Benefits of the Three Tier Structure for Real Estate Investors
Allan Madan, CA
Are you wondering what are the benefits of the three tier structure for real estate investors? Read this article to find out more
The three tier structure is designed for and used by real estate investors. It consists of three corporations.
- A management corporation
- A Real Estate company
- Holding corporation
The management company provides property management services to the real estate company in turn for a fee. The real estate company owns land and buildings. The holding company behaves like a piggy bank and owns 100% of the shares of the real estate company. I use the term “piggy bank” because the real estate company distributes cash dividends from its rental profits to the holding company on a periodic basis.
There are three major benefits to having the three tier structure.
- The management company pays a very low rate of tax of only 15.5% on business profits.
- The real estate company has reduced risks for lawsuits because it’s not performing any property management services.
- The holding company protects cash retained earnings from creditors.
Here is the tip! If you are a serious real estate investor, use the three tier structure to reduce legal risk, protect cash, and lower your tax bill.
The information provided on this page is intended to provide general information. The information does not take into account your personal situation and is not intended to be used without consultation from accounting and financial professionals. Allan Madan and Madan Chartered Accountant will not be held liable for any problems that arise from the usage of the information provided on this page.
In this 3 tiered structure, then the lease is between the Management Company and the Tenant? Leases are normally between Landlord (the Real Estate Company) and tenant. How is the Property Management Company able to have a lease with the tenant? Is there is an assignment of lease? And if there is an assignment of lease, it is a sale of leasehold interests and there are tax consequences for it.
The lease agreement is with the real estate company. The property management company enters into contracts with vendors on behalf of the real estate company.
Allan Madan, CPA, CA
How do we go about setting this up, just go to an accountant and they should know?
You can contact your local accounting professional. While I cannot assure you that they will be familiar with these type of structures. You can also contact me for a consultation.
Hi Allan, First, I want you to know that the properties we are talking about are all residential properties.
In this case who is charging the rent from the tenants (real estate company or the management company). In any case won’t the real estate company be specified investment corporation as there are no employees (or less than 5 full time employees) in the real estate company. As a matter of fact less than 5 full time employees in the whole group of three companies. If it will be a specified investment business then highest tax rate will be charged on the passive income. If management co. will charge the rent from tenants and management company will pay the rent back to real estate company then also won’t it be the same thing. Real estate co. will be treated as specified investment corp (due to less than 5 F/T employees). Thanks
Thanks for your question. The rent cheques are made payable to the Real Estate Company. The Management Company collects the cheques and deposits them in the bank account belonging to the Real Estate Company.
Yes, the Real Estate Company is carrying on a Specified Investment Business, unless it is more than 5 full time employees. The ‘5 employees test’ is applied to each corporation separately.
You are correct that the Real Estate Corporation is paying a high rate of tax. That is why it’s best to pay management fees from the Real Estate Company to the Management Company in order to reduce the taxable income of the Real Estate Company. Remember that the Management Company pays tax of only 15.5% on its business profits.
Hello, can I transfer all the income of the real estate company to the management company?
If we can transfer all the income, therefore no net income, what’s the point of having a holding company?
Thanks for the article Allan, very interesting. A group of friends and I are purchasing residential apartments and we would like to consult you about this structure as the structure we currently have in place is going to be much more complicated than this. We’d like to keep it as simple as possible. We are based in Vancouver. Please advise how to connect with you. Many thanks Allan. Darren
I would be pleased to speak with you. I will reach out to you to schedule a time to speak.
How much does it cost to setup this structure at the beginning?
And what’s are the ongoing cost to run this structure?
Do you set up one real estate company per Realestate property?
Hi Xing fa, my setup fee is $1,500 CAD + disbursements and taxes. Entity creation fees are separate and the cost depends on the State where the entities are formed. For ongoing tax filing fees, please see this brochure that I have prepared. http://madanca.com/services/real-estate-tax/us-real-estate-tax/
You can create one partnership and it can hold several properties.
Are you able to turn 100% profit from rental into non-passive-income and retain into the corporation for reinvestment? So pay around 15% in Canada.
Or only the rental managemenet income portion can be active income only, your article doesnt mention clearly.
Hi, a corporation that carries on a rental business (e.g. rental of Canadian properties) is classified as a Specified Investment Business (SIB). A SIB is taxed at a high corporate tax rate of 50%, unless it has more than 5 full time employees. If there are more than five full time employees of a rental business, then the rental business will pay tax at the small business rate of 13.5% (2018).
If hiring more than 5 full time employees is not practical, then the rental business should consider paying a management fee to a property management corporation, which is owned by you, in order to save tax. Property management fees range from 5% to 10% of gross monthly rents collected. The property management fee will be tax deductible to the rental business and taxable to the property management corporation. The property management corporation pays corporate income tax at a rate of 13.5% (2018).
By shifting income from the highly taxed rental business (50% tax rate) to the lowly taxed property management corporation (13.5% tax rate) through management fees, you will save tax.
Is the percentage the property management corp. charges the real estate corp. flexible such that only the exact profit from the real estate Co. gets charged by the property management Co.? I imagine one wouldn’t want to create a net loss in the real estate Co, since this would increase overall taxes due by the property management Co. (versus creating a net break-even within the real estate Co), since there is no tax credit for generating a loss in the real estate Co. at the expense of higher income in the property management Co.
There’s no point in creating a loss for the real estate company and profits for the management company by charging high property management fees. The loss cannot be offset with the profits, since they are generated by different corporations, and so you will be paying more in taxes.
The property management fee ranges from 5% to 10% of gross monthly rents collected, plus disbursements.
can I just do a Property management Corporation to offset rental property sole proprietorship income? (instead of doing a 3 tier, just do a sole prop and a property mgmt corp)
You cannot set-up a property management corporation for the purpose of charging a property management fee to yourself (sole proprietor).
Hi Allan, can these benefits be applied to the US Cross border tax structure for US real estate investment? The LP owns the real estate, the GP get paid for management, and the CAN holdco will pay dividends to CAN shareholders? That way you pay only 15.5% for the management fees portion and the CAN shareholders get a tax deduction due to the expense for the management paid to the GP. Thanks
Yes, your strategy is possible. However, the GP should be a US company (e.g. US C-corporation). A separate Canadian corporation (non-partner) can be created to bill management fees to the US Limited Partnership. Management income is treated as active business income, subject to the small business deduction.