While it may seem convenient, owning business real estate within an operating corporation may be a big mistake. For many reasons, you may want to consider having a separate family limited partnership (“FLP”) or limited liability company (“LLC”) own the real estate. Among the reasons to separate the real estate from the operating company are the following:
· Eliminate Double Taxation. If your company is a C corporation, when you dispose of the real estate the resulting gain will be subject to a double tax. The corporation will pay income tax on the sale – remember, corporations do not get capital gains treatment on the sale of real estate – and the shareholders will be taxed on the sale proceeds distributed to them from the corporation. Real estate owned in a FLP or LLC, which are pass-through entities, avoids double taxation upon sale.
· Asset Protection. If your business fails, the real estate will be at risk along with the other operating assets. By owning the real estate in a separate entity, you isolate the real estate from the claims of business creditors.
· Rent Deduction. You may deduct rent you pay to your related real estate entity as a business expense. Rent received by the owner of real estate is not subject to employment taxes.
· Enhances Saleability of Business Assets. Potential buyers of your company usually want to buy operating assets, not real estate. If they do not buy the real estate, their initial cash outlay will be less. Further, the new owner can deduct rent paid to you for the real estate as a business expense.
· Separate Source of Cash Flow. By leasing the real estate to the new owner, you establish a separate source of cash flow. Further, if you want to generate cash from the real estate, you can obtain a mortgage. Generally, cash-flowing real estate is a good credit risk.
· Estate Planning. While a business owner may not want to transfer shares of an operating company to his or her children, it is more palatable to transfer FLP or LLC interests that restrict participation in management.
· Income Tax Reduction. If children become the owners of an interest in the real estate entity, income distributed to them may be taxed at a rate lower than that of their parents.
Business owners should always consider owning business real estate in a separate entity to maximize their planning opportunities. If you are considering purchasing real estate for your business, please telephone us. If your business real estate is presently owned by your corporation, you should telephone us to determine if it makes business (and tax) sense to transfer the real estate into a separate entity to take advantage of the many planning opportunities available.