After a long period of pouring your heart and soul into the business, you are starting to see major progress. You are building up extra cash and you are looking for ways to grow your wealth through investment opportunities. Some business owners may connect with a financial advisor and begin to invest in stocks, mutual funds, or other securities. Others however, may consider buying a real estate property. If real estate is your choice, then the question becomes – should you buy real estate property using a corporation? There are a few factors you need to consider that will determine if this is right for you.
Getting a mortgage
For a newly incorporated business, you are unlikely to obtain a mortgage from lenders because the company has limited credit history. The lenders view you as risky since you haven’t demonstrated that you have the ability to repay the loan. You will likely need to personally guarantee the mortgage if the bank allows you to close with the corporation.
However, if your business has shown a few years of strong financial performance, you should be able to negotiate a substantial mortgage based on the company’s earnings. The health and financial backbone of the business is what’s going to allow you to qualify for the mortgage.
Using pre-tax dollars
Buying real estate using a corporation means you are using pre-tax dollars as opposed to taking cash out and buying a real estate property under your personal name. This is important because you haven’t paid any personal taxes on that income.
For example, suppose your company earns $400,000. At a corporate tax rate of 13%, you are left with $348,000 to invest in real estate property. Since you left the money in the business, it’s considered pre-tax.
On the other hand, if you buy the property personally, you’d need to take money out of the company by way of a salary or dividend. Assuming you’re at a higher tax bracket (say 50%), that would leave you with only $174,000 of after-tax dollars to invest. The extra $174,000 is definitely a good argument to buy real estate using a corporation.
In some situations, corporations have a lower tax rate than individuals. If you purchase a real estate through the operating company, any income or gain will be subject to additional tax. This puts you in a similar tax position as making the investment under your personal name. However, you will be subject to a lower tax rate by making the investment through a holding company.
You can accomplish this simply by transferring excess cash tax-free from the operating company to the holding company via intercorporate dividend. In addition, buying real estate property in a holding company provides asset protection, tax deferral, and facilitates estate planning which are discussed below.
Buying a real estate property in a holding company helps keep the asset safe from creditors if something happens to the operating company. Companies are exposed to risk through everyday business activities. Transferring assets of the operating company to the holding company can provide a layer of protection if creditors come after those assets.
Using a holding company offers flexibility in the timing of income which creates the opportunity for tax deferral. As a business owner, you can wait until you are in a lower tax bracket to pay yourself a dividend from your holding company. If planning is done properly, you can defer income from one year to another which reduces your overall tax bill.
At some point you may wish to transfer your assets to the next generation. Using a holding company can help facilitate succession planning in the most tax efficient manner. This is commonly referred to as an estate freeze which can be achieved by using a holding company.
An estate freeze allows you to add another shareholder and shift all future appreciation of the real estate assets while allowing you to retain control of the holding company. Also, it has the effect of freezing your current position which limits the income tax liability that will arise upon death.
What’s the verdict?
If you have excess cash and are able to secure a mortgage through the corporation, buying real estate property using a holding company may be the way to go. However, keep in mind that each person’s situation will be different so a careful analysis of the factors above should point you in the right direction.