PB Law Blog... Trusts and Stuff

Tuesday, January 8, 2019

Buying Vs. Renting Commercial Real Estate: What Are The Tax Benefits?

By: Shu Saito, CEO, - Forbes, YEC CommunityVoice, Link

While I’m not an accountant and don’t have any professional training in this field, I do have extensive experience as a business owner. Additionally, I would like to think that I have an advanced understanding of accounting and finances in general. So, while you should always consult with an experienced CPA before making any financial decisions that involve large amounts of money, this article may provide some clarity about the real number tax benefits of owning a property.

Owning property in an LLC can save money and build equity.

Generally, when you buy real estate for business, you will want to create what is called a limited liability company, or LLC. An LLC is similar to a real estate holding company, but because some people may think the holding company is a C Corp or S Corp, I recommend sticking with an LLC. It’s usually a good idea to avoid corporations in this case, not only because LLCs are the least complex business structure and require minimal management but also because corporations are slightly less welcome by banks and lenders in general.

When you buy real estate for a business, you will own two business entities working together: the LLC in which you’re going to put your property and your main company. Let’s call your main company “Company A” and the LLC “Company B.”

When you purchase a property, the real estate contract deed and mortgage will be in Company B’s name. In other words, the business property would be in Company B’s name, and Company A pays rent to Company B (keeping in mind, of course, that you are the owner of both). It’s important to note that Company B has the loan on the real estate, which is beneficial because a loan for a commercial property is a nice way to build equity quickly.

Owning property in an LLC can provide tax advantages.

LCCs are also advantageous for tax reasons because LCCs are, by default, taxed as a partnership if there are two or more members. Partnership classifications are beneficial because they usually provide corporate-like advantages and protections without the trouble of being an actual corporation. The problem with corporations is that they don’t have the flexibility of distributing assets (such as real estate) without triggering income -- on the other hand, partnerships can do that.

It is important to note, however, that the LCC needs to break even or make a small profit because passive losses (rental losses) are not deductible and can carry forward to future years. If the company paying the rent is very profitable, you probably want it to make a fair return on investment.

Owning property allows you to take advantage of depreciation.

Another reason to own your own business property is that you’ll see tax savings through depreciation. Let’s take a look at an example:

• Land value: $200,000

• Building value: $800,000

• Property total: $1,000,0000

The tax savings here would come from the depreciation of the building (land is not depreciable because it doesn’t depreciate). Say that the IRS allows you to depreciate the building value using a 39-year schedule (see IRS Publication 946 for more details). You can depreciate the following amount annually:

Building value = property value - land value (land value isn’t depreciable). So, $1,000,000 - $200,0000 = $800,000

Depreciable amount per year = building value / 39. So, $800,000 / 39 = $20,512

Additionally, say that Company B collected just enough rent from Company A and made $25,000 in income in a period of a year. After depreciation, the taxable income will only be: $25,000 - $20,512 = $4,488

Essentially, you lowered your taxable income by $20,512, which is a notable amount.

The depreciation claimed can also be increased by having a cost segregation analysis and writing many of the building components off over seven, 10 and 15-year periods instead of 39 years. But if the extra depreciation only creates greater losses, then it’s not worth the expense of the study.

So, should you buy or rent?

Of course, individual business owners should weigh carefully all of the tax facts and benefits of owning or renting a business property based on their own circumstances. If you’re short on capital, leasing may allow you to allocate your money toward building your business and grant you greater freedom to respond to potential opportunities in the industry. Additionally, sometimes leasing provides an opportunity to establish a business on a more expensive prime property.

However, if you have solid capital and can qualify, I suggest you own instead of rent. Even with varying inflation rates, local supply and demand conditions and changing interest rates, the fact is that real estate property value always appreciates over time. In short, by owning your own property, you are making a valuable long-term investment while lowering your taxable income at the same time.

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