5 minute read

Financial Considerations of Owning Business Property: Should The Business Pay Rent When Its Owner Owns the Property?

It’s common for individuals to lease their residential property or commercial buildings to a company or organization and receive rental income.

But what if you’re the property owner and want to lease it to your small business? Should the company pay rent for your own property? Leasing your property to your own company is perfectly legal. And it’s a great way to bring in extra cash and save money come tax time. But there are various things to consider.

Industries Where Business Owners Also Own Property

The commercial real estate market can be divided into several categories, including co-working space and multifamily properties. However, the most common segments for owner-occupied businesses are:

• Office buildings: Located in a central business district and often grouped into Class A, B, and C buildings, depending on their location and the health of their surrounding markets. Examples include high rises in downtown areas of medium-sized cities and the suburban office space like mid-rise structures outside a city center.
• Industrial or logistics properties: Segmented based on size and specific use cases, such as product assembly, warehouses/storage, and regional product distribution.
• Retail properties: Includes commercial properties like strip or shopping centers with a mix of small retail stores (salons, restaurants, dry cleaners), community retail centers occupied by multiple anchors like drugstores and grocery stores, and power centers—which host smaller, inline retail stores and a few major box retailers.

There are certain industries where the practice of small business owners owning the property from which they operate is prevalent. For business owners who own office buildings, having a strategic location for easy access to clients, partners, and employees provides value, control, and stability. While businesses in industrial or logistics industries may benefit from owning facilities they can tailor to their unique manufacturing, assembly, or warehousing requirements to create cost-effective operational efficiencies. And for retail enterprises that are reliant on location for foot traffic and brand image, owning property adds value in providing owners the ability to maintain control over the appearance and atmosphere of the business.

The decision for small business owners to own their property often stems from the desire for stability, control, and long-term cost benefits. It can also be seen as an investment in the future, as property values can appreciate over time, providing an additional source of income and wealth for the business owner.

Why Business Owners Should Pay Themselves Rent

Renting from your own real estate investment pays off with the following:

• Cost savings: Rent is an allowable business expense for the business paying rent. And it’s tax deductible. And you can offset the rental income with building expenses like property taxes, insurance, and depreciation.
• Asset appreciation: Over time, the property's value will likely increase and be worth more than what you paid for it.
• Lease flexibility: You can structure the lease to your benefit.
• Income stability: Renting to your business can provide a steady source of income.

But be aware of two things when considering renting to your business.

1. Charge a fair market rental rate. Otherwise, the IRS may disallow the tax deduction.
2. Self-renting nonpassive rules. Generally, losses from passive activities can only be used to offset income from other passive activities. However, the self-rental rule treats net rental income as nonpassive when renting the property to a business where the taxpayer materially participates. This means you can't use losses from other passive activities to offset the rental income.

Impacts on Business Valuation When Preparing To Sell a Business

To get the most money possible for your businesses, you must show buyers your business has consistent cash flow and a profitable revenue stream.

And when preparing to sell your business, consider how paying rent to yourself impacts your valuation.

• Paying rent below or above market rates will impact your profitability. Paying too little will overstate your income, and paying too much will deflate it.
• Transferable leases with favorable terms may entice a potential buyer.
• But leases with future rate increases may discourage buyers.

What Buyers Need To Know About Buying a Business That Also Includes Real Estate

Buying a business and real estate comes with some additional items to note.

• Separate the business and property and value them independently.
• Ask the seller for a recent valuation or appraisal on the property, or consider getting one done. It may help when approaching lenders for a mortgage on the property.
• Complete due diligence to review legal filings, zoning regulations, environmental studies, and local ordinances on how the property can be used.
• Financing will require more capital, larger down payments, and financing options may differ from buying a business or real estate.
• Review the tax implications of buying real estate and a business with different tax rules.
• Consider the risk concentration of buying the building and the business. If the company fails, the property may become vacant.

Selling a business is a multi-step process, with many variables. If your business is leasing your property to your own company, there are a variety of valuation and tax implications to consider. It’s a good idea to assemble a team of professionals to help guide you through the process of valuing the business and real estate for a business acquisition. Legal matters require an attorney's expertise, while property-related decisions necessitate a real estate agent's knowledge, and overall business considerations benefit from a business broker's guidance. BizBuySell's Broker Directory can assist you in locating a qualified business broker to guide you through the intricate process of selling your business.

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