Three physicians – Tina, Fred and Maurice.
One medical building.
One corporation.
One decision that quietly transformed their financial futures.

At the beginning, it all felt remarkably simple.

Tina and her two colleagues were tired of paying rent to someone else. Like many physicians, they reasoned that if they were going to occupy office space for decades, they might as well own the building themselves.

A holding company (“Holdco”) was incorporated.

Each physician subscribed for:

• 100 common shares
• at $1 per share

Total initial investment:

• $100 each.

Holdco then purchased a medical building in Calgary for $1.5 million, financed entirely with a mortgage from Knotiabank.

At the outset, the shares were just a detail.

Ten years later, nobody viewed those shares casually anymore.

The Building Quietly Became a Wealth Machine

Every month:

• the physicians’ professional corporations paid rent to Holdco
• the mortgage steadily declined
• Calgary real estate values quietly climbed

The physicians themselves were occupied with:

• patients
• call schedules
• staff shortages
• electronic medical records
• family life
• burnout
• the ordinary pressures of practicing medicine

Meanwhile, beneath the surface, something slowly but consistently was happening.

The building was quietly accumulating wealth.

Ten years later:

• the mortgage had fallen from $1.5 million to approximately $750,000
• the property was now worth approximately $5.5 million

The corporation now held:

• approximately $4.75 million of equity

Each physician’s one-third ownership interest was now worth approximately:

• $1.58 million

All from a $100 initial investment.

Then came the Saturday morning phone call.

The Moment Everything Changed

One of Tina’s partners – Fred – had been out for a ride and had been struck and killed in a cycling accident.

Suddenly, amid grief and shock, a practical reality emerged:

Now what happens to Fred’s shares?

Fred’s estate now owned shares worth approximately:

• $1.58 million

If Tina and Maurice, the other surviving physician, wished to retain ownership and control of the building, they would likely need to purchase those shares from the estate.

Half each.

Required cash:

• approximately $791,000 each

And quickly.

The Financial Problem Most Physicians Never Anticipate

Where does nearly $800,000 suddenly come from?

Without planning, both Tina and Maurice will be forced to:

• remortgage the building by a further $1.58 million
• borrow personally from a bank
• liquidate investments either held personally or through their professional corporations
• trigger taxable gains and incur the cost of tax
• sell personal assets
• use corporate cash reserves
• negotiate with a grieving spouse or family

This is where many physicians discover something important:

Buying real estate together is not simply a property transaction.

It is effectively the creation of a long-term private investment “partnership” of sorts.

And over time, successful partnerships quietly accumulate both wealth and risk.

The Insurance Solution Many Sophisticated Shareholder Groups Use

Fortunately, there is an effective planning strategy commonly used in closely held corporations:

Life insurance funding for shareholder buyouts.

The idea is simple:

If a shareholder dies, insurance proceeds received as a result create the liquidity needed for the surviving shareholders — or the corporation itself — to purchase the deceased shareholder’s shares from the estate.

Without insurance, the buyout can be lengthy and may become financially painful.

With insurance, the transaction can often occur smoothly, efficiently and tax-free for Tina and Maurice.

Option #1 — Cross-Owned Insurance Between Shareholders

Under one common structure:

• each shareholder personally owns life insurance policies on the lives of the other shareholders
• each shareholder personally pays the premiums

For example:

Tina owns:

• a $1,000,000 term life insurance policy on Fred
• a $1,000,000 term life insurance policy on Maurice

The other shareholders do the same.

If Fred dies:

• Tina personally receives a $1,000,000 death benefit
• Maurice also personally receives a $1,000,000 death benefit

Generally, those proceeds are received tax-free.

Tina and Maurice can then use those funds to purchase the deceased shareholder’s shares from the estate.

The advantages of this structure may include:

• simplicity
• tax-free receipt of insurance proceeds personally
• liquidity arriving immediately when needed
• avoiding forced borrowing or asset sales

However, there is a drawback.

The premiums are paid personally by Tina, Fred and Maurice using after-tax dollars.

That means shareholders must first:

• earn income
• pay personal tax
• then use the remaining after-tax funds to pay the insurance premiums

Option #2 — Corporate-Owned Insurance Through the Professional Corporations or Holdco

This is where things get more interesting.

Instead of Tina, Fred and Maurice personally owning the policies, their professional corporations own the policies.

For example:

• Tina’s Medical Professional Corporation (“MPC”) could own insurance on the lives of Fred and Maurice
• or Holdco itself may own the policies

Under this arrangement:

• the corporation pays the premiums directly
• using corporate dollars before those funds are distributed personally to the shareholder

This can create a significant cash-flow advantage.

Why?

Because corporate income in a professional corporation is generally taxed at lower corporate tax rates than personal tax rates.

In practical terms, it may be less expensive to fund the insurance inside the corporation than personally.

Why the Corporate Structure Can Become Extremely Powerful

Now the strategy becomes particularly interesting.

Imagine:

• Holdco owns a $1,000,000 term policy on each shareholder

One shareholder dies.

The corporation receives:

• a $1,000,000 insurance death benefit
• generally tax-free

But something even more important may then occur.

Most or all of the insurance proceeds received by the corporation (less the policy’s adjusted cost basis) may be added to the corporation’s:

• Capital Dividend Account (“CDA”)

The CDA is one of the more remarkable features of Canadian tax law.

Amounts paid from the CDA to Canadian-resident shareholders may generally be received:

• tax-free

In simple language:

• the corporation may receive the insurance proceeds tax-free
• then distribute much or all of those proceeds to shareholders tax-free through the CDA to Tina and Maurice

Those funds can then be used to buy or redeem Fred’s shares at their fair market value in exchange for cash needed by Fred’s surviving spouse.

The Astonishing Economics

This is where the planning can become incredibly powerful over long periods of time.

Consider:

• shares originally purchased for $100
• growing to values exceeding $1.58 million
• funded buyouts occurring using insurance proceeds
• proceeds often received with little or no tax leakage

The surviving shareholders may effectively acquire additional ownership interests in a highly appreciated building using funds generated through insurance planning established years earlier while everyone was healthy and insurable.

Why Early Planning Matters

The irony is that the better the real estate investment performs, the larger the future problem may become.

Over decades:

• property values rise
• shareholder equity grows
• buyout obligations increase
• income tax obligations accrue
• insurance needs expand

At the same time:

• shareholders age
• health changes
• insurance may become prohibitively expensive or unavailable

The time to discuss these issues is almost always earlier than physicians think.

The Shareholder Agreement Is Often More Important Than the Building Itself

Many physicians spend enormous time discussing:

• office layouts
• parking
• signage
• finishes
• mortgage terms

Yet comparatively little time discussing the shareholder agreement itself.

Ironically, the shareholder agreement may ultimately become the most important document connected to the investment.

Because eventually:

• someone dies
• someone becomes disabled
• someone divorces
• someone retires
• someone wants out
• someone’s family becomes involved

And when that happens, the quality of the planning suddenly matters enormously.

Questions Physicians Should Ask Before Signing a Shareholder Agreement

Before signing, physicians should ask:

• What happens if a shareholder dies?
• Is life insurance mandatory?
• Will insurance be personally-owned or corporate-owned?
• Which corporation will own the policies?
• How much insurance coverage should exist?
• Will insurance coverage increase as property values rise?
• What happens if a shareholder becomes uninsurable?
• How will insurance premiums be funded?
• Is the Capital Dividend Account planning being considered?
• Is there a mandatory buy-sell provision in the shareholder agreement?
• How are shares valued upon death?
• Who selects the valuator?
• Can the estate refuse to sell?
• Can surviving shareholders refuse to buy?
• What happens upon disability?
• What happens upon divorce?
• Can spouses or children inherit voting shares?
• What happens if one shareholder retires early?
• What happens if a shareholders declares personal bankruptcy?
• Can one shareholder force a sale of the building?
• How are disputes resolved?
• Have both legal and tax advisors reviewed the structure?

What begins as:

“Let’s buy a building together” may quietly become a multi-million-dollar private investment partnership spanning decades.

The physicians who recognize that reality early are often the ones best positioned to preserve both wealth and relationships over the long term.

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Disclaimer

This article is intended for general information purposes only and should not be relied upon as legal, tax, insurance, accounting, or financial advice. Insurance structures, shareholder agreements, and tax consequences can vary significantly depending upon the facts involved and the manner in which arrangements are implemented. Readers should obtain independent legal, tax, accounting, and insurance advice before implementing any strategy discussed herein. Tucker Professional Corporation accepts no responsibility for reliance placed upon this article without obtaining appropriate professional advice.