Owning the building where your business operates is indeed a smart move, and many entrepreneurs find it to be a beautiful arrangement. Typically, the process involves creating an entity like a limited liability company to take title to the real estate. Then, the business operation “rents” the address from the LLC, often as a separate corporation.
This setup offers some distinct advantages: tax benefits, depreciation, interest deductions and the ability to build equity. However, many owner-occupants make critical errors that can undermine these benefits. Let’s delve into two of the most significant mistakes: When acquiring a building, businesses typically finance the purchase, often through the Small Business Administration, which allows financing up to 90% of the purchase price.
With only 10% equity needed for the buy, the resulting debt service typically dictates the rent the business pays to the LLC. This means the rent is usually based on debt service requirements rather than market rates. While this might seem convenient, it can lead to significant financial discrepancies over time.
Consider this: As the debt decreases, the rent remains static, potentially falling below market value. This discrepancy can create substantial financial issues. For instance, if the rent is significantly below market rate, the business’s profits appear artificially inflated.
This can complicate matters if the owner decides to sell the company. Potential buyers might see an inflated pro.