The classic financial benefits derived from business ownership typically fall under two categories:
- Earned income – salary and bonuses as reported on your W2 form each year.
- Unearned (investment) income – distribution of profits from the operation and/or sale of the business.
But there are other ownership advantages that I call “stealth benefits,” because they’re not as evident as operating opportunities. The stealth benefit that is not only the most generally accepted, but which has the most wealth creation potential is to personally own the real estate in which you operate your business.
Here’s an invariable: Every business is a tenant of a landlord under a commercial lease. There are many financial and strategic reasons to lease property from someone else. But this arrangement offers only tax advantages – deducting expenses associated with the lease – no direct investment benefits.
Now let’s consider a lease relationship that includes stealth benefits. As long as your business is legally structured as a tax reporting entity, like an S Corp or LLC, you can accrue those stealth benefits by personally owning the real estate your business operates in, and becoming the landlord of that legal entity. For example: Smith Enterprises, Inc., tenant of Tom Smith, property owner and sole shareholder of tenant.
The first stealth benefits are your business doesn’t have to worry about prohibitive rent increases, or getting kicked out because the landlord won’t renew the lease. Other stealth benefits are tax and investment related:
- As with any lease, the business deducts lease expenses before net profit passes through as income to shareholders.
- As owner and landlord, you personally deduct expenses necessary to deliver on the lease agreement, including mortgage interest and depreciation.
- Profits arising from this venture are taxed as unearned (investment) income, subject to income tax, but not payroll tax. And unlike your business sometimes, most profits – and even some losses – usually come with distributable cash.
- Upon the ultimate sale of the property, basis-adjusted profit is taxed at the current capital gains rate, typically lower than income tax.
- Over time, as rents rise against constant mortgage payments, monthly cash distribution is possible.
- When the mortgage is paid off, you property becomes a cash-producing annuity.
Take advantage of the business owner’s stealth benefit of owning the real estate your business operates in.
Last week on The Small Business Advocate Show I talked more about the benefits of owning your business’ real estate with Chris Hurn, CEO and co-founder of Mercantile Capital Corp. based in Orlando, FL and author of The Entrepreneur’s Secret to Creating Wealth: How the Smartest Business Owners Build Their Fortunes. Click on one of the links below to hear what he had to say.