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Beneficial Trusts in Real Estate Investing

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In this video, Keith Uthe from Enrich Mortgage Group talks to RMI’s Managing Partner Irfanali Moledina about advantages of Beneficial trusts in real estate investing.

For those who prefer to read, a transcription is available below the video.

using beneficial trusts in real estate investing

Keith:
Hey good afternoon everyone, Keith here with Mortgage alliance and Enrich mortgage group, and I am fortunate to have here someone who’s got some extensive knowledge and is going to help give us some understanding and direction around beneficial trusts and using them in real estate investing.

So, with us today we’ve got Irfanali Moledina and he is with RMI Chartered Professional Accountants, he is a CPA and CA located here in Calgary and he’s got a plethora of knowledge that he’s going to share with us today. Welcome, thanks for coming and doing this for me.

Excellent, well you know what let’s jump right into it. One of the most common questions that I hear from real estate investors and conversations, whether it’s clients of mine or on real estate investing groups, is “When does it make sense to have an investment property in a corporation?” And I know that the easy answer to that is well, it depends, but are there any things that you would say are considerations of what might be triggers for them to make sure they’re having a deeper conversation with their accountant about that choice.

Irf:
For sure yeah it is, it is such a common question that comes in and the biggest factors that I really look into are first of all, what is the individuals income in main source of income, so, for example, if they’re self employed or already have a business if they’re able to keep their funds or their savings inside the corporate structure there’s potential tax savings there, rather than take that income in personally so that’s one consideration we always look at.

The other one is how much income are they earning on the personal side if you’ve got an employee who’s got substantial income 150, 200, 300,000 they’re in a higher tax bracket already. And so, at that point, it may make sense to look at that corporate structure so they’re not taking any extra income in from the rental properties they have.

And the biggest, that is what are they doing with the property too, right. Is it going to be something where they’re going to be flipping the property that again might lead to saying let’s keep it inside of a corporate structure.

Are they doing long term rentals or are they doing short term rentals right like AirBNB and there’s different tax structure as well on those and so those are the biggest factors that I really look at is kind of what’s their personal income at today where’s the down payment, the initial money coming from for the investment piece, and then, of course, what are they doing with the property at the end of the day.

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change of lending rules

Keith:
Excellent, well you know as a mortgage broker for me and for my clients, the biggest thing we run into is how lending rules have changed. You know the days of being able to buy rentals and put them into a holding company and get the financing and all things are glory and golden and away we go that’s changed it’s not your grandpa’s lending environment anymore or your dad lending environment whatever you want to call it.
And so, now there is, you know the beneficial trust conversation is certainly one that you and I, when we talked about this is one that is coming up more and more and more. And the biggest thing I think is a lot of people don’t understand what is beneficial trust and then, when can it be used so let’s start with what is beneficial trust.

what is a beneficial trust

Irf:
For sure and it is becoming more common because, clearly, the banking rules have made your guys’s job so much harder so what tends to happen, a lot of times is you take an individual who’s got really good income and the banks want to just lend to them personally. So what we do is turn around and we institute this beneficial trust and what it is is a document that says that the property is in an individual’s name interest of the corporation.

benefits of a beneficial trust

And now why this is so handy is for a couple of reasons, because the banks and lending look at title ownership so they’re going to be concerned who’s on title.

So if we do this trust agreement or the beneficial trust agreement and it’s in the individual’s name CRA on the opposite side looks at beneficial ownership, so that document, then says that the benefit is going to the corporation. And because the benefit is going to the corporation we’re able to actually claim income and expenses under the corporation, even though the mortgage and the property is in an individual’s name.

And that just allows us to look at different scenarios where it’s easier to get the mortgage qualified. You get the better rates because it’s still in the personal name but we’re taking advantage of being able to do everything through a corporate structure, at the same time.

Keith:
And for the beneficial trust, does that have to be then registered on title or is it just something that needs to be kept and recorded in your documentation?

Irf:
It’s something that needs to be kept and recorded in your documentation. It’s really important if CRA was to ever come back. It’s handy if you do register on title but it’s not required it’s something that just has to be there, so when CRA comes back to say okay well, who is the owner of this property, who is getting that benefit and at the end of the day, so where the income goes, we need to be able to provide that document.

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when and how to use a beneficial trust

Keith:
So when can it be used or when should it be put into place?  As an example I’m not sure when I’m buying this property if it’s going to be personal or whatever. Do I need to declare it, do I need to decide it the day that I get the mortgage or the day after, or do I really need to decide before I file my taxes, in this case for 2022?

Irf:
I would say it’s something that you should decide when you buy the property. Because a lot of times you also want to make sure, that everything tells the same story, so what will happen is, if you want to treat it under the corporation you have to make sure the corporation exists. So if somebody buys it under their name they don’t have an existing corporation. And then tax time comes, and he says, well, I should have done it that way you won’t be able to, right. So it’s important to do it right away.

Another good reason why is, if you are going to do it through the corporation you want the rental agreements to showcase that. You want the money to be flowing through the corporation, right so. You got to make sure everything’s telling the same story at the end of the day otherwise CRA can come back and deny it.

Keith:
So if you’re getting new leases you need to make sure that your leases are in the corporation’s name, not your personal name as well.

Irf:
Absolutely, yeah.

Keith:
I see there’s a huge tip for you investors out there that want to use beneficial trust, make sure your leases are in the name of the corporation for that beneficial trust.

buying a property with tenants

Keith:
What if I’m buying a property and I’m assuming the tenants that are in the property and there’s already leases in place.

What kind of documentation do I need? Do I need to write up new leases for those tenants with my corporation, so that even though the terms can remain the same, but do I need to do that?

Irf:
Yeah I typically would recommend doing new leases in that situation. If, for some reason you can’t you can include that stipulation inside of the beneficial trust, so that trust agreement can be amended in some ways to be able to pick up the leases to be factored into it. But, better recommendation of course is do new leases at least you know it’s your leases it’s your control it’s what you want to make sure it’s covered off in those agreements and then at least you get a fresh set of agreements with the tenants.

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What to do with an existing property

Keith:
That’s awesome. So if I bought a property while ago, you know, maybe I’ve owned it for a year, two years. And now maybe my employment changes, my income goes up, or maybe I go from being an employee to self employed for whatever reason, that things happen, can I now implement the beneficial trust process and use that through a corporation at that point?

Irf:
Yeah, that’s another good question I get that commonly too or sometimes I get it where somebody’s got a property from like three years ago, and then they’re looking at buying a second or third and they’re like well now that I’m getting more active in this maybe it should be in a corporation.

And, the answer is, it can be done, but it has to be careful because CRA’s rules also say that when you transfer property to something you control and own, it has to be done at fair market value. So if you bought a property, five years ago, most likely, it has hopefully gone up in time. So if it’s gone up in time we have two options:

We either can declare a capital gain if removing it into a corporation, and a lot of times we don’t want to do that because you’re going to get taxed on it right away.

The second option, and this is more common is you can do something called a section 85 rollover and what that rollover does is it allows you to move the property into a corporation at the cost price.

The difference between fair market value and cost you get issued preferred shares that you redeem over your lifespan so it’s a tax deferral that we can put into place to avoid the taxes on the capital gain that you incur.

And in that situation because we’re most likely not going to change the mortgage at that time we’re not going to go and re-qualify for anything so instead we’d also create the beneficial trust to then align it with the rollover to then make sure everything gets moved into the corporation and going forward from that point we can use the corporation only.

lifetime capital gains exemption

Keith:
Oh, that’s awesome that’s a great piece of information. Now, you mentioned something – a word, a couple of words in there called capital gains. There is something out there called lifetime capital gains exemptions – does that play into this consideration of whether you have to pay capital gains on that rollover or how would that work into this whole picture of choosing corporation or not? If you maybe only own $2 or $3 million worth of real estate and that’s where you’re going to be but you’ve got your lifetime capital gains exemption does that play into this picture somehow in these choices?

Irf:
Yeah it can for sure, so the lifetime capital gains exemption what it is, is it’s about $900,000 now and it’s going to be about a million and then it’ll stop at a million, but it is on the sale of land, for example, or farm property or the sale of shares in a private corporation you can use this exemption and everybody individuals entitled to it. So where it can become beneficial if you’re somebody who’s looking at owning many properties and that’s the business and we treat it as active income in a business and you go and sell that group of properties, there is a chance we can use your capital gains exemption if you’re doing a share sale.

If it’s one or two properties, we can’t do it because they’re passive in nature, but there’s things now like with short term rentals.

AirBNB income that’s all considered active income, so if you’re starting a business where you might have five properties and they’re all AirBNB short term rentals and then you decide to go sell that business and the shares of it, you can take advantage of the lifetime capital gains exemption.  So there is certain pockets, where it can actually be taken advantage of in real estate as well.

Keith:
For the active flippers that’s there for them the lifetime capital gains exemption can help save them as well, so just a matter of choosing when and where to use it appropriately. 

So that active income versus non active income, I guess that also dictates, whether you have your property in a holding company versus an operating company because active versus inactive income so that’s really an important conversation to have with the accountant.

Yeah so are there anything ans we’ve touched on this, I think a little bit, but is there anything that investors should be doing to maximize the benefits of having an investment property in a beneficial trust corporation or in the corporate incorporation purely?

Irf:
For sure so there’s a couple of simple things if you are using the corporation. A lot of times we look at setting up something called a three tiered structure, even where you might have a holding company, a real estate company and then an active management company, for example. And so what that allows you to do is take your real estate properties, where you might be earning passive income and passive income gets taxed at a higher rate inside of a corporation and being able to move some of it to management entity, where now you can actually get the active business income, right.

Or if you’re doing some of the AirBNB short term rentals or flipping or doing that kind of stuff if we can change your income from passive income to active income, you get a huge benefit from that end.

And then other things that you got to keep in mind if you’re using a corporation for real estate investing is that corporate structure. You got to make sure you’re maintaining good books and records like any corporation, right, and you got to make sure you’re actually staying on top of your banking and like we talked about tell the same story, so you want your mortgage payments to come out of the corporation if it can, you want to rental income to be going through there so just good business practices at the end of the day, become important.  

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residential investment properties

Keith:
That’s awesome so you know, one of the last things, though, is what are the pitfalls that investors need to be aware of, if they want to use a corporation for, not commercial, that’d be a completely different conversation, but for residential investment properties, what are some pitfalls that they should be aware of that they they should be cognizant of is making that choice.

Irf:
For sure I think the two big ones that come to mind, of course, is cost. If you’ve got one investment property it doesn’t make sense to go through this whole process, incur the extra cost of having a corporation to then have it in that structure. May be, but it’s something you got to really look at carefully.

Cost is for sure big one, and then the second other factor, too, is again that personal income level if you’re somebody who’s in a low income tax bracket already then you really need to move into corporate structure where your tax rate might even be higher, because it’s passive income compared to your personal rate, so the biggest pitfalls is, if you do it prematurely, or you don’t do it properly, it can actually end up costing you more.

Keith:
Gotcha. That’s huge at consideration because, everybody’s looking for the ways to pay less tax, but the wrong choice based on the wrong information from not talking to the right professional can cost you more than taking the time to reach out to you and say hey, this is what I’m thinking. Am I thinking right, am I making the right choice here, because the wrong choice can really cost you.

Irf:
Absolutely, and it’s about doing that planning in advance too, right. You don’t want to wait too long before you’re making this decision because, again, it could lead you to having made the wrong choice when you don’t want that.

Keith:
You’d rather take the time to set them up right at the beginning than have to take the time to clean up a disaster after. Generally cheaper up front and after isn’t it.

Irfanali, this has been fantastic information and highly valuable I know to my clients, how can, if somebody wants to have a conversation with you and reach out to you obviously they can connect through me, but if they want to get a hold of you directly, how should they do that.

Irf:
For sure, so you can just look for us – it’s RMI Professional Corporation on Google. Our website is www.accountantscalgary.com and you can always reach us by phone at 403-457-4232.

Keith:
Hey that’s amazing I appreciate you coming and doing this for us today, and you know it’s such valuable and timely information because why real estate investing just seems like it’s taking on a whole new world a whole new meaning here during Covid as people have realized things about their life, and you know things like Covid and the impact and how fast things can change so very timely and a very important conversation to have.

Irf:
Yes, thank you for having me today, it’s fantastic.

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Have more questions about how to properly handle your real estate investments from a tax point of view?

Book a Free consultation today or contact us at 403-457-4232 or by email at info@rmiassociates.com.

And if you need to speak to a mortgage broker, you can call Keith at 403-614-8843 or email keith@enrichmortgage.ca.

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