Buying and selling business property the smart way

IN THE LIFE OF A BUSINESS, opportunities to own real estate often arise. A company's management may consider relocating to a facility better suited to its current operations. Or perhaps the company's lease contains an option to buy its existing space.

At first blush, owning rather than renting saves money. The lessor's mark-up is removed. Equity is built up over time. In the troubled economy several years back, many businesses were able to weather the storm by drawing on free and clear real estate to sustain them. For other businesses, real estate became the owners' retirement nest egg.

Of course, there are also pitfalls. The typical business owner or manager has little direct experience with real estate investing. Past appreciation is no guarantee of what the future may bring. Gluts of office and industrial space impact values severely. Unanticipated risks accompany the dollar savings.

Also, when the time ultimately comes for the owner to retire, exiting a business tied to real estate is more difficult than a business alone. Competitors interested in buying the business are likely to have no interest in its facilities.

Assuming that these issues have been satisfactorily considered, and the company is to go ahead with the purchase of real estate, tax-saving strategies should be planned. Two major areas are ownership and exchange. This article is not intended to provide advice in any particular situation. The advice of competent counsel should be sought.

Ownership

Because of the significance of the asset and tax implications, it is best not to commingle real estate with existing business assets. Unlike the business, real estate is a passive investment. Even if its value is not appreciating, equity grows as the mortgage is paid down over time.

From the standpoint of asset protection, businesses incorporate to limit liabilities to their owners and the owners' personal assets. Likewise, real estate should be separated from the business, so that built-up equity is not accessed by business lawsuits.

From a tax perspective, the same principle applies. Carrying title to real estate through the business inevitably makes it harder to separate the two later. In some cases, the tax consequences can be severe.

For example, two major disadvantages accrue when real estate is owned in a regular "C" corporation. One is that the lower tax rates for individuals on capital gains arising from the sale of real estate do not apply. Full "C" corporation taxes are incurred on capital gains just as ordinary income.

Secondly, "C" corporations incur double tax. The "C" corporation is taxed on its income. Then, the owner incurs tax when drawing out the money as dividends. Effective tax rates for profitable companies can easily exceed 50%.

Owning the real estate personally overcomes these problems but creates others. Just as in a business, if litigation arises relating to the property itself, the owner's personal assets are put at risk in absence of a separate entity.

It is better to own real estate in an entity where taxable items "flow through" directly to its owners. In that manner, capital gains retain their beneficial tax treatment and the income is not double-taxed. Ideally, it is as if the owner held the property personally, but with less risk.

Today, the most popular and useful "flow through" entity for holding real estate is a Limited Liability Company, or LLC. It allows for flexibility of structure and distributions, as well as providing additional basis for deductions if losses occur.

Even after separating the real estate from the business through an LLC, problems are not yet completely resolved. Rent between a rental entity and the business should not be set at a bargain rate. Real estate losses are considered passive under tax law, meaning that they are suspended until there is income or disposal of the property.