If you are one of those people looking to build wealth through real estate, at some point you will (hopefully!) end up buying your first property.
And when that day comes, you will inevitably face the question:
Do I buy this property in my own name, or do I buy it through a corporation?
The answer, like most things in life, is not straightforward.
And so, having gone down both routes in the past, I wanted to do a detailed post outlining the pros and cons of each approach.
The perspectives below have a clear North American twang to them, as that’s where all of our properties are located.
That being said, I have also tried to provide a UK angle wherever possible.
We will begin with some of the advantages of putting your properties into a corporate vehicle:
#1: Limitation Of Liability
Protecting the downside is one of the most important aspect of your job as a landlord.
Regardless of how you own a property, the one thing you should never skimp on is proper insurance coverage.
In addition to reimbursing any physical damage losses, typical landlord insurance policies will also give you legal liability protection in the event someone injures (or worse) themselves at your property – and decides to go after you for damages.
Now, a typical policy coverage amount is somewhere between $1m and $2m.
However, when you get into multiple-unit, mixed-use commercial and residential properties, $2m might no longer be enough.
After all, there is always a (highly unlikely) risk of a catastrophic event. It could be asbestos, structural damage, or a simple freak accident.
In other words, crap happens. And if it does, you want to make sure it doesn’t bankrupt you.
Making sure you’ve got sufficient insurance coverage is obviously a must.
But going the corporation route is the only way to completely de-risk your personal downside.
#2: Limitation Of Losses
In addition to legal risk, there’s also the far more proverbial risk of a drastic decline in your property’s value.
Snap – and you are suddenly underwater on your mortgage.
One reason could be a market correction. It never feels that way in the heat of the moment, but most market price corrections are actually temporary.
This is exactly what happened in the US in 2008. Speculators who panicked and sold ended up locking in their losses.
Those who bought on the fundamentals (i.e., cash flow) and had a truly long-term view are sitting pretty – and that’s before the most recent bull run in property values.
Of the folks who did sell, the ones who held their properties through corporate vehicles have been able to limit their losses up to the amount invested.
Those who bought properties directly ended up having to make the bank whole – or file for personal bankruptcy.
There’s also a possibility that your property will suffer a permanent impairment in value unrelated to market conditions.
Perhaps there’s a chemical spill nearby, or a big employer (a plant or an army base) decides to fold shop, or it turns out your property has been sitting on a landfill all these years. Or maybe you bought a place in downtown Detroit.
Holding property in your name leaves you on the hook for the mortgage no matter what.
A corporation gives you a chance to walk away, with losses capped at the amount of money originally invested.
#3: Tax Advantages
As a general rule of thumb, corporate vehicles provide for a number of legal, albeit creative, ways to minimize your tax bill.
First of all, corporate tax rates are usually lower than personal tax rates (especially for higher earners).
It is true that before you can access the money, you’ll have to pay it out to yourself as either salary or a dividend, both of which are also taxed at your personal rate.
However, nothing stops you from timing those distributions in a way that minimizes your tax bill.
Perhaps it’s a year when you didn’t make that much money to begin with. Or a year when you didn’t utilize your full tax-free dividend allowance.
And if you own a property jointly with a spouse but via different share classes, you can “channel” distributions to the party with the most favorable tax circumstances.
In other words, possibilities galore.
Here in the UK, there’s also the question of deductibility of mortgage interest. It’s still possible for corporations, but not for retail landlords.
Other countries are thankfully far more sensible on this point. But with sharply rising property values and regular elections, one can only wonder for how long.
Finally, there’s the flexibility around estate planning. Once again, a corporation confers much more flexibility on this point.
To make a long story short, you should always hire an accountant to help you sort through the tax points.
That being said, I would be shocked if a qualified accountant wasn’t able to find a way to reduce your tax bill by using a corporate vehicle.
You don’t necessarily want your tenants to know what you do and where you work.
Yes, corporate information (including how much money it makes) is often out there in the public domain. But the reality is that few people will ever bother to look it up.
Using a corporation alongside a PO box and a property management company can give you a significant degree of anonymity when it comes to dealing with tenants and other nosy parties.
Property can be expensive. As such, at some point you may want to partner with your family or friends.
It’s much easier to formalize that relationship using a corporation than a handshake. As a matter of fact, I would strongly advise you against any handshakes when it comes to doing business.
So far, so good. I mean, why wouldn’t you use a corporation?
Well, notwithstanding all of the above, using a corporate vehicle also has a number of disadvantages:
This is the bit that puts most people off.
The reality is that incorporating just isn’t that hard.
However, it’s also fair to say that doing it for the first time is far from straightforward (it certainly wasn’t for me).
And if you are only going to buy one property, the time and effort involved in figuring out the process might not be worth it.
#2: Administrative Costs
It’s nice to get all those tax advantages – but you will most likely need an accountant to help you sort through that exciting topic.
Sadly, I’ve yet to come across a good accountant who was willing to volunteer his or her services for free.
#3: Higher Financing Costs
Banks aren’t stupid.
In fact, they are fully aware that one reason you are using a corporation is to give yourself an option of walking away if things go south.
Thus, corporate mortgages tend to be more expensive than retail ones.
To give you an example, we bought two properties in a span of 9 months.
The one acquired through a corporation was financed at a 2.45% variable rate. The one in our names – 1.65% fixed.
#4: Lower Loan To Value
Once again, no one will ever allow a corporate mortgage with a 95% LTV.
70% is probably as far as you’ll be able to push it.
The way the maths work is simple – the more equity you put in, the lower your overall return.
But the less equity you put in, the higher the chance you will walk away if things get dodgy. Banks wouldn’t be banks if they weren’t fully attuned to that fact.
#5: Capital Release Flexibility
If you own a (somewhat) paid-off property in your own name, it’s very easy to release cash through a refinancing.
As a matter of fact, that’s how I got my start in real estate.
Just head over to the bank, give them your pay and credit score information – and sign on the dotted line.
When the economy is booming, they will happily sign you up to another 30 years of mortgage slavery – and advance a nice chunk of cash straight into your bank account.
With a corporation, there is an additional hoop to jump through – because the funds will be advanced into your corporate bank account.
And you can’t just raid that piggy bank whenever you so choose, especially without triggering a tax event.
It’s doable – but will likely involve shareholder loans, related party transactions, and other creative structures, depending on the jurisdiction.
If these sorts of words make your eyes glaze over, you could be better off keeping it simple.
At the end of the day, choosing to hold a property through a corporation vs directly is a simple, profit-maximizing decision.
I hope that today’s post can help clarify which option is best for you.
Best of luck – and happy investing!
About Banker On Fire
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Banker On FIRE is an M&A (mergers and acquisitions) investment banker. I am passionate about capital markets, behavioural economics, financial independence, and living the best life possible.
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