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You've decided to start a business or expand your existing business at a new location. When you acquire the land for your business, you should carefully analyze how you wish to hold title to the property.

You could hold title in your own name, however, ownership of real estate, particularly commercial real estate, can result in personal liability for a variety of matters. If you hold title in your name, you may be personally liable for any accidents or injuries that occur on the property, for any environmental contamination found on the property, or even for the actions of your employees or tenants on the property.

How can you limit your personal liability? First and foremost, maintain adequate liability insurance on the property and your business generally. Second, you may wish to put the property into an entity such as a corporation, limited liability company, partnership, etc.

If your business is already an entity such as a corporation, you first thought may be to place the property into the corporation. However, your business is then subject to all of the risks associated with owning the property. For example, if environmental contamination is found on the property, all of the assets of your business may be at risk for clean up costs. Therefore, it may be advisable to place the property is a separate entity with few or no other assets.

What type of entity should you use? From an income tax standpoint it is generally advisable not to use a corporation or an S corporation because it can be very costly to remove the property from the corporation. You may wish to separate the property from the business in the future for a number of reasons. For example, you may wish to sell the business but keep the property. Distributions from corporations are generally taxable, and the distribution of an appreciated asset can result in double taxation. Assume that your corporation owns property with an income tax basis of $100,000 and a fair market value of $200,000. Distribution of the property from the corporation to you can result in taxable gain for the corporation of $100,000 ($200,000 - $100,000) and taxable income to you of $200,000 (the value of the distributed property). Unfortunately, this is a common problem, and there are no good solutions. Therefore, never hold title to real property in a corporation without considering other options.

Other options include a partnership or a limited liability company. These entities are much more flexible under the Internal Revenue Code and can still provide limited liability.

Partnerships include general and limited partnerships. A general partnership is simply an agreement among people to work together some way. A general partnership does not require a certificate from the Secretary of State or even a written agreement (although you should always have a written agreement). However, a general partnership does not provide any liability protection. Every general partner is liable for all debts and other obligations of the partnership.

A limited partnership has two types of partners, general and limited. Limited partners have no liability for partnership debts beyond the value of their investment in the partnership. The general partner still has personal liability for partnership obligations, however, a corporation or limited liability company can serve as general partner. The limited partnership is a common choice of entity for real estate investments. The investors are limited partners and the operators serve as general partner, usually through a corporate general partner.

A limited liability company ("LLC") is similar to a partnership except that there is no general partner. Therefore, a second entity is not required. Limited liability companies are very flexible. The can be managed by the members or by a manager. One disadvantage of LLCs is that the filing fees with the Illinois Secretary of State are much higher than for corporations or limited partnerships, however, the extra cost is only a few hundred dollars per year and may be more than worth the price.

Mere creation of a corporation, limited partnership or LLC will not absolve you from liability. You must operate the entity correctly. You cannot treat the LLC checking account as your personal account, paying for your groceries, etc. You must file annual reports with the Secretary of State and file tax returns. If you disregard the entity, a court may also disregard it in determining liability. You will also continue to be responsible for your own actions. If you cause the injury on your property or you spill environmental toxins, you will not be absolved simply because the property is held in an entity.

Think carefully before acquiring your commercial real estate. Consult with your CPA and your attorney to ensure that you are protected now and do not face unpleasant tax consequences in the future. Analyze your situation every year to ensure that you continue to protect yourself and your business.
Posted in: February, 2004
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