Many businesses choose to separate ownership of the building and real estate from the business itself. The strategy shields these assets from claims by creditors if the company ever files for bankruptcy. And the property is better protected against claims that may arise if a customer is injured on the property and sues the business. This article briefly discusses the tax angle of such a move and its implementation. The challenges of family owned businesses are also discussed.
Your business’s real estate: Avoiding a costly mistake
Your business consists of a variety of physical assets, but the largest physical asset is often the building and the land it sits on. Many businesses choose to separate ownership of the building and real estate from the business itself.
Why? The strategy shields these assets from claims by creditors if your company ever files for bankruptcy (assuming the property isn’t pledged as loan collateral). And the property is better protected against claims that may arise if a customer is injured on your property and sues your business.
What about the tax angle?
There are also tax considerations. For C corporations, the costs of owning real estate are generally treated as ordinary expenses on the company’s income statement. But when the real estate is sold, any profit is subject to double taxation: first at the corporate level and then at the owner’s individual level when a distribution is made. As a result, putting real estate in a C corporation can be a costly mistake.
If the real estate were held instead by the business owner(s) or in a pass-through entity, such as a limited liability company (LLC) or limited partnership, and then leased to the corporation, the profit upon a sale of the property would be taxed only once — at the individual level.
What’s a wise tax strategy?
The most straightforward and seemingly least expensive way for a business owner to maximize the tax benefits is to buy the property outright. But this could transfer liabilities related to the property directly to the owner, putting other assets — including the business — at risk. This would negate part of the rationale for organizing the business as a corporation in the first place.
So, it’s generally best to hold real estate in its own limited liability entity. The LLC is most often the vehicle of choice for this, but limited partnerships can accomplish the same ends if there are multiple owners. No matter which structure is used, though, make sure all entities are adequately insured.
What about family businesses?
Family businesses face many distinctive challenges. One is that several family members may participate in the ownership of the company. Under such circumstances, separating real estate ownership from the business creates more options to meet the needs of multiple owners.
Let’s say that a family business is passing from one generation to the next. One child is very interested in owning and operating the business but doesn’t have the means to finance the purchase of both the business and its real estate.
If the two are separated, it’s possible for one sibling to take over the business while other siblings hold the real estate. In this case, everyone can benefit: The child who buys the business doesn’t have to share control with the other siblings, yet they can still reap benefits as property owners.
A time-tested move
Businesses that own the building they’re in, plus the land it’s on, may have unnecessary tax and liability exposures. So, it may be smart to consider the time-tested strategy of separating the legal title of your business from the building and the land it’s on. Talk with your tax advisor about your situation.