The most trending tax and financial industry issues.

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Lane Keeter, CPA

Partner: Tax Consulting, Estate Planning, and Heber Springs Managing Partner

Should You Separate Real Estate Assets from Your Business

Historically, when a business purchased real estate for use in the business, title to the real estate has commonly been held by the business. Many business owners of late are choosing a different route, where ownership of business-related real estate assets are owned separately from the business itself.

And for good reason! What if there are injuries that occur on the property - could the business be held responsible? Or what about legal issues and liabilities encountered by the company - might those result in loss of the property?

The answer to all of these questions is YES! These things are definitely possible. So separating ownership can be valuable for important legal reasons.

There are also valid and potentially beneficial tax purposes for owning real estate in an entity separate from the business.

Avoiding Costly Mistakes

Many businesses operate as C corporations so they can buy and hold real estate just as they do equipment, inventory and other assets. The expenses of owning the property are treated as ordinary expenses on the company's income statement.

However, 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.

I have also seen situations where the corporation sold the business but retained the real estate, and the owners wished to dissolve the corporation and distribute ownership of the real estate to themselves. Unfortunately, this has the same tax bite as just described, including double taxation, because under the law, the distribution of corporate assets is considered (believe it or not) as a sale of those assets at fair market value followed be a deemed cash distribution.

Maximizing Tax Benefits

So what are some alternatives to the above that would help maximize tax benefits?

The most straightforward and "seemingly" least expensive way for a business owner to maximize the tax benefits is to buy the property outright. This is certainly one option.

However, doing it this way could transfer liabilities related to the property directly to the owner, putting other assets, including the business ownership, at risk. In essence, it would negate part of the rationale for organizing the business as a corporation in the first place.

Alternatively, in my opinion, 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 ownership structure is used, though, it is critical to make sure all entities are adequately insured.

The Benefits of Separation for Family Businesses

Family businesses face many distinctive challenges. One is that more than one family member may participate in the ownership of the company. Separating real estate ownership from the business can create more options to meet the needs of multiple owners.

For example, 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 business and real estate interests are separated, it's possible for one kiddo to take over the business while others hold the real estate.

In this case, everyone can benefit! The child who buys the business doesn't have to share control with his or her brothers and sisters, yet they can all still reap benefits as property owners.

Tailoring the Right Strategy

There are many issues and complexities to a business owning real estate, and there's no one-size-fits-all solution to protecting yourself legally while minimizing your tax liability. But if you do nothing and treat real estate like any other business asset, you could be exposing your business to substantial risk and loss of tax benefits.

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