Like most businesses, yours probably has a variety of physical assets, such as production equipment, office furnishings and a plethora of technological devices. But the largest physical asset in your portfolio may be your real estate holdings — that is, the building and the land it sits on.

Under such circumstances, many business owners choose to separate ownership of the real estate from the company itself. A typical purpose of this strategy is to shield these assets from claims by creditors if the business ever files for bankruptcy (assuming the property isn’t pledged as loan collateral). In addition, the property is better protected against claims that may arise if a customer is injured on the property and sues the business.

But there’s another reason to consider separating your business interests from your real estate holdings: to benefit your succession plan.

Ownership transition

A common and generally effective way to separate the ownership of real estate from a company is to form a distinct entity, such as a limited liability company (LLC) or a limited liability partnership (LLP), to hold legal title to the property. Your business will then rent the property from the entity in a tenant-landlord relationship.

Using this strategy can help you transition ownership of your company to one or more chosen successors, or to reward employees for strong performance. By holding real estate in a separate entity, you can sell shares in the company to the successors or employees without transferring ownership of the real estate.

In addition, retaining title to the property will allow you to collect rent from the new owners. Doing so can be a valuable source of cash flow during retirement.

You could also realize estate planning benefits. When real estate is held in a separate legal entity, you can gift business interests to your heirs without giving up interest in the property.

Complex strategy

The details involved in separating the title to your real estate from your business can be complex. Our firm can help you determine whether this strategy would suit your company and succession plan, including a close examination of the potential tax benefits or risks. Call or email us today- 205-345-9898, info@covenantcpa.com.

© 2019 Covenant CPA

With millions of dollars at stake, an overextended real estate developer has a lot to lose if lack of funds causes a project to collapse. To attract investment capital, some developers have been known to resort to financial statement fraud. If you’re considering financing a project, you need to know how to spot such deception.

Ample opportunity to cheat

There are many ways to falsify a financial picture. For projects in the planning phase, a company seeking financing may provide overstated appraisals of the completed property. Or it may fail to mention its inability to secure utility access or approval from local authorities to rezone the property’s intended location.

For projects already under construction, the developer may inflate the percentage of development completed or amount of materials already purchased. Or a developer could neglect to report funds received from previous lenders or investors.

Sweat the small stuff

To avoid shady deals, review project proposals carefully. For example:

Look at supporting documents. In their rush to “improve” financials by manipulating income statements, balance sheets and cash flow statements, some companies may overlook supporting documents such as project-related budgets and forecasts. Compare these to the company’s primary financial statements and, if you find discrepancies, ask for a detailed explanation.

Scrutinize line items. Certain financial statement line items tend to correspond to each other. For example, labor expense and the accounts payable balance should increase at a rate similar to the percentage of construction completed to date. If line items appear out of sync, ask to see the books of original entry such as the accounts payable aging reports or salary expense reports.

Employ analytical techniques. Common size analysis can help you verify the integrity of specific line items. The process converts each item to a percentage of a base number. For example, to analyze wages and benefits expense, you would divide wages and benefits expense by revenue. Once you’ve converted every line item on the income statement to a percentage of revenue, you can compare the percentages within a reporting period and against prior and subsequent reporting periods.

Professional skepticism

Given the inherent complexity of commercial and residential construction projects, there are plenty of ways for unscrupulous developers to con lenders and investors. Contact us at 205-345-9898. We can help you determine whether a project’s financial statements appear sound.

© 2018 Covenant CPA

If you hold significant real estate investments, tenancy-in-common (TIC) ownership can be a powerful, versatile estate planning tool. A TIC interest is an undivided fractional interest in property. The property isn’t split into separate parcels. Rather, each TIC owner has the right to use and enjoy the entire property.

TIC in action

An individual TIC can’t sell or lease the underlying property, or take other actions with respect to the property as a whole, without the other owners’ consent. But each owner has the right to sell, mortgage or transfer his or her TIC interest. This includes the right to transfer the interest, either directly or in trust, to his or her heirs or other beneficiaries.

Someone who buys or inherits a TIC interest takes over the original owner’s undivided fractional interest in the property, sharing ownership with the other tenants in common. Each TIC interest holder has a right of “partition.” That is, in the event of a dispute among the co-owners over management of the property, an owner can petition a court to divide the property into separate parcels or to force a sale and divide the proceeds among the co-owners.

TIC and estate planning

Here are a couple of the ways TIC interests can be used to accomplish your estate planning goals:

Distributing your wealth. Dividing real estate among your heirs — your children, for example — can be a challenge. If you transfer real estate to them as joint tenants, their options for dealing with the property individually will be limited. What if one child wants to hold on to the real estate, but the other two want to cash out? Transferring TIC interests can avoid disputes by giving each heir the power to dispose of his or her interest without forcing a sale of the underlying property.

Reducing gift and estate taxes. Fractional interests generally are less marketable than whole interests. Plus, because an owner must share management with several co-owners, fractional interests provide less control. As a result, TIC interests may enjoy valuation discounts for gift and estate tax purposes.

Get an appraisal

If you’re considering using TIC interests in your estate plan, it’s critical to obtain an appraisal to support your valuation of these interests. Keep in mind that appraising a TIC interest is a two-step process. It begins with an appraisal of the real estate as a whole. Then an appraisal of the fractional interests follows. In some cases, it may be desirable to use two appraisers: a real estate appraiser for the underlying property and a business valuation expert to quantify and support any valuation discounts you claim. Contact us with questions at 205-345-9898.

© 2018 Covenant CPA