Does your business own its real estate in a separate holding company, such as a limited liability company (LLC) or limited partnership? This practice can provide several advantages, including shielding property from your company’s creditors. It can also ease estate planning if, for example, you want to transfer business interests to your children while retaining ownership of the real estate. In addition, there are good tax reasons to separate the two. Let’s take a look.
Asset protection and estate planning advantages
Owning real estate in a separate legal entity can wall off an operating business from its real estate’s potential liabilities (and vice versa). A creditor who targets your business generally can’t reach real estate held in a separate entity. And if, for example, someone slips and falls in your office, factory or warehouse and sues, holding the property in a separate entity may help protect your operating business’s other assets.
Such protection extends to bankruptcy. If your business is forced to file for bankruptcy, creditors typically can’t recover separately owned real estate. However, there’s at least one exception. Real estate you’ve pledged as collateral for a business loan may still be subject to claims by lenders.
Owners of real estate in LLCs or limited partnerships also enjoy estate planning and succession flexibility. Let’s say you have two grown children, but only one is actively involved in the business. You can equitably divide assets by transferring the business to the actively involved child and the real estate to the other. Also, gradually gifting interests in a separate entity holding real estate can reduce the value of your taxable estate.
Tax matters
C corporations that hold real estate can risk unnecessary taxes. Real estate expenses are treated as ordinary expenses on the company’s income statement. If the property is sold, any profit is subject to double taxation: first at the corporate level and then at the owner’s individual level when proceeds are distributed. If you instead own real estate in a pass-through entity, and then lease it to your company, the profit upon sale would be taxed only once — at the individual owner level. Also, your operating business might be able to deduct lease payments so long as the rent is reasonable.
To simplify matters, some business owners buy business real estate themselves. However, this can transfer the property’s liabilities directly to owners and put other personal assets — including the business interests — at risk. So it’s generally best to hold real estate in its own limited liability entity. Just make sure your entity carries adequate insurance coverage.
Possible downsides
Aside from the costs, there are possible downsides to owning real estate separately. For instance, you’ll need to manage separate finances, tax filings and legal structures. But for most small to midsize businesses, the advantages outweigh any disadvantages. Contact us to discuss this strategy and determine what’s right for your situation.
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