Many real estate investors invest for the reason of providing a legacy to the next generation.
They want to use the money they earn to finance their children’s education.
They want financial freedom.
They want to retire early.
If there’s money left over, they may even want to help their kids to buy their homes.
What if… the investment comes with a risk, a risk of being sued that could potentially affect your own home, your RRSP, and your savings…
One of the top reasons to incorporate is because of the extra layer of legal protection provided by the corporation.
Business lesson 101 here: Corporation is considered a separate legal entity. This means that it can be sued on its own. If the corporation doesn’t have the money to pay for its liability, it could declare bankruptcy and closed off.
Shareholders’ personal assets would not be affected.
At least that’s the story a lot of business books taught us.
Having a corporation has its own benefits, and its downside as well. One of the biggest complaints is that the setup cost is high and the annual filing cost is high as well.
Some real estate investors would tell you that the setup cost and the extra filing cost are too much, they would rather buy a bigger insurance policy to have the extra protection.
Good point, isn’t it?
How likely are you going to get sued from real estate investing?
Or… to rephrase the question, how likely would you really need the extra layer of legal protection offered by the corporation?
Over 10 years ago, I managed three commercial plazas. One of the commercial plazas has a huge parking lot.
In a very cold Winter, I got a call from a lady claiming that she slipped and fell in this property.
We immediately called the snow plowing company, a father and son team. They’ve been taking care of the property for over 10 years. They kept a logbook whenever there’s snow. They also documented whenever they completed snow plow in the area.
Turned out, there was no snow for the previous 10 days. I immediately left a message with this lady who fell at the property. She never called me back.
I always thought that slip and fall incidents were only a myth from the movie – it really could happen in real life.
Thankfully we had diligent documentation at that time.
Fast forward to 2018, a client came in for a mid-year consultation – we always encourage our clients to be proactive about tax planning.
Her tenant was burning marijuana oil in the basement unit of a triplex in Whitby.
It blew up.
According to her neighbor who witnessed this “explosion”, the entire house got lifted an dropped back down.
Thankfully, no one got hurt (the other tenants were not inside the house when this happened) and this tenant suffered minor injuries.
The house was deemed to be uninhabitable and she had to tear the entire house down.
The insurance company is footing the bill, thankfully. My client, however, was still in shock.
Moral of her story? She’s going to put all future real estate holding into a corporation.
You may still think – oh well, this lady still got the insurance company to foot the bill. I got insurance coverage too. Is a corporation still necessary?
A few days ago, a client and I were having a chat about his 2018 personal tax year.
We discussed the usual, tax estimate, strategy for 2019, etc. and he asked me again about setting up a corporation.
I’m a big proponent of the corporation – simply because of the flexibility it offers to real estate investors and business owners.
But… in his situation, given that he only had one investment, it wasn’t worth while to set up a corporation for one property, yet.
He then dropped the bomb – that he got sued on this joint venture investment. He was not on the title on this property, but he owns 50% of the property as the real estate expert.
He was named in the law suit of a slip and fall accident on this property. This injured person is suing for a 7-figure compensation.
Each property insurance would have a slip and fall component. You would normally think that it is somewhat covered in it.
But because he wasn’t on the title, the insurance company would not cover his case. ☹️
Even with the JV partner who’s on the title, according to him, this insurance company is trying everything to get out of the case.
Sometimes, we forget that insurance company has its policies. If you miss one fine detail, you may not get covered. ☹️
Morale of the story? You don’t know what you don’t know.
Be extra cautious, be protective, be diligent.
Will corporation protect you from all these?
A big disclaimer here, I’m not a lawyer. Consult a lawyer to get a better understanding before you proceed with anything. You may still get sued even if you own your investment through a corporation.
But it does provide an extra layer of protection.
Be sure to consult a lawyer.
Until next time, happy Canadian Real Estate Investing.
Cherry Chan, CPA, CA
Your Real Estate Accountant