Most businesses start their lives in rented quarters. Sometimes, they remain that way throughout their lives, but many companies, especially those not dependent on retail traffic, decide that it is far better to own than to rent. There can be many reasons for this, but they generally boil down to economics. Following are a few considerations in making the decision to buy or rent your place of business.
The Rewards of Ownership
Ownership has its rewards, especially in a rising market. Assuming the building you purchase is not a single use type building, as each day passes, your investment as an owner will increase. Even if the market is flat, with each principal payment, your ownership of a tangible asset increases. Neither of these is true of renting. There is no potential return on your investment when you lease property and you do not build up any ownership equity when you pay the monthly rent.
Disadvantages of Ownership
Everything has its rewards and its disadvantages. In good times, buildings can be good investments, but times are not always good. Market fluctuations can cost a building owner a great deal in investment value. In addition, if the building is single use, like medical and similar specialty buildings, when it comes time to dispose of the building, the market could be very limited.
Just the simple costs of ownership can be a disadvantage to owning your own building. Major repairs can be very expensive. While some leases basically require the lessee to cover normal building expenses, most do not require major repairs or replacements like roof repairs, replacements and other major system repairs.
If you have been around business for very long, you may be thinking that there are tax advantages to leasing real estate. This is true, but you pay for those advantages. In setting rent, a building owner must consider all of the expenses of operating the building, including building depreciation. Since the owner cannot bank on an increase in the value of the building, rent must be set to cover all of these costs and provide a reasonable return on investment. This means the rent must be higher than what the building cost would be if you owned it. The offset to this higher cost is, of course, immediate deductibility of your monthly payments instead of capitalizing and depreciating the building over a long period of time, generally 39 years.
Tax laws affecting real estate ownership can be very tricky, but for the most part, they penalize ownership by corporations, but reward individual ownership. This is because regular corporations (i.e. those that are taxed on their income at a corporate level) have few ways to get profits out to their owners without incurring double taxation (i.e. tax at both the individual and corporate level). Accordingly, if a corporation owns real estate that can be sold at a gain, the gain will first be taxed at the marginal rate of the corporation. If you, as shareholder, then want to get the money out, then you must do so through a dividend (generally taxable at 15%) or by increasing your salary, which increases payroll taxes.
On the other hand, individuals pay tax once. Any gain on a property will be taxed at a 15%-25% tax rate, but only once. The problem with individual ownership is it places all of the assets of the owner at risk should there be a liability suit asserted against the building owner. For this reason, the most popular entity in which to hold real estate today is the limited liability company (LLC). The LLC basically affords the owner of real estate the asset protection afforded a corporation while allowing the owner to treat the company like a partnership for tax purposes. Since partnership income is taxed on the tax return of the partner, any gain on a property sale is taxed once.
Another advantage of owning property as either an individual or in an LLC is that the company can pay a reasonable rent (one that exceeds the ownershipÂÂÂ costs) and get income out to the owner without causing self-employment or payroll taxes.
Many businesses these days are finding it more economical to own rather than lease their business premises. The reasons for ownership and the manner in which ownership is held are critical decisions in maximizing value to you as the business owner. Before you take the plunge into real estate ownership for your business property, give us a call and together we can determine what is best for you.
Have a great May.