Investing in real estate, especially within the restaurant sector, can be a strategic move with several potential tax benefits. Many business owners also own real property from which they operate. This article will cover tax-saving tips whether you are buying real estate for your business or selling property you currently own and use.
Debt-financed distributions
This is a common strategy for real estate owners who are looking to monetize on real estate appreciation but are not yet ready to sell property they own. The LLC that owns real property can take out a loan (or refinance existing debt) and distribute excess debt proceeds to the LLC members in a tax-free manner. The new debt is typically nonrecourse to LLC members, distributed debt proceeds are generally not taxable, and members can receive a return of capital before exiting the partnership or property being sold.
Cost segregation
Whether you are constructing a new restaurant, renovating an existing one, or have owned the property for several years, you may be able to utilize a cost segregation study as a potent strategy to improve your bottom line.
Implementing cost segregation from the start of a new construction or renovation enables immediate benefits. It helps identify all costs associated with your project that can be reclassified to shorter-lived categories, allowing for accelerated depreciation deductions from year one and thereby enhancing your cash flow.
If you are renovating or expanding existing operations, cost segregation can help identify new assets, such as specialized kitchen equipment or updated HVAC systems, which can be depreciated over a shorter life compared to commercial real property depreciation.
Even older businesses that have been depreciating for several years can tap into the benefits of “look-back” cost segregation studies. This catch-up process lets you claim depreciation that could have been leveraged in past years, delivering a significant one-time boost to your current year’s depreciation deductions and cash flow.
Property tax assessments
Restaurant owners typically view property tax as a fixed cost and neglect this expenditure unless there is a significant increase from one year to the next. Property values are generally determined every few years, or at the time of property ownership change. These events provide an opportunity for the owners to protest and appeal their new property tax bills. Given the numerous potential errors in valuing property for real estate tax purposes, it’s a good idea to review each assessment. The first thing to check is the factual data the assessor used in the determination of value, including the acreage, year built, type of building, and finish and amenities. Experienced legal and tax counsel can help with these points and determine whether or not to protest the assessed value.
Tax strategies for real estate dispositions
Drop-down LLC sale
Many states impose real property transfer tax when property changes ownership. The tax is usually a percentage of the property’s sale price and is typically paid by the seller of the property. One commonly employed strategy to avoid real property transfer tax on a sale is a drop-down LLC transaction. Many state jurisdictions do not impose real property transfer tax on the sale of LLC membership interest. This framework enables the drop-down LLC transaction, where the seller may transfer the property to the LLC and then sell the interest in the LLC instead of outright real property sale. In recent years, some states have started pursuing such structures and taxpayers should consider the risks associated with drop-down LLC sales.
Like-kind exchanges and Opportunity Zone investments
If you are considering selling real property, you should consider some of the common tax deferral strategies: like-kind exchanges and Opportunity Zone (OZ) investments. Both have complex rules and regulations that are beyond the scope of this article, and we strongly encourage contacting your tax advisor to discuss potential benefits and requirements for each.
Like-exchanges enable taxpayers to defer the tax on the sale of real estate by replacing it with a ‘like-kind’ asset that has equal or higher value and equity of the relinquished equity. Please note that unlike the OZ investment discussed below, the tax is only deferred and will become payable when the replacement property is disposed of (unless another like-kind property is purchased).
Taxpayers can temporarily defer tax on capital gains from a sale of real property when those capital gains are reinvested into OZ Fund. The larger tax benefit is that upon exit from the OZ Fund, any gains from the appreciation in the OZ investment could be completely tax-free if the investment is held for 10 years. There could also be added tax benefits in the form of tax credits for those investing in Ohio OZ Funds.
There are many tax strategies to explore when it comes to owning the real estate where your restaurant or business operates. These strategies can not only save you money but also defer taxes and boost your cash flow. Reach out to your GBQ advisor with questions.
