How to setup your business and related real estate

Do you have a business that is expanding and succeeding, and you want to acquire your own real estate for it--such as for an office building, warehouse, machine shop, or fabrication shop?

How do you undertake this purchase?  First, you need advisors.  You need a good business attorney who has knowledge not only in business law, but tax law and real estate law.  Some firms have someone who has knowledge in all three areas.  Sometimes, you will need a firm with multiple attorneys.  You should also have a good accountant who can perform financial analysis on purchase versus lease, with the after-tax cost of each.  You also need a good commercial real estate agent.  Finally, if you are to build, then you need a good construction management consultant and/or an engineer to help with the design and build.

You should also be in contact with your banker on the financing, and you should start the discussions before you start looking.

For the main point in this article, how do you setup the real estate ownership?  You should setup a separate company to own the real estate, and nearly every time, the separate company should be an LLC classified as a partnership for income tax purposes (for high value real estate, an LP may be used).  The operating company's business liabilities should be held separate from the ownership of the real estate.  The operating company should enter into a long-term lease with the real estate company and pay rent.  The real estate company then pays the bank.  You are not obligated to "put all your eggs into one basket" when you are in business.  Accordingly, you are not obligated to place a valuable property into your company and risk losing the business and real estate.  

Your banker should want you to place the real estate in a separate company.  Bankers will act like it such a problem to change the loan underwriting package, because the owner will be different.  Separate ownership is very common, and the banker's concern is just a lack of knowledge.  A banker should want the real estate in a separate company.  If the operating company tanks, the banker should want its collateral separate from the disaster!  Also, the bank will require the operating company to have liability on the loan anyway, along with any principals who generally own 20% or more of the company.  Instead of the operating company being the borrower, it will be a guarantor.  Big deal, there is no way around that.

There are other reasons to keep the real estate separate.  First, there are tax reasons.  Operating companies are often s-corporations.  An s-corporation should not own real estate.  If you transfer real estate outside a corporation to the shareholders (a distribution), the transfer is treated as a sale of the real estate for fair market value (even if the shareholder owns 100% of the s-corporation--would you expect that?).  If the corporation borrows money and distributes the money to the shareholders, you might create a capital gain if the stock basis is less than the amount of the distribution.  Would you expect "paying tax on borrowed money?" These are terrible tax results.  Partnerships, including LLC classified as partnerships, do not have these problems.

Second, there are business reasons, other than liability risks, to keep the operating business separate than the real estate. Do you have a key employee?  Perhaps, you want to award key employees with ownership in the business.  If the business owns the real estate, then you will also be granting the key employee ownership in the real estate too.  By keeping the two separate, you can award key people with ownership in the business and still own the real estate 100%.  Third, sometimes, only certain owners have the money and creditworthiness to invest in the real estate.  In this case, separate companies makes the ownership much more feasible.

A second business reason occurs upon the retirement or sale of the business.  If the two are separate, then you could just sell the business and keep the real estate.  Sometimes, a seller will "sell" the "stock" or "membership interest," especially if there are key contracts to keep in place.  If the real estate is outside this entity, then it is easier to sell the company and keep the real estate.  Keeping the real estate can make it cheaper for the buyer to acquire the business, and the real estate can provide retirement income--rent!