorry, pros and cons of transferring the property into the corporation. The biggest cost is really lend transfer tax. There is an election that’s available for us as Canadian citizens who transfer the assets, the property to the corporation on a tax-free basis. So there’s no income tax being triggered but because ownership of the properties change you will immediately incur the land transfer tax. Having said that it’s not uncommon for some of my clients who do the transfer, do the corporation, here is the reason why. I can give you an example. One of my clients bought, years ago bought a lot of shares and they were in the market buying and selling and they lost hundreds of thousands of dollars in the corporations. The corporation is in a professional service type of business.
So they don’t have the sale of the shares, regular capital gain. When we transfer the assets into … Sorry, the sale of the shares traded with a capital loss and the capital loss would not be allowed to be applied [inaudible 00:14:45] regular business income. As a result one of the ways to utilize this and use capital laws is to transfer your asset into the corporation that has a huge gain, but have a huge gain if you sell it to a third party. Going to the corporation when we sell it to a third party we will be able to utilize a capital loss carry forward. Even though we are triggering the land transfer tax it is still worthwhile to do that.
Andrew la Fleur: Interesting, yeah. One of the tricks of the trade if that makes sense. Generally speaking when you’re coaching people, people asking you this question about incorporation. Maybe describe the type of scenario or the type of real estate investor where you would generally coach them to not incorporate. What would that investor look like or what would their portfolio look like?
Cherry Chan: I always advise my clients to incorporate almost all the time. Nine out of 10 times. But usually for first time buyer, first time investor or for the investor that are making likely under $60,000 to $70,000 and they have no concern whatsoever about the risk, I would tell them there is no need to incorporate because first of all you have to … For the first-time investors, really simple for me. You have to like being [inaudible 00:16:16]. There is cause involved in setting up the corporation and if you don’t like being a [inaudible 00:16:25] what’s the point? It’s easy to sell the property and have it all [inaudible 00:16:29] in your own name. But if you have to close up the corporation you have to wait for a couple of years and all the extra cost involved.
Andrew la Fleur: Right. So it’s like some people get into real estate investing for the first time and buy their first property and they might decide it’s not for them. So it may not make sense to set up that corporation and incur all … What kind of costs are involved with setting up corporations for investment?
Cherry Chan: Usually we have our clients at the corporation and the cost is around $2,000. We’ve seen a range that’s being charged from $1,000 to three, $4,000. I’ve seen a charge of $10,000. I don’t know what’s reasonable and what’s not reasonable but that’s typically the cost that you would have to account for. Make sure that you don’t set up all the infrastructure and you’re left with no money to invest.
Andrew la Fleur: And then what are the ongoing costs if you have it in a corporation versus having it in a personal?
Cherry Chan: If you have it in a corporation and your filing of a corporation tax return is generally more expensive than the personal tax return, usually it ranges from anywhere to 2,000 to 3,000, sometimes it could be $4,000. But for a personal tax return usually it’d start off with two properties around 800 to $900. As you get more properties in your personal tax return it gets more complicated and obviously the fees will go up as well.
Andrew la Fleur: Right, so you’ve got ongoing fees to consider there as well. Thinking about first time investors in particular, what are the most common mistakes that you see from a taxation, from an accounting standpoint? What are some of the most common mistakes that you see first-time investors making that maybe they come to you after the fact and you say, “Ooh, you did this wrong, or you should have done it this way. You could have done it differently.”
Cherry Chan: Actually the majority of the first-time investors are pretty good. The only thing that I’ve noticed is that if they don’t use an accountant at all and do their personal tax return then sometimes they would calculate a capital cost allowance incorrectly. Because there’s regular software that you can get off the street, the taxpayer has no idea what capital cost allowance is and how it is calculated. That’s why it could be an easy investment. The second thing is that they would miss some of the deductions. For example automobile expenses and home office expenses. If you use less than 20% down to purchase a property or if you incur other finance charges they’re probably not deducting the finance charges properly.
Andrew la Fleur: Speaking of CCA, capital cost allowances you mentioned, maybe you could briefly touch on that? Because as you mentioned a lot of people don’t know what that is or how to use it. In layman’s terms what is the CCA, capital cost allowance? What do investors need to know about it and what is your general advice on how to use it?
Cherry Chan: Capital cost allowance is basically the tax term for wear and tear. CI randomly picks a number, 4% on building. When you buy a property you would … The purchase cost save $500,000. The purchase cost of the building is 500, you add the closing cost and you can claim 4% a year as a wear and tear on the property against your net rental income. When you use that the challenge is that it is only a inferrable [inaudible 00:20:41]. It is not tax … It’s not a deduction, it’s not a write-off per se. It is a deferral. It’s kind of similar to what RSPI always use in analogies. The year that you earn the net rental income, you claim the capital cost allowance, you can reduce your … Sorry. You can reduce your net rental income to zero and so you’re not paying any tax on your net rental income.
But the year that you sell your property, all the capital cost allowance that you’ve taken over the years, every single year has to be added up to your own income. You sell the property and it is them being taxed a year of sale. Similar to your RSP when you contribute you don’t have to pay tax on the chunk of money that you contributed. Then the year you take it out you have to. I think that’s the simplest way to explain what capital cost allowance is. In terms of my [inaudible 00:21:39] on capital cost allowance it goes back to the individual tax pay if you’ll be honest. I had a consultation with a client earlier last week and he’s making over $250,000 a year. And so the marginal tax rate on any income over and above $250,000 is 54%. Whether you earn $200,000 over or $10,000 over you’re still paying 54%.
If you are at the highest marginal tax rate or close to the highest marginal tax rate to me it’s a no-brainer. You should take the capital cost allowance because yes, you have to pay tax eventually but you’re paying tax the same amount ten years down the road. The dollar in your pocket today is worth a lot more than the dollar in your pocket ten years from now. So definitely take the capital cost allowance. But if you are really making no income at all and for some clients that I have they are living the dream, they only collect rent and they don’t have any other income. Would you take capital cost allowance? They don’t have any other income, they may be having 20, $30,000 at rental income. So there is really no point taking capital cost allowance. Then it goes back to the personal preference.
If you want to pay the tax on the 20, $30,000 rental income or do you want to give the cash now? Some of the clients actually like to give the cash and that’s why they take it. Some people are like, “Well I have low enough tax rate, it’s not going to get any lower.” And I would not take it. I hope that answered your questions.
Andrew la Fleur: No, that’s great, really. As with a lot of these questions as you said, a lot of it just comes down to the person’s situation and the answers are different depending on your situation and who you are-
Cherry Chan: [Crosstalk 00:23:46].
Andrew la Fleur: It’s so important, preferences. And that’s why it’s just so important to have a professional like yourself working alongside the investor to help them make these decisions because they are different for every person. Maybe just as another question to touch on something, one of your blog posts recently talking about capital gains versus income and come of the CRA’s recent rulings on particular condo assignments for … Talking to the condo investors assignments are always a hot topic. I know you’ve written about that recently. Maybe as a broader question what is the difference between capital gain and just regular income and as the investor how do you know which one you’re going to be paying? How does that [inaudible 00:24:36]?
Cherry Chan: To step back let’s talk about what the difference is between capital gain vs income. Capital gain if you make $100,000 profit, if it is considered capital gain only $50,000 would be taxable. Then you multiply the $50,000 with the marginal tax rate, let’s say 50%, you pay $25,000 tax. On the income side if it is considered income the $100,000 is 100% taxable. So you multiply by your marginal tax rate, say the same 50% and now you pay $50,000. So capital, you pay 50% of the tax. Income you pay 100% of the tax. That’s really where the difference is. As you imagine everyone wants to call themselves buying capital investment rather than running a business. CR actually has a set of criteria that they consider that includes the taxpayer’s profession, it includes looking at the taxpayer’s intention, it also includes looking at the duration of ownership.
Also they look at mortgage terms, a bunch of criteria that they look at in one particular transaction and also in the history of your life, what happened. For example today, this morning I wrote a blog post about someone who is actually a real estate agent, bought a property to her name, pre-construction condo and sold it immediately, within one month after closing. She actually did not report that income at all, capital gain or income. She never reported it. And so that was wrong, number one. CI found out and then they said, “Well this is on the income account,” and she appealed. She said, “No, this is on the capital account. I bought it for my granddaughter to go to Seneca College. She claimed her intention was to buy it for her granddaughter to go to the college, but her behavior is actually not showing it, showing that way.
CI actually look at her tax return which shows only $20,000 net income. She’s in no position to qualify for a mortgage to close the property to begin with. CI also look at her profession and in the court case the judge actually quoted that she’s been a real estate agent for 20, 30 years. She’s never lived in the property but she should have the knowledge that she has to report the income. It also notes that look at the financing firms arrangement. They look at the whole scenario all together and then decide, conclude on your intention. In this case obviously they also look at the duration of ownership. Sorry, I forgot to mention that. They look at the whole situation and say, “Hey, this does not look like you are buying an investment and it really looks like you are really trying to make a quick profit.”
That’s considering all the income accounts and so 100% off the profit would be taxable. In that particular court case they also add in the gross negligence penalty, meaning that you did not report the tax, you report the income, you intentionally cheated on the tax return. Now if you owe us $20,000 we are going to add $10,000 penalty on top of 50% of whatever you owe. That’s the gross negligence penalty.
Andrew la Fleur: Very hard lesson for that real estate investor. If you were advising that person before they made these decisions that lead to that what would you tell them to do differently?
Cherry Chan: Right now CI is actually going after anyone that owns property, particularly pre-construction houses or condos. They’ve owned it for less than one year. The definition of one year as you know, you may know, you’re really familiar. The closing of a condo or a new home, newly constructed home does not happen until a while after they let you move in. After the occupancy date. The closing day and the sale day have to be more than one year. One year is not a guideline, one year is not a rule written in the CI’s rule book. But if you own it for less than one year it’s just a low-hanging fruit for the CI to come after you. They are going after the low-hanging fruit. Secondly if you have multiple … You flip multiple properties, they would use a second property as the evidence that you’re in the business of trading condos, a newly constructed home.
That’s also something that you need to look at, not just profession, duration of ownership. It’s also your behavior, your repetitive behavior that would also drive it. If you are really doing flipping you can put it inside a corporation. If you put it inside a corporation selling and buying … Buying and flipping property then consider business income reported as such. It’s only subject to 15% tax in the corporation, one five percent, 15%. It’s much better than … This scenario, I always tell people, “You should incorporate.”
Andrew la Fleur: Right so if you’re flipping and you do it in a corporation that’s considered-
Cherry Chan: [Crosstalk 00:30:59].
Andrew la Fleur: What, active income of the business income as opposed to passive-
Cherry Chan: Yes, rental would be considered passive, yeah.
Andrew la Fleur: Rental income? So if you are flipping, if that is your business model, your MO for investing in condos and you’re flipping then it actually does make more sense for sure to put it in a corporation for that reason. Just only taxed at 15% and then you’re able to reinvest those profits within the corporation. Is that right?
Cherry Chan: Yes, I know. Our really handsome Prime Minister just came out with these proposed tax changes recently. They are a couple of tax changes. Can I talk about this? The recent tax changes-
Andrew la Fleur: Yeah, absolutely. Let’s get into it.
Cherry Chan: Actually target small business owners. If you have a flipping business per se they are really targeting you as well. What they do is if you make $100,000 from the sale of a property and you report it in the corporation’s name, you’re only paying 15% tax. 100,000 – $15,000 tax, you’re left with 85,000. You can easily take the $85,000 and go somewhere and buy another property for long-term [inaudible 00:32:26]. Versus if you, the same investor did not incorporate the same $100,000 even assuming that investor has no other income, that $100,000 profit you likely will be paying 30% tax. So you’re paying $30,000 to the government. Now your base is 70,000. If you incorporate your base is 85,000. They’re really trying to target the people that are setting up the corporation and have net income left over for investment.
What they’re saying right now is that they would only allow you to invest up to $50,000 a year. Even though you have $85,000 left over you’re really only allowed to invest the first 50,000. The remaining 35,000, if you do investment that’s fine but that income that’s curated from the $35,000, [inaudible 00:33:25] $35,000 is going to be subjected to the highest tax rate, 50%. We don’t know how they’re going to implement it, we have no idea. They are going to come out with the rule in the coming federal pundit to announce to the world how they’re going to implement it. The downside of that is that they are going to come out with draft legislation it’s going to go through regardless and they will not listen to the accounting world or the general public feedback.
Andrew la Fleur: So this is all happening in real time and we’ll have to certainly see how this plays out. But that’s a major change that we certainly as investors need to be aware of things like this. And again, very important to have an accountant as part of your team that is able to advise you on these things in real time as the changes are occurring.
Cherry Chan: Absolutely. But that does not deter you from incorporating. I would still incorporate if you flip properties. Chances are you can save the $50,000 and the remaining $35,000 you are still reinvesting in your business and buying more property and flipping more. I would still go into the corporation, save the $50,000, save 30% or sometimes 35%, yeah.
Andrew la Fleur: You still advise that, interesting. Cherry, really appreciate your time today so far. We’ve covered a lot of different subjects today, really appreciate your insights. Once again if people want to get a hold of you or download in particular this seven questions to ask yourself when deciding to incorporate, this PDF that you got [crosstalk 00:35:25].
Cherry Chan: My website and my website is Realestatetaxtips.ca.
Andrew la Fleur: Realestatetaxtips.ca, great. Of course we’ll include a link to that in the show notes-
Cherry Chan: Thank you.
Andrew la Fleur: As well. Thank you so much Cherry and-
Cherry Chan: Okay, thank you so much.
Andrew la Fleur: Looking forward to hopefully having you again on the show soon.
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