A critical decision a business owner may contemplate is whether to rent or own the property for their business. There are many factors to consider in deciding whether to purchase or lease a property, including one that many business owners may not be aware of.
One of the biggest advantages to owning a property over renting one, is the ability to take a tax deduction for depreciation on the property while building equity personally or within the entity that it resides. A strategic buyer realizes this benefit with the intention that the property will appreciate in value over time.
Commercial properties are generally depreciated over 39 years and residential rental properties are depreciated over 27.5 years, respectively, for tax purposes. Upon acquisition, a business owner may benefit from having a cost segregation study performed on the property to maximize depreciation deductions and accelerate non-cash expenses to the business in early years. To this point, certain assets with shorter lives may be eligible for bonus depreciation whereby 100% of the cost of the assets may be deducted in the year of acquisition. (Note, the federal bonus depreciation rate is currently 100% in 2022 and absent a law change will decrease to 80% in 2023).
Business owners that purchase a building are also afforded interest expense tax deductions if the property is acquired subject to a mortgage. Depending on the circumstances, business owners may have additional space to lease part of the building to other businesses. This gives the business owner the opportunity to collect rental income that may help cover the cost of the building or mortgage payments.
In some instances, it may make more economic sense to rent a property. For a business that is growing, the capital needed to purchase a property may be better utilized in fueling that growth rather than invested in a building. For a business that may be struggling, having significant equity tied up in a property may prohibit that business from having sufficient capital and liquidity to weather a downturn in business. The condition of the real estate market and interest rates may also make a purchase cost prohibitive.
Business owners also need to weigh the risks of owning a property and may not want to deal with the headaches and burdens that landlords face from a liability standpoint should something happen to the property. Repairs and maintenance can also be costly and may impact cash flow in the business when funds are needed to support operations.
Another factor to consider, that many business owners aren’t aware of, is the financial statement impact of the adoption ASC 842 which went into effect for fiscal years that began after December 15, 2021. Prior to the adoption of ASC 842 most leases weren’t included on the balance sheet, however the new standard requires companies to record right of use assets and liabilities. These changes are intended to make it easier for all readers of the financial statements to see the company’s exposure to risk and true financial position. This will transform how the company’s financials look and will change the way accounting departments record transactions as well. Stay tuned for updates on how to implement this challenging new standard.
Should you have questions on this topic please contact your TBC Advisor.