Does your business require property to operate, or is real estate held under your business's name? If so, it might be time to reconsider this strategy. Separating real estate ownership from business operations can offer several benefits, including tax advantages, liability protection, and estate planning flexibility.
Tax Implications of a Real Estate Sale
If your business is structured as a C corporation, it treats real estate similarly to other assets like equipment and inventory. The costs associated with these assets are recorded as expenses on the income statement, often tax-deductible in the year they’re incurred. However, selling real estate in a C corporation comes with a drawback - double taxation. Profits from the sale are taxed at both the corporate level and the individual level when distributed to owners.
Good News! This double taxation can be avoided. By transferring real estate ownership to a pass-through entity, such as an LLC, any profits from a sale will typically be taxed only at the individual level, potentially saving you a significant amount in taxes.
Protecting Assets from Liability
Separating real estate ownership from your business operations can also protect valuable assets from creditors and other claimants. If your business faces a lawsuit or financial liability, any real estate held in the business's name may be at risk. However, if the property is owned by a separate entity, it generally cannot be targeted by claimants against the business. This separation can also be beneficial in the event of a business bankruptcy, as real estate owned outside the business entity is typically shielded from creditors unless it has been specifically pledged as collateral.
Estate Planning Benefits
Holding real estate separately from your business can open up estate planning options. If your business is a family enterprise, but not all heirs wish to participate in its management, separating property from the business provides an additional asset that can be allocated differently. For instance, you might pass ownership of the business to one family member and the real estate to another.
Structuring the Transfer
To implement this strategy, the business could transfer ownership of the real estate to another entity, which could then lease it back to the business. One option is for the business owner to purchase the real estate and hold it personally, although this approach comes with potential downsides. For example, liabilities tied to the property could inadvertently affect the owner's personal assets, including interests in the business.
A more common approach is transferring the property to a separate legal entity, such as a limited liability company (LLC) or limited liability partnership (LLP). Using an LLC can be particularly advantageous: expenses related to the property flow through to the owner’s individual tax return, offsetting rental income from the lease-back arrangement. LLCs are also relatively easy to set up, typically requiring only one member, while LLPs require at least two partners and may have additional state-specific restrictions.
Consider the Trade-Offs
Separating real estate ownership from your business may offer valuable benefits, but it’s not always the right choice for every business. Whether it’s a wise move will depend on your specific circumstances and long-term goals. Consult a professional to ensure your approach maximizes tax advantages and minimizes transfer costs while considering liability and estate planning factors.