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Real Estate for Small Business Owners

Whether to lease, purchase or build a location for their venture is among the most important decisions a small business owner makes. Each has its pros and cons.

Buying vs. leasing

All things being equal, deciding whether to buy or lease property usually boils down to how long you intend to remain at the location. If you think the property will suit your needs for a minimum of seven years, you’ll save money by purchasing the space. Buying is more expensive, but you build equity in the property and the value should appreciate. You have a better idea of your ongoing monthly costs if you have a long-term, fixed-rate mortgage. Rental rates are more subject to market forces and are less predictable.

However, things aren’t always equal, so consider whether you want to tie up your capital with a mortgage rather than rent and use those funds to grow your business. Future expansion is another consideration. If a purchased property doesn’t easily lend itself to expansion, you’re better off leasing. The bottom line is always whether a particular investment helps your business grow.

Tax considerations

You can deduct all or most of your lease expenses. If you buy, you can deduct your interest payments, but nonresidential real property depreciation expenses are written off over 39 years. Ask your attorney or accountant whether leasing or buying makes the best financial sense for your situation.

Location, location, location

Location can make or break a retail business. It’s a situation where you usually get one chance to do it right. Do your homework, and identify your customer demographic and where they are likely to shop or use your services. For your type of business, how important is customer proximity? While competition is good, you don’t want a location where you have too many direct competitors. You pay a premium for a top location, but it also drives your business.

When considering a location, do some traffic monitoring at peak hours for your operation. If the volume isn’t appropriate for your needs, look elsewhere.

Site history is important. There are places where no one stays in business very long. Find out what businesses were previously in the location, and what happened to them. Success or failure doesn’t just lie in management; certain areas just aren’t conducive to retail establishments.

Obviously, if your business doesn’t need walk-in traffic, location is less crucial. That doesn’t necessarily mean you don’t need convenient access to major roadways or other requirements dependent on the nature of your enterprise. Industrial or office parks may offer better opportunities and costs than buildings located on main corridors.

Building

Building an office or store exactly to your specifications is probably the dream of most small business owners. New businesses may have high tech needs that an older building’s infrastructure can’t accommodate. If it’s an option, pursue it, but consider the downside. Building is time-consuming, and you may need approvals from local planning or zoning boards. Environmental or other property issues can stop a project in its tracks—perhaps permanently. Cost overruns are a given.

Commercial real estate broker

You’ll save yourself a lot of valuable time with a good commercial realtor. Unless you have expertise in negotiating leases, you aren’t likely to save money forgoing a realtor and finding and leasing property on your own. You want a realtor whose sole—or at least major—representation involves commercial tenants. As with other professionals, word-of-mouth helps find a reputable realtor. So does asking local businesses in your intended area which broker they used and whether they would recommend the person. Brokers often specialize, so find a person familiar with your type of business and its needs. A broker should know about any municipal ordinances or zoning that could affect your business—issues you certainly don’t want to discover after you’ve signed the lease or purchased the property.

Selecting a Business Structure

When you’re starting a small business, you’ll have to decide what type of business structure suits your particular enterprise. There are pros and cons to each type of business structure, and some may not be applicable to your situation.

Sole Proprietorship

If your small business consists of just you and perhaps your spouse, a sole proprietorship is the simplest way to go. Basically, you are the business and the business is you. You file taxes under your Social Security number. The downside is personal liability. If your business fails, creditors can claim personal assets such as your home and bank accounts.

Partnerships 

If you’re in business with one or more partners, a general partnership agreement may make sense structurally. In a general partnership, profits and liability are divided equally among the partners. Other types of partnerships are geared toward special projects or are limited according to investment percentages. While a partnership must file an informational return each year with the IRS, each partner reports income and losses on their individual tax return.

Limited Liability Corporation

An LLC makes sense for many small businesses, as it provides personal liability protection and can consist of various members—not shareholders. For IRS purposes, an LLC is not a tax entity. Proceeds are passed to members, who must pay tax on them. The members themselves decide how these proceeds are divided. Although regulations vary by state, an LLC is relatively easy and inexpensive to set up. You’ll need to:
      •      Choose a business name. This cannot conflict with an LLC of the same name in your state.
      •      File articles of organization. This paperwork includes your business name and the names and addresses of members.              In most states, this document is filed with the secretary of state.
      •      Generate an operating agreement. Some states require creation of an operating agreement, and outlining your LLC’s              structure and its regulations.

If your business operates as an LLC, all members are considered self-employed. That means they must pay the self-employment tax when it comes to Social Security and Medicare.

S Corporation

The IRS defines an S Corp as an entity electing to pass through income, losses, deductions and credits to their shareholders for tax purposes. Unlike larger “C” corporations, S Corps are not required to pay federal corporate income tax on profits, although some states require S Corps to pay taxes on income. The IRS limits an S Corp to 100 shareholders—all of whom must be U.S. citizens or legal residents—but there’s just one class of stock. Besides individuals, estates and certain trusts qualify as shareholders, but not partnerships or other corporations. As with an LLC, these shareholders report income on their personal tax returns, with taxation at their individual rate. Shareholders must pay taxes on income in the year it is earned, not distributed.

Creating an S Corp is more expensive than creating an LLC. You must initially file as a corporation, then submit Form 2553 to the IRS, signed by every shareholder or shareholder representative. One caveat: The IRS tends to scrutinize S Corps more than other types of small business structures.

Your attorney or accountant can advise you on the best business structure for your particular small business.