Many business owners will eventually buy a building and then rent it to their business. This can be an appropriate strategy for many. If you are planning on being in business for an extended period of time why not own the real estate? If you do own rental real estate you’ll need to know how to Form an LLC to Protect Your Assets.
1) Have a Signed Lease Agreement
Having a signed lease agreement between the company and the owner of the real estate is a good place to start. When the business owner also owns the real estate where the business is run, it’s clear there is no arm’s length transaction here. With that said a signed lease agreement will support that these are two separate legal entities and that the business is paying rent for use of the facility. While a security deposit would not be needed, many of the other terms would you expect to see in any commercial lease should also be present. This would include the lease term, renewal options and whether this was a gross or net lease.
2) Pay Market Rent
It’s important to pay rent that approximates the market rent. This is where some business owners can get themselves into trouble. Unlike wages or self-employed earnings, rental income is not subject to social security tax. Therefore some business owners will charge very high rent. If the rent is not reasonable, the IRS can re-characterize these payments.
3) Pay the Rent on Time
The cash flow of many small businesses will be and flow. There can be times when it seems the only cash flow is negative cash flow! When the cash flow slows down, some business owners will stop paying the rent. This might be appropriate some time. However to constantly be doing this can be challenging. If there is a mortgage on the property or the business has outstanding debt it’s likely the bank that provided the loans will have some requirements. Most banks will require the business owner to submit their business and individual income tax returns and personal financial statement annually. If the business has debt there may also be financial statements required. Most loans will also have some covenants included in them. There can be financial covenants that will restrict the balance sheet and income statement of the borrower. Not paying the rent per the lease agreement can influence these and may require additional explanation to the bank.
Do you rent your real estate to your business?
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