Buying Your First (or second) Building

Buying Your First (or second) Building

You’ve decided to buy instead of rent. You found a building you couldn’t refuse in today’s market. Now you can stop paying the landlord and generate some equity. But who should own it?  It sounded simple when you decided to buy, but suddenly there are a lot of questions.

Your banker wants to keep it simple and just have your business buy the building. Your accountant likes the idea of you and your wife owning the property to benefit from the “at risk rules.” An estate planning website suggests you put it in your revocable trust. Lastly, a financial planner tells you to protect the building with a separate entity. How do you sort through it all?

First fork in the road – should you own the property inside or outside of the business? It’s not likely that you will want to put the property in your business entity since it puts the real estate at risk for all of your business debts and liabilities. Yes, it may bring a nice “bankable” asset to your balance sheet. But, in the beginning you’ll also pick up a hefty mortgage/liability on that same balance sheet and the net won’t really mean much. The bank won’t eliminate the loan personal guarantees just because your business owns a building (with a mortgage). If your business is taxed as an S-Corporation, you’ll be passing up serious tax advantages under the “at risk” rules.  The better option is holding the building outside of your business.

Second fork in the road – who should be the “outside” owners? The most important factor is who owns the going business. Are you and your spouse the only owners, or do you have some other co-owners? In either event, do NOT own the building in you and your spouse’s name (or your revocable trusts)[1] or with your co-owners as individuals. That will subject your single largest “business” asset to the creditors of each owner. The solution? Put your building in a separate limited liability company (NOT a corporation) where it’s shielded from the business debts and liabilities (and perhaps from your personal debts as well). The LLC may be owned by some or all of the business owners (and spouses). Be certain that your building LLC is taxed as a partnership (not as an S Corporation).

If the property doesn’t belong to the business, how does the business benefit? Answer: you rent “your” building to the business entity and life continues as usual. It’s perfectly fine to use your mortgage payment as a base for the monthly rent. Most importantly, you can allocate expenses between the landlord (you) and the business (remember all of that pass through stuff your landlord made you pay?). Think taxes here. Who can use the tax deductions the most? Hint: you’ll likely pass most of the building expenses on to the business (as the tenant), where you have income to offset them. The key is your commercial lease. Do NOT take a form off of the internet. The lease must be carefully drafted and a commercial attorney will be worth the investment. This is not your college student apartment. It’s a commercial building. You must document an arm’s length transaction to satisfy the tax code, and this is no time to play lawyer. Similarly, consult your CPA, and get a good insurance agent who understands commercial leases. This may not be the agent who handles your car and homeowners insurance.

Lastly, make sure your banker offers the SBA 504 loan program which is specifically designed just for you to purchase real estate. http://www.sba.gov/content/cdc504-loan-program. Want help? Contact any local EDC (http://www.jeffcountymo.org/SmallBusiness.aspx)
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[1].  Having your revocable trust as a member of your LLC is not “wrong” but it may require you to disclose your trust documents to outsiders, e.g. your lenders. Therefore, I prefer you hold your membership individually. To avoid probate, your membership in the LLC should transfer on death to your revocable trust. This is accomplished by a beneficiary designation. You’ll need an experienced attorney for this. New article coming on this topic soon.