Could a Lease Back Work Well for Your Business?
Whatever your business, you share common goals with all business owners. You want to operate at a profit, and you want to grow the value and size of your business. You want to grow the hard assets of the business and your equity, possibly with a plan for when you want to make your exit.
Unfortunately, many businesses have mostly depreciating assets in the way of office and production equipment, furniture, and other fixtures used in the business. The business owner is actively building goodwill, documenting customers and repeat business as assets that should convert to money in the sale of the business. These other assets may even include “trade secrets” or proprietary processes, software, or practices.
Too many business owners overlook one way to acquire and grow a business asset over time, and often without increasing their costs of doing business. They rent their business space instead of owning it. There is a way to continue to rent, but to gain amazing tax and business growth advantages along the way. It is the lease back arrangement for the business space.
Pros and Cons of the Lease Back Arrangement
There are choices as to how to structure the lease back arrangement, and you should discuss them with a tax professional. Often the owners of the business purchase the real estate which will be used for the business, and the business entity then leases it. The most common arrangement is the owner(s) forming an LLC, Limited Liability Company, which purchases the real estate. Then the separate business entity leases it. Advantages can includei:
Because the landlord(s) also own the business, they landlord/tenant relationship is a friendly one that is beneficial to both parties. The landlord understands the needs of the business.
Often much longer leases are involved because of this relationship.
The landlord entity understands the business’s cash flows and structures the lease to be sure that they business will be able to make rent payments as due.
The landlord can make improvements to the real estate that benefit the business operations but also the landlord entity by increasing the value of the asset.
The landlord entity gets the tax advantage of depreciation of the property.
The primary benefit of the lease back arrangement is that the business is not throwing money away for rent, instead building equity in the building over time that is owned indirectly by the business owners.
Of course, when there are advantages, there are usually some items on the other side. Disadvantages could include:
The business is not able to afford fair market rent, so the landlord entity has a reduced return on investment.
A poor business climate or downturn is a double blow, as the business income drops and can result in lowered rent payments that negatively impact the owners as landlords.
If the landlord entity cannot afford to purchase the best locations for the business, then over the long term the performance and profits of the business could suffer due to the location.
All these considerations should be carefully weighed before the purchase of real estate.
Nothing involving the IRS and gaining tax advantages is simple, so it is crucial that the business owners consult and plan with tax professionals. Business management consulting may also be necessary. Some considerations includeii:
The type of business structure for the business and separately for the landlord entity. Often LLCs are chosen, but every situation is unique. Totally separate entities make tax planning easier.
Deciding on improvements and which entity pays for them can become an issue, as each of the owners could have their own unique tax situations.
The IRS will be diligent in making sure that there are not any self-dealing violations in the arrangement.
The lease back is a legal and valid business practice of value, but doing it properly is necessary to enjoying all the advantages.
The business entity that will purchase the property, the landlord entity, involves the interests of multiple owners. This makes it a complex set of agreements as to who will own what, who is responsible for different aspects of the property management, and even what happens when owners die or there are disputes.
Often these arrangements involve multiple owners. It is critical that the purchase documentation, ownership percentages, and other differing needs of the owners be covered in the purchase contract and other documents setting out ownership.
Purchase documents must me properly recorded, and they must set out the agreements between owners in detail and legally. This can be a complex process, and legal professionals should be consulted to assure owners that their interests are protected and to make sure they understand the arrangement.
The lease agreement should be long term, and it should be carefully prepared. It is creating a relationship between two different legal entities.
The Devil is in the Preliminary Preparation
“The devil is in the details” is a popular saying, and it applies in the lease back arrangement in many ways. The owners of a business who are considering this arrangement for the obvious growth and equity reasons should sit down with tax and legal professionals to set out a plan that covers the details carefully. It is the best way to assure a long-term beneficial arrangement for all involved.