6 Reasons to Separate Real Estate from Your Business Assets

Dec 16

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When businesses acquire real estate, they often title it under the company name. Although this might seem straightforward and logical, it's not always the best choice — particularly for properties expected to appreciate significantly in value. Learn why separating real estate assets from your business can be beneficial and for guidance on how to go about it effectively.

The Mechanics

Separating real estate from your company isn't a burdensome process — it's generally just a matter of transferring title. The main issue is what type of entity should receive the transfer.

Typically, it's best not to buy real estate from the business and hold it in your own name. Doing so could make you personally liable for any debts associated with the property. Moreover, in case of a judgment against you, the plaintiff could pursue your real estate as well as your other assets — including your interest in the business that previously owned the real estate.

Thus, it's usually safer to form a limited liability company (LLC) or a limited liability partnership (LLP) to hold the property. LLPs, however, require at least two partners, aren't allowed in every state and, where they are, sometimes are permitted only for certain kinds of businesses. Also, some LLPs might not provide adequate protection for the partners' personal assets.

On the other hand, an LLC can be established with only one member, and personal assets are protected from the entity's creditors. Another advantage is that distributions are made at the discretion of the managing member, whereas partnership distributions may be done on a pro-rata basis unless otherwise specified in the partnership agreement.

Potential Benefits

Under the right circumstances, separating real estate from your business may offer many advantages. These include:

1. Avoiding double taxation. Perhaps the most obvious reason to separate real estate from a business is when the company in question is structured as a C corporation and, therefore, subject to double taxation.

Initially, it might seem logical for a C corporation to buy real estate in its own name so it can report the related expenses on its income statements and deduct those expenses on its tax returns. But think ahead to when the real estate is eventually sold. At that point, the profits will be taxed at both the entity level and the individual owner level when a distribution of the profits is made. By transferring the real estate to a pass-through entity, such as an LLC or LLP, you can avoid double taxation and incur only individual taxes on the profit.

2. Limiting legal liability. Another possible boon is the ability to shield the real estate from lawsuits involving the business, regardless of whether your company is a C corporation or a pass-through entity. A plaintiff can pursue only the business's assets, not real estate owned by a separate entity. And that, of course, goes both ways — if someone has a slip-and-fall or suffers some other type of compensable injury related to the real estate, they can't go after the company's assets.

Similarly, if your business ends up in bankruptcy court, your creditors can't recover separately owned real estate that hasn't been pledged as collateral for the company. You can sell it for fair market value, grabbing what could be a valuable lifeline during a difficult time.

3. Easing sales or transfers. Potential buyers of either the real estate or the business may find the opportunity more appealing without the baggage of the other. That is, by separating the two assets, you might attract a broader range of buyers and enjoy a more streamlined sales process. You could, for example, sell your company and retain the real estate to use as a type of annuity that provides a steady income stream in retirement, whether it's leased to the business buyer or another tenant.

Separating property from your business also can make it easier to offer interests in your company to investors or as part of an employee incentive program. You're free to cede business interests without reducing your interest in the real estate.

4. Lowering financing costs. Obtaining financing on real estate that's separate from your company can be more cost-effective. Lenders don't need to account for any risks associated with the business, which can translate to more favorable interest rate offers. On the flip side, you can always use the real estate as collateral when seeking financing for the company.

5. Enhancing estate planning. Separating your assets, including real estate, can make it easier to handle thorny situations — such as when some family members aren't interested in or able to run the business. You can, for instance, transfer business interests to those who are interested and use the real estate to gift others. Or you could sell the company and gift the proceeds, keeping the real estate for yourself for now.

6. Simplifying valuations. When the assets are separate, the values of the business and the real estate are distinct from each other. That means it's less challenging for an appraiser to estimate the value of each.

Worth Exploring

To be clear, separating real estate from your business may also trigger negative tax and financial consequences. Your CPA can help you identify and consider all the implications before making a decision.

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Disclaimer of Liability
Our firm provides the information in this article for general guidance only, and does not constitute the provision of legal advice, tax advice, accounting services, investment advice or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal or other competent advisors. Before making any decision or taking any action, you should consult a professional advisor who has been provided with all pertinent facts relevant to your particular situation. Tax articles in this blog are not intended to be used, and cannot be used by any taxpayer, for the purpose of avoiding accuracy-related penalties that may be imposed on the taxpayer. The information is provided “as is,” with no assurance or guarantee of completeness, accuracy or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability and fitness for a particular purpose.