As a business owner one of the largest checks you write each month is likely your rent check. What if you could be writing that check to yourself each month? Maybe you’ve considered owning your own building in the past but were unsure of the ramifications. Owning your space may be a good option to consider for a growing practice if you utilize a brick and mortar location to serve your customers or clientele. We work with a variety of industries including dental and medical practices, fitness, real estate and consulting, many of which require a physical space to deliver these services. At some point, there comes a time when you need to take a look at your current financial situation and whether it makes more sense to lease or purchase your space. Regardless of which you choose, it is a substantial investment for your business and there are pros and cons to each that should be thoroughly considered as you look at this decision.
There are multiple factors involved in choosing to lease or purchase your building, but we have put together a list to help you take a look at some of the advantages of each option.
Benefits of a Lease
Low Initial Cash Commitment
No large down payment is required. If you are not in a position to invest a large amount of capital and tie it up in a building, leasing could be a better option for you.
Repairs and maintenance will be taken care of by the property owner. The specifics of this will be determined on your lease, so this is a detail you will want to review before you sign the lease on a new office. Keep in mind that some leases require that you care for the property or at least certain aspects of it.
You have more mobility if you choose to lease. Should your business needs change or the area you are in is not as desirable as other locations, you have the opportunity to move more easily.
The real estate market is generally not as volatile as say the stock market, however, choosing to buy means you are investing and any investment comes with a risk of market decline. With leasing, you avoid this risk.
Benefits of Owning
You are building equity with every payment since those monthly payments are now going to you. Choosing to own is choosing to invest in the future. That equity can then be used as collateral should you choose to move your office or expand at some point in the future.
Owning can ultimately save you money and make for a more steady cash flow situation. Because rent is subject to increases over time, owning gives you the opportunity to refinance and find lower rates if needed and provides more control over your mortgage payments. You’re also not at the mercy of your landlord when it comes to making changes to the building.
There are a number of tax benefits for real estate owners. Mortgage interest and depreciation deductions can help offset your income. For a full understanding of how owning real estate could help your specific situation, please consult your tax advisor to make an educated decision. Some of the tax advantages can be a little more involved and this is where a CPA can really help you. Here are some things to consider.
- Depreciation – Commercial properties may be depreciated over a period of 39 years. Many people are familiar with general depreciation, for example, if your business purchases a piece of equipment that is expected to be used for 5 years at a purchase price of $100,000, with a percentage of the $100,000 deducted over each of the five years it is in use. This helps to offset the lost value that asset experiences as it is used for the business.
- Cost Segregation – The IRS allows business owners to complete a Cost Segregation Study performed by a professional which allows the depreciation of building upgrades and maintenance, like wiring and lighting, helping to offset maintenance costs. Cost segregation can allow for faster rates of depreciation, allowing you to recapture initial costs more quickly. So instead of the entire purchase price of the building being deducted over 39 years, some components could be recaptured over 5 years, 7 years, etc. as the tax law allows.
- Deductions – If structured appropriately, i.e. a separate company to own the property, you will be able to take the rent deduction on the active business, recognizing rental income on the passive business. This is generally accomplished by creating a separate entity, usually an LLC, to set up a “passive business” to which your active business will pay monthly rent. You will then be able to offset that income in your passive business with the mortgage interest and depreciation deductions, often times producing a taxable loss. This type of structure can be confusing if you have not had experience in this area, and we advise working with your attorney and CPA or tax advisor to ensure you are following tax laws and structuring everything appropriately.
- Another tax consideration when owning is the passive loss limitations outlined in Internal Revenue Code (IRC) Section 469. This may limit what deductions you can take currently. Your tax advisor can assist you in analyzing this limitation.
- Financial Leverage – You can rent out extra office space if the building you select is more space than you require. This allows you to collect rent from someone else to help cover the cost of the building. This last advantage comes with a large caveat. You have to be willing to act as a landlord, which can be a business all on its own. It can be very lucrative, but if you are not ready to dedicate the time necessary to manage the property, this may not be for you.
The bottom line is that it really depends on your individual situation. While financially speaking, purchasing is generally the best option, you have to consider your current financial standing, your geographical area and anticipated future needs for your practice before making any decisions.
As with any real estate purchase, it is crucial to be aware of the market and know that you’re not making these transactions in a vacuum. If you make a purchase simply on the basis that it is an investment and that building is in a run down area of town or you’re not savvy to the current state of the real estate market, that “investment” may not pay off for you in the long run. Again, we always recommend meeting with your tax advisor prior to making any decision regarding purchasing a property. If you would like assistance in looking at your specific situation, please contact us today.