Ranked in Top 500 Fastest Growing Companies in The USA
Business owners need to take advantage of all available opportunities to lower their tax obligations. You work hard for your money, and your business often needs all the investment you can give it. But if your business operates from a building it also owns, you may not be taking advantage of an important tax reduction strategy. What is it? How does it work? And what pitfalls must you avoid?
Here's what every business owner needs to know about separating real estate assets.
Transferring your business building to a separate entity and renting from it is an additional complication in your books and taxes. So, why do it? There are two main reasons. The first is to separate each part of the business from potential liability. As separate entities, they are less likely to be seized to pay any obligations of the other entity.
However, for tax purposes, this is done in order to reduce taxable income and boost deductions. The renting business gets to deduct rent, reducing its taxable income. The building owner declares income, but it can also deduct the expenses of maintaining ownership. In essence, whoever owns both businesses gets to deduct nearly double what it would otherwise.
Leasing or renting to your business is simple once you set up the additional business entity. First, you need to select the right entity to own the building. Many business owners use LLCs or S corporations, although other choices may be appropriate for your particular circumstances.
Then, the tenant business pays market rent to the building owner each month. At the end of the tax year, the tenant business adds this up and claims tax deductible rent expense on its income tax forms. The same amount of rental income is declared by the landlord business on its tax forms. It then deducts additional things like taxes, depreciation, mortgage interest, utilities, maintenance, landscaping, and more.
These deductions may result in a profit or loss for tax purposes. The landlord business pays any tax due or carries forward excess loss for the next year. In some cases, the owner may be able to use that loss to offset other investment ventures.
While renting to yourself is a legitimate tax move, it can also be an audit flag. The IRS is aware of the potential for misuse of tax law, and so they may look carefully at how you handle this relationship.
The most important thing to do is to follow the rules. In general, this means drawing up a lease agreement in writing, outlining policies regarding late payments, and actually paying the rent each month. Ensure the two entities are legally separate, and don't mingle their finances. Treat this like a typical landlord/tenant relationship. This simple approach will prevent a myriad of problems.
In addition, use a standard market rate for comparable business space. Artificially inflating the rent is a quick route to an IRS audit, because it indicates you're trying to abuse the system. Similarly, paying for individual building costs through whichever entity is in the best financial position to do so may be a red flag. Consistency and transparency are key to this strategy.
As with any tax planning strategy, the best place to begin is to consult with an experienced tax professional. There are pros and cons to leasing a building to yourself just as there to renting it or the business owning it. Start by meeting with Golden Tax Relief. We'll work with you to identify all the ways you can legitimately reduce your overall tax bill without creating unnecessary complexity. Call today for an appointment.