Real Estate Owned Separately From The Business

A common arrangement in closely held businesses is that the operating company leases its premises from the owner personally or from a separate entity they control.

Why the separation exists

Holding real estate outside the operating company is often done for liability reasons, keeping a valuable asset away from the risks the business carries.

It also allows the property and the operations to be sold or transferred independently, which can be useful when the eventual buyers are different people.

Tax considerations frequently drive the structure as well, and those depend on rules that vary and are revised over time.

The lease is doing more work than it appears

While one person controls both sides, the lease terms are rarely negotiated seriously, and the rent may bear little relation to market levels.

Once ownership divides, that same lease governs a real commercial relationship between parties whose interests no longer align.

A below-market rent transfers value to the operating side, and an above-market rent does the reverse, which becomes contentious when different people own each.

Succession can split the two apart

Estate plans commonly leave the business to a child working in it and the real estate to the others, on the reasoning that it produces income without involvement.

That arrangement makes the successor a tenant of their siblings, with the rent, the lease term and the maintenance obligations all becoming family negotiations.

Where the lease is short or informal, the business may have no security of tenure at all in the premises it depends on.

Buyers examine this closely

A purchaser of the operating business needs to know what happens to the premises, and an unclear or expiring arrangement affects both price and financing.

Where the property is not included in the sale, a long-term lease on defined terms is usually required before a transaction can proceed.

Preparing that arrangement in advance removes a common obstacle that surfaces during a sale process rather than before it.

What to have reviewed

Documenting a lease on commercially reasonable terms while one person still controls both sides is far easier than negotiating one afterward.

The interaction between entity structure, lease terms and transfer method has tax consequences that require a tax professional's involvement.

A business attorney can confirm what the current documents actually provide, which frequently differs from what the owner believes they say.