Tag Archives: Martin H. Abo
Let’s explore Corporate Owned Real Estate. A frequent mistake made by small business owners is to have the operating corporation own the real estate, or to have a separate C corporation own the property and lease it to the business. The reason is that when the company eventually disposes of the property, usually after it has significantly appreciated and been substantially depreciated, a double tax bill will result. First, the corporation will be taxed on the appreciation upon the disposition of the real estate, and then, the shareholder(s) will be taxed on the proceeds of the disposition when they are distributed to them as a dividend or through liquidation. The tax traps are not limited to C corporations. Holding real estate in an S corporation has its own pitfalls. Mortgage debt does not constitute “basis” for tax losses when the accompanying real estate is owned in an S corporation. As most real estate investments yield potentially deductible losses after factoring depreciation on the structure, this could eliminate the tax benefits for a great deal of investors. There are great alternatives to corporate owned real estate.
A Better Approach to Corporate Owned Real Estate
A better approach than corporate owned real estate is for the business owners to own the real estate personally in a limited liability company or in a partnership with other investors, and then lease it to the operating business. Among the advantages:
• The business owner can sell the real estate interest for his or her own account, avoiding tax at the corporate level.
• The owner can refinance the property for his or her own benefit.
• Lease payments received by the property owner are not subject to employment taxes and are deductible by the company as a business expense.
• If the property owner dies while still owning the property, heirs will get it at its stepped-up basis, eliminating tax on all of the gain resulting from appreciation.
It’s particularly important for small business owners to engage in careful tax planning with respect to real estate being acquired for use by their business, and we receive frequent requests for assistance with appropriate tax strategies.
While we’re talking real estate and hopefully that which is not titled in corporate form, do you own a property that has appreciated considerably and that you want to sell? Are you concerned about incurring a large capital
gains tax liability? One option is to structure the sale as an installment sale. Here the buyer pays the cost of the property plus interest in regular installments, frequently for a period of 5 years, enabling the seller to reflect the capital gain for tax purposes over the entire payment period. Sellers who decide on this strategy are cautioned, however, that an installment sale carries more risk than an outright sale of the property. Thus, the seller needs to:
• Carefully assess the creditworthiness of the buyer and possibly obtain personal guarantees, if the purchaser is a business.
• Evaluate the future income producing capability of the property to make sure it provides sufficient cash flow to enable the buyer to make the payments.
• Use an interest rate that is competitive with current market rates in the area so as not to squash the deal.
• Obtain a down payment of at least 20% to have a cushion in the event of buyer default, and to cover the expenses if foreclosure becomes necessary.
Similarly, a topic for another alert is our frequently suggested use of Section 1031 which provides an alternative strategy for deferring the capital gains tax that may arise from a business/investment property sale. As of the writing of this Abo and Company Tip-of-the Month, we’ve read that the days of deferring 100% of gain via likekind
exchanges of real-estate could be numbered if the much talked about tax reform occurs in this particular arena does take place. Republican lawmakers are seeking tax breaks to trim or scrap to offset the cost of significantly cutting the income tax rate for businesses. We’ve seen tax-free real estate exchanges/swaps targeted before nixing like-kind swaps, immediately taxing the full amount of gain or in President Obama’s proposal to cap the deferral at $1 million. If the deferral is curbed, we don’t think the break will be axed retroactively but who really knows at this point.
Business property transactions are often complex, and the services of a knowledgeable CPA (hopefully we at Abo and Company) can be vital in developing strategies that make it possible to bring a contemplated transaction to a successful conclusion.
FOR MORE INFORMATION:
Martin H. Abo, CPA/ABV/CVA/CFF is a principal of Abo and Company, LLC and its affiliate, Abo Cipolla Financial Forensics, LLC, Certified Public Accountants – Litigation and Forensic Accountants. With offices in Mount Laurel, NJ and Morrisville, PA, tips like the above can also be accessed by going to the firm’s website at www.aboandcompany.com.
By Martin H. Abo, CPA/AB/CVA/CFF October 16, 2015
Do you own a property that has appreciated considerably and that you want to sell, perhaps to free up some capital, perhaps to downsize your operation, perhaps to expand but now rent rather than own? Are you concerned about incurring a large capital gains tax liability? One option is to structure the sale as an installment sale.
Of course, selling commercial real estate in a slow or problematic market, you will often be requested anyway to provide financing to ensure the deal gets consummated. Where at least one payment is received after the tax year in which the sale occurs, the installment sale method is used to defer a portion of the income tax due on a gain. In fact, unless you specifically elect out, the installment sale method is mandated by the Internal Revenue Service.
Under the installment sale method, the seller recognizes a portion of each payment as gain when received. Typically, each payment the seller receives consists of three parts:
(1) a return of basis (investment) in the property sold,
(2) gain (profit)on the sale, and
(3) interest on the installment note. Only the gain and interest portions of each payment are taxable to
Reporting gain from the disposition of property under the installment sale method allows the seller to spread the tax liability over several years rather than all in the year of sale. Thus, the seller’s payment of tax corresponds with the actual cash flow generated from the sale.
Of course, a number of limitations and restrictions come with the use of the installment sale method. In general, persons who regularly sell or otherwise dispose of personal property on the installment plan or who hold real property for sale to customers in the ordinary course of business (“dealers”) generally cannot use the installment sale method except for sales of timeshares, residential lots or farm property. However, in the case of timeshares and residential lots, interest must be computed and paid each year on the deferred tax liability. Also, any item that must be included in ending inventory is ineligible for such installment sale reporting.
We are CPAs and business advisors and NOT attorneys but sellers who decide on this strategy are cautioned that an installment sale carries more risk than an outright sale of the property. Rather obvious suggestions to keep such risk manageable include:
- Carefully assessing the buyer’s creditworthiness. Consider getting personal guarantees.
- Evaluate the future income producing capability of the property to make sure it provides sufficient cash flow to enable the buyer to make the payments.
- Use an interest rate that is competitive with current market rates in the area so as not to squash the deal.
- Obtain a down payment of at least 20% to have a cushion in the event of buyer default, and to cover the expenses if foreclosure becomes necessary.
In certain circumstances, it may be beneficial to elect out of the installment sale method and report the entire gain in the year of sale. When you or your business has expiring carryovers such as net operating losses, tax credits, or perhaps charitable contributions, opting OUT OF reporting the entire gain in the year of sale could allow use of those carryovers and minimize any tax liability. In addition, if you are concerned that applicable tax rates will increase in the future, it may be advantageous to elect out of installment sale treatment and avoid higher taxes down the road.
Business property transactions are often complex, and surrounding yourself with a credible “team” made up of your CPA, attorney and real estate professional can be vital in developing strategies that make it possible to bring a contemplated transaction to a successful conclusion.
Martin H. Abo, CPA/ABV/CVA/CFF is a principle of Abo and Company, LLC and its affiliate, Abo Cipolla Financial Forensics, LLC, Certified Public Accountants – Litigation and Forensic Accountants. The below article was retrieved from the “E-mail alerts” disseminated to clients and friends of the firm. With offices in Mount Laurel, NJ, Morrisville, PA and Franklin Lakes, NJ, tips like the above can also be accessed by going to the firm’s website at www.aboandcompany.com or by calling 856-222-4723.
Martin H. Abo, CPA/ABV/CVA/CFF
307 Fellowship Road, Suite 202
Mount Laurel, NJ 08054
(856) 222-4723 phone
(856) 222-4760 fax