Over the years I’ve worked with hundreds of small businesses in many different industries. This week I had a meeting with one of our clients that’s growing very quickly and in desperate need to move into a bigger facility. We discussed the benefits of owning the space versus renting it. I decided it was such a good discussion that I wanted to share it with you.

This particular client is a manufacturing company and they’re only a few years old. When they started out they moved into a rented space that they knew they’d eventually outgrow, but they didn’t think it would happen as quickly as it did. For the past year, we’ve worked tirelessly to find the perfect space to move into. We’ve looked at over 50 spaces and there always seems to be something wrong. We even identified two properties that would work well, the first one, after being on the market for over two years, was purchased before we could sign a lease; and the second one ended up being condemned by the City for having roof issues and is being demolished.

As you can imagine this has been a long and painful process, but we may have found a space that will work. Up until now, we’ve been mainly focusing on renting because of the cost of entry and the availability in the region. This property in question is for sale and it might just be the perfect solution.

While we reviewed the logistics of making an offer on this property, we discussed some of the tax and strategic advantages to owning the property over renting. So here are some things that you need to consider before you purchase a building for your business.

If your business is a corporation, do not purchase the property with the same company. There are several reasons why you should keep the property in a different entity than your business.

First and foremost, the whole purpose of having a corporation rather than a sole proprietorship is to protect your assets from liability in the event that you get sued. You need to limit the assets that you put into each corporation. If someone sues your company, the last thing you want to do is have your building up for grabs as well.

Secondly, if your business is a corporation (not a sole prop) you can charge your company a reasonable monthly rent. Here’s where your tax savings come into affect… (the next part is going to get technical, hopefully I can simplify this so it’s easy to understand)

If your business is a Subchapter S Corporation (S Corp), then you are required, as an officer, to take a reasonable salary in addition to any distributions that you take out of the company. The reason behind this is that income from your S Corp is not subject to self employment tax. However, in order to prevent people from avoiding paying into social security and medicare, the IRS Guidelines requires that you be on payroll for a reasonable wage. Unfortunately, there’s very little information from the IRS explaining what would be considered reasonable. In order to save as much as you can on taxes though, you want to minimize the amount of money you put through payroll. I usually try to analyze the industry and also recommend to my clients that if they’re going to take a distribution to always make sure the salary is at least as much as the distribution. So if you go by that recommendation and you have $100k available to you, you’d take $50k in a salary and $50k in a distribution. Well, if you own your building, that gives you a third option for taking money out of the business… raise the rent! Rental income still has to be reported as income on your personal return, but since it’s considered passive income it’s not subject to self employment tax! See the example below:

You currently take a salary of $50,000 from your company, you pay your self rent of $36,000 per year, and you plan to take a distribution of $50,000. However, at the end of the year your accountant explains that you actually have an extra $12,000 that you can take as compensation from the company. So your options are to take it as a distribution, additional wages, or an increase in rent. Your accountant explains that since your wages are only $50k, he doesn’t recommend taking $62k in a distribution so that means your only options are to increase your wages or raise the rent. Just considering the additional costs of social security and medicare on the additional $12,000 you’ll spend an extra $1,836 if you take it as an increase to your wages. Since rental income is considered passive, it’s not subject to self employment tax (social security & medicare), therefore you can take the full $12,000 without incurring the additional tax.

And the third reason to keep it as a separate entity is for future strategic planning. For most business owners the eventual goal is typically to sell the company for millions and millions of dollars, right? Well we hope so anyway. If you own the building in a separate entity, you can keep it out of the sale of your company. Allowing you to continue collecting rent from the company even after you’ve made your millions.

So the moral of this story is, buy the building! But do it in a separate entity and track it separately. You know you’re going to have to pay rent for a workspace, why not pay it to yourself.

If you have any questions about this post, please don’t hesitate to contact me at JerryKenna@JerryKenna.com.