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What to consider before purchasing a property for your business—and what to do at tax time
I own an antique store and would like to buy the building I currently rent. The current owner is a bank that foreclosed on the previous owner three years ago. I've been offered the building for $335,000, with $15,000 down and 7% interest for 20 years. If I go ahead with this deal, would I be able to deduct my payments (principal and interest) as a business expense? At what point would I be able to depreciate the building?
Let's start with the easy part of your question first. The interest you'll be paying on your mortgage will be deductible as a business expense. However, the principal payments you make on the mortgage are not a tax-deductible business expense (see BusinessWeek.com, 6/29/06, "Can You Write Off a Victorian?") .
Moving on to depreciation, which is a trickier issue: Depreciation is the annual deduction that allows you to recover the cost or other basis of your business or investment property over a certain number of years. Generally, you can begin depreciating when you first use the property (an asset such as a building, machinery, or equipment) in your business. You cannot, however, depreciate land purchased for a business. The Internal Revenue Service provides both general and specific information about depreciation at its Web site.
It's likely that the $335,000 figure you've been given covers both the cost of the land and the cost of the building itself. You'll need to figure out what the assessed value of each component is, says Alan Weiner, senior tax partner at Holtz Rubenstein Reminick accounting firm in Melville, N.Y. "Sometimes real estate bills will show assessed value breakdowns attributable to each," he notes. And even though the assessed value will probably be lower than the market value that you'll be paying, you can figure out the percentage attributable to the land and the building and use those figures to allocate the actual cost of each.
LLC or Corporation?
If that turns out to be impossible, you'll need to contact a qualified appraiser in your area and get the appropriate breakdown between the cost of land vs. the building. That's because the cost allocated to the building portion is depreciable over a 39-year time period, but the allocated land cost is not depreciable, Weiner says. Your accountant will be able to set up a depreciation schedule for the building that you will use each year when you file your taxes.
Consider forming an LLC to buy and own the property. "This will protect you from most liabilities attributable to real property ownership and it's preferable to a corporation, in my opinion," Weiner says. You can maintain the integrity of the LLC and protect your antique business by having the two entities enter into an arm's-length lease for the business operations.