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Divide and Conquer: Separate Real Estate Entities can be Advantageous

Apr 30, 2017

If your dealership owns the building it’s in and the land it’s on, you might literally be sitting on unnecessary risks. But separating your business from those possessions can help protect you from an assortment of liabilities. And making it happen isn’t hard.

Transfer the title

Legally, you can separate your dealership business from the building(s) and the land it owns by transferring the real estate title into a newly created legal entity such as a corporation, limited liability company (LLC) or trust. Once the separation is complete, your dealership would simply rent the space from the new legal entity in a landlord-tenant relationship.

You could, however, incur transfer or capital gains tax when you transfer real estate into the new entity — as if the real estate had been “sold” to that company. Your tax advisor can help you choose an entity type that minimizes transfer costs and maximizes tax saving opportunities generated from the lease.

Reduce your risks

When you separate real estate from other business assets, those assets are better protected from lawsuits and property claims if, say, a customer trips over something in your service area. (Even if you hold title to the business separately from your real estate, you must have adequate liability insurance for both legal entities.) 

On the flip side, if your dealership files for bankruptcy and you own the real estate separately, creditors generally can’t seize the land and buildings unless they’re pledged as collateral. So, you could theoretically liquidate the dealership, and then sell the land and buildings at their full market value. The real estate sales proceeds would likely escape the bankruptcy court’s purview.

Think ahead

Estate planning is another good reason to consider holding real estate in a separate legal entity. This allows you to gift the interest in the dealership without giving up the real estate interest. Gifting of the real estate can take place at a later date, or provide retirement income as you transition out of the dealership’s operations.

Or perhaps you want to award stock to a key employee as a way to incentivize performance and gradually transition ownership to him or her. Creating a separate real estate holding entity lets you transfer shares in the dealership to the key employee, again without transferring real estate ownership.

This strategy gives the employee a stake in the business’s increased value but not in real estate appreciation, which is largely unrelated to employee productivity. A caveat: Discuss any employee stock transfers with franchisors — they may need to approve the new owner first.

Yet another benefit: If you sell the dealership but keep the real estate entity, you can continue to collect rent from your dealership’s new owners, thus creating cash flow through rental income.

Meet a variety of objectives

When a dealership is owned by more than one person, the owners might disagree about whether to own or lease the facilities. Everyone’s objectives can be met by creating a separate real estate holding company.

Not all the owners need to invest in the real estate entity. One dealer, for instance, wanted to build a new showroom that was more visible from the expressway. His older partner thought this expansion was too risky, especially because he planned to retire soon.

The younger partner had a longer investment horizon and was willing to take the risk, so he funded the expansion plan himself using a real estate LLC. Then he leased the property to the dealership using rental rates based on nearby comparables.

Time-tested strategy

Separating the legal title of your business from the building and the land where it’s situated is a time-tested management strategy. If this is something you wish to explore, your tax advisor can help you map out a plan that’s best for your particular situation.

Dealer Insights - March/April 2017

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