Buying as Corporation, with back to back loan

13 Replies

Hello,

Long time lurker, first time poster.

Short background on me - I've been buying & renting properties for nearly 12 years. I've brought my wife into the mix, and we now have a total of 9 units across 7 properties. My wife is stay-at-home, and I work a decent job as a self-employed IT contractor. I'm in the Hamilton, Ontario Canada area, with majority of my properties in Niagara Region.

Between a large portfolio & being self employed, I'm at the point where lenders are harder to find.

To continuing growing, I'm turning to partnering with others who have some land lording experience, good income & a drive for success. This will help me get financing with the banks & more competitive rates. We'll be doing up agreements to discuss how to handle all the scenarios we can think of around the property, ranging from putting more money into it, picking tenants, to sale/divorce.

This brings me to 2 questions

1) Is it worth incorporating? We plan on buying multiple properties, and even bringing in more investors.

2) We'll each be putting in 10% of our first property purchase to get the 20% down. In terms of pulling money out of the corporation, is there any benefit in lending the money at a higher rate than I'm borrowing it for & amortizing it over a significantly longer period? What's the best way to get my money back out of the initial investment, or is it even worth it?

Thank you

@Darryl Allen

As someone who's in a rather similar position to you: own my own IT company; have 7 properties on my own and have recently started working with two new partners.

My bad news / warning to you is that your baggage (the 7 properties) will most probably still impact your and your new partner(s) ability to seek conventional financing as they will want everyone whose going on title - if you are incorporated, everyone who is an owner or director - to be vetted as a borrower and be a signatory (or at lease a guarantor) to any financing.

As for pulling money from a corporation - are you talking about returning your capital?  If so, it will depend on how you injected it in the first place.   If you are talking about pulling out retained earnings, you can pay dividends.   If going the incorporation route and individual partners may have different timing needs for taking earnings, etc, I would recommend using a separate series of shares for each shareowner.

Thanks @Roy N.

My partner only has 2 properties, with 50% equity and great income, with strong debt servicing ratio. Would this not strengthen the position of the application versus if I went on my own?

....wonder if there's any underwriters or mortgage experts on here who could answer?

@Darryl Allen

It would no-doubt strengthen your position, but probably weaken his ... he could secure conventional financing easier without you.   Find a mortgage broker who is investor aware and work out a plan before you start buying ... {as we should have done ;-) }

In general, and this is not legal or tax advice, just information - while there are exceptions, you rarely want to buy any sort of depreciable property as a corporation.  This creates problems down the road when someone wants to sell their interest or dies.  Under US Tax law, C corporation are not "pass through" entities - meaning there are 2 layers of tax - one layer at the entity level (the corporate tax) and one layer at the shareholder level (the tax on dividends).  While you could choose an "S" corporation and have pass-through tax, there are a number of problems with this: (1) you are possibly creating character mis-matches of ordinary income and passive losses, depending upon the level of management activity you have; (2) a buyer is not generally likely to want to purchase your fractional interest in stock - they will insist on a discount or worse, an asset sale.  The asset sale will trap the capital gain inside the S corp.  While it could be distributed, it will come out as gain as well; (3) there is no "step up" in basis at the death of the shareholder, except as to the basis in the S corporation stock (which is not depreciable) - thus, the surviving spouse can re-set the basis and re-depreciate the property (or sell it and recognize no gain).

Most investors I know either use trusts (a discussion of trusts is beyond the scope of your question), or LLC's taxed as partnerships when investing in depreciable property. In this instance, you are creating an entity (an LLC) but still obtaining one layer of tax (through the pass-through treatment of gains, losses, income and credit). We literally can spend weeks evaluating what type of entity to deploy for a particular investor's purchase. It is rare that a C corporation pencils out when all of the planning factors are considered.

hth,

Peter S. Myers

Darryl,

I live in Canada and work for a mortgage lender in the states so I have an understanding of both sides of the border. I cannot speak to all of the tax implications of a Corporation but I can tell you that finding a lender to finance your deal will be difficult. Lenders do not typically like to lend to a business due to bankruptcy forgiveness for corporations and it is much easier to obtain financing as an individual.

If your partner has a strong profile to qualify for a loan you may be better off having them finance the property then forming an LLC afterward.

@Darryl Allen

If you are investing here at home, you can ignore the LLC advice above - we do not have LLCs in Canada. If you are investing in the U.S.A., consult an accountant versed in cross boarder taxation before embarking in an LLC as they are typically not recognized by the CRA.

   

@Mark Merdita  - Five of my seven financed properties are held inside a corporation.  Conventional lenders in Canada will require you personally guarantee any financing to the corporation, but we've never encountered a problem obtaining mortgages due to the properties being in a corporation.

Now, if the corporation is undertaking a JV with an individual, we have encountered lenders who will not allow a corporation and individual to jointly take title or hold the financing {there is no legal restriction here, it is just an internal lender policy} when financing residential properties.

Similarly, if you have more than 2-3 shareowners or partners, our experience has been longer vetting and approval processes from lenders when pursuing residential financing.

    

@Peter Myers - things work a little differently north of the 49th.

@Peter Myers I learn something every day. Thanks for the clarification. I am not familiar with Canadian business and tax law but I am working on it as we speak.

@Roy N. would you expect to have no problems if you own many properties already but find a JV who will entirely take on the mortgage? Is there any reason for the bank to vet you if the mortgage is in their name? I guess perhaps it could depend on if you are also on title, but with a JV agreement is it really necessary to be on title?

Originally posted by @Matt Geerts :

@Roy N. would you expect to have no problems if you own many properties already but find a JV who will entirely take on the mortgage? Is there any reason for the bank to vet you if the mortgage is in their name? I guess perhaps it could depend on if you are also on title, but with a JV agreement is it really necessary to be on title?

 Matt:

If there is a JV agreement, then when your "partner" is asked if there is a 3rd-party interest in the property, he would be beholden to disclose that to the lender.

In practice, this happens where the JV agreement is just a handshake, but you as the non-partner, partner are taking on a huge risk as you have little to no provable claim on the property ... and if you did prove your interest, you could be a part to mortgage fraud :-(

In the U.S.A. it appears there are (or there were) lenders who would allow a single member of an LLC or partnership to taken on the burden of the financing ... though I presume all members would have to consent to the pledging of property as the mortgage.

In Canada, lenders require anyone with an interest in the property to a guarantor of the financing (with exception of minors ... but their trustee would have to be a guarantor).

@Roy N. this is interesting. I've been given the impression by my reading of Julie Broad's website (www.revnyou.com) that JV's are unlimited if the partner does the financing.

Am I misunderstanding you or Julie when I conclude that even if I have ten mortgages in my name, I can still JV if someone else gets the mortgage? This is the theory that half of my real estate target path is based upon, so I need to know if I'm in the wrong.

Of course, I'll disclose to the bank that I'm on board, but should my being mortgaged to the hilt affect my partner's ability to get financing if they would otherwise have qualified without me?

@Matt Geerts

It's going to depend on the lender ... they all have their own internal policies and they are all fluid.

When I bought a place with my sister-in-law a few years ago, I carried all the financing.  They still required her to be a signatory to the mortgage and to be on title ... and would not allow my portion to be held in my company (their policy did not permit companies and individuals to jointly own property).

On recent visit to that same lender - with another partner - I was told having me on the deal would put things under far more scrutiny and greatly slow-down the process ... despite the partner having more than sufficient capacity to carry the mortgage on his own.

I think if you find the right lenders and set things up in advance (almost like being pre-approved), @Julie Broad 's approach still has legs, but my recent experience (this past year) is that it's becoming more difficult.

@Roy N. thanks again!

Also, I had no idea that Julie had a BP account, though it looks very defunct.

I have no idea what is required north of the 49th, or how they define an interest.

Here, if you are in title you must execute the security agreement, mortgage or deed of trust but you do not have to be a borrower or guarantor. If you're not on the note then it doesn't matter if you qualify or not. This is often done where one party can't qualify, like a husband & wife, same with business partners, but there is the underwriting of commercial loans that takes into consideration "management" "stability" of all parties, etc. 

Who you partner with makes a difference in a lender's risk, someone a step out of bankruptcy or bad credit can mean law suits, exposure to other creditors or partners, weak partners can go belly up in a project, a good partner should be able to carry as much water as you do.

When say 2 partners have mortgaged a property held in the business entity and later take in other partners, the lender can go by the terms of the note and security agreement and call the loan in really bad transactions or simply not renew the loan later on, so it does matter who you deal with. 

Now, if those 2 partners don't allow that other partner in, they can still contract with someone or another entity, they can form affiliate entities or parent/subsidiaries and not cloud title on the property. After the initial real estate financing, another may inject capital and take a second mortgage, but check the original note and security agreement as this too may have issues in a commercial loan. (Dealing with a tenant/buyer or lending on a consumer side, this is predatory lending and dealing, but not in commercial lending).

If there is an issue with subsequent financing, ask the lead lender to allow it, they really can't say no without taking on a lot of management liability causing a company to go bust with a choke hold on their business. After that, consider when and if that loan will need to be renewed, they can say no then.

I suggest you and your partner to be go talk to a lender and spill the beans of your plan, it could be that you being the weaker party won't be relied upon as much, depending on what ailments you have, if your partner is much stronger they may say yes. 

You need to talk to an attorney and a CPA, partnerships can get to a point where you'll need annual audits ($$$$) and keep in mind the maintenance of the entity as well, an attorney will tell you, so it matters which entity you select, not just for taxes but to keep the business running properly. 

Good luck :)

  

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