Deciding Whether to Lease or Sublease Your Commercial Space

When searching for the right office space for your business, you may be deciding whether it is best to lease or sublease your commercial space. While there are pros and cons to both, the right choice ultimately depends on your unique business needs. There are many variables that should be factored into this decision, and having all of the facts at your disposal will help you to make an informed choice.

Consider the Long Term Viability of Your Business

The amount of time you expect to stay in your current location has a bearing on whether you should take on a commercial lease or sublease your space. For a commercial business such as a retail store, salon, fitness center or bakery, it may be advantageous to secure your space with long-term commercial lease as the primary lessor. This will allow you to lock in your rate over a longer period of time and enjoy greater profits when your sales increase.

If, however, you are likely to move within five to ten years, are a seasonal business or anticipate needing a larger space in the future, subleasing may be right for your business. In addition, if you are opening a new company, you may consider subleasing to test the market for your product or service without locking yourself into long term contracts. Seasonal businesses may find that subleasing space from a larger, more established business is more cost effective.

Subleasing Office Space vs. Leasing

Some of the main businesses that take advantage of subleased space are businesses that need office space. These businesses often sublease a portion of a larger office, taking advantage of reduced rent and utilities, shared facilities and access to technology. Subleasing office space also means that you will have the flexibility to move without penalty if your current space is not working for your business. With subleased office space, there are no long-term contracts, lower commercial rent rates and increased flexibility.

Older more established businesses may find leasing office space more suitable than subleasing for a number of reasons. If your company has been in business for years, you may want the stability of being recognized at a certain location over time, which adds to your credibility. You may want to appear stable, consistent and stronger than your more temporary counterparts. In addition, you may be able to take advantage of better deals on longer leases and lock in low rates, even if the value of your leased property rises.

Like any other business deal, the decision to lease or sublease must be made with careful consideration. Factor in the pros and cons of either leasing or subleasing and consider your company’s long-term needs when choosing what option is best for your business.

Deferring Capital Gains Taxes on Business Property

The tax deferred exchange provides real estate owners with one
of the last true tax breaks and the only method of deferring tax
on the sale of investment and business property. Most
taxpayers know they can exclude the gain on a sale of their
personal residence. Unfortunately, many business and
investment property owners fail to capitalize on the benefits of
another type of tax-deferred exchange, under Internal Revenue
Code Section 1031.

Far too many business owners sell their business and
investment property and pay capital gain taxes because they are
unaware of provisions in the tax code that allow for deferral.
Internal Revenue Code Section 1031(a)(1) states in part that
“no gain or loss shall be recognized on the exchange of
property held for productive use in a trade or business or for
investment if such property is exchanged solely for property of
like kind which is to be held either for productive use in a trade
or business or for investment.” Examples of property types that
typically qualify are vacant land, office buildings, warehouses,
farmland, single-family rental units and shopping centers. Even
leases with 30 or more years remaining are considered real
property and can be traded for other real property.

How does one get started? The procedure is fairly simple as
Treasury Regulations issued in April of 1991 provide a
guideline for taxpayers to follow. Once a buyer for the property
to be sold (the “relinquished property”) has been found, a
phone call to a selected “qualified intermediary” to assist with
the Section 1031 exchange is all it takes to begin the process.
The qualified intermediary will produce the necessary legal
documentation required to facilitate the exchange process.
Once the closing of the relinquished property has occurred, the
taxpayer has 45 days from the date of closing to identify in
writing to the intermediary the possible replacement properties.
Due to significant restrictions, it is usually best to identify no
more than three replacement properties. The final step is to
close on one of the identified properties within 180 days from
the date of closing of the relinquished property.

Although the 1031 tax code section is very liberal, various
modifications over the years have resulted in a few additional
restrictions. Partnership shares, notes, stocks, bonds,
certificates of trust cannot be exchanged. A taxpayer who holds
a partnership interest or shares in a corporation that owns real
estate cannot trade that interest for similar share interests.
Business owners should consult a tax expert or legal advisor in
this situation.

With the reduction in capital gains tax rates, taxpayers were
given a rare break. However, this break was not as generous as
originally proposed. Most taxpayers are aware of the new
capital gains tax rate of 15 percent, lowered from the previous
28 percent rate. This is applicable for gain generated from the
sale of capital assets held for more than 12 months. At the last
minute, however, Congress altered the tax rate for recapture of
depreciation taken on real estate to be taxed at 25 percent. This
higher rate is applicable for all depreciation taken after May 6,
1997. Combining the 25 percent depreciation recapture rate
with state and federal tax rates could cost a taxpayer who sells
business real estate over to 40 percent or more of their profit.
On the other hand, a property owner who chooses to perform
an IRC Section 1031 tax deferred exchange can defer taxes on
the all of the capital gain! This leaves the prudent exchange or
with the entire amount available for reinvestment.

Many business owners are unaware that personal property used
in a business, such as a medical practice, can be exchanged as
well. The major difference between a real property and
personal property exchange is what the Internal Revenue
Service considers “like kind” property. I.R.C. Section 1031
defines like kind as “…property held for productive use in a
trade or business or for investment.” Like kind as it applies to
real property is very broad in definition. Determining whether
personal property is like kind to other personal property
requires a much narrower scope. The Internal Revenue Code
does not define “like kind.” The IRS has published regulations
that can be used to decide if an exchange involves like-kind
properties. The Treasury Regulations distinguishes between
two types of personal property: depreciable tangible personal
property (DTPP); and other personal property (OPP), which
consists of intangible and non-depreciable personal property.
DTPP can only be exchanged for other DTPP. These properties
must be of a “like class” or “like kind.” In determining whether
DTPP is of a like class the Treasury Regulations designate 13
general asset classes. These classes combine particular types of
personal property into a certain class group. Some examples of
these groups are office furniture and fixtures, information
systems, airplanes and helicopters, automobiles and taxis, and
buses.

The Regulations also designate that personal property can fall
within product classes contained in the North American
Industry Classification System. These numeric codes can be
used as an alternate method to define the characteristics of a
particular property.

OPP is difficult to classify as like kind to other OPP. It does
not fall within the like class safe harbor available to DTPP.
Intangible personal property, such as a lease or copyright, can
be considered like kind to similar intangible property. The
determining factors are the nature and character of the rights
involved and the nature and character of the underlying asset.
Selling a business can create more than one personal property
group in which to exchange. The IRS looks at the sale of a
business as an exchange of each asset to be transferred, and not
the exchange of the business as a whole. The underlying assets
of a business (e.g., lease value, covenant not to compete,
equipment and fixtures) will need to be analyzed in respect to
their comparable replacement property. Each asset is placed
into the proper exchange group. An exchange group is a
subgroup of the total assets exchanged. Every exchange group
will either have a surplus (trading up in value) or a deficiency
(boot). When the total fair market values of the properties
exchanged are different, the value equal to that difference is
called the residual group. The property in the residual group
will consist of cash and other property that does not fit into an
exchange group.

An example of a business exchange would be the exchange of
one medical practice for another. The relinquished medical
practice value consisted of: (1) the medical equipment (x-ray
machines, etc.) and office fixtures; (2) a covenant not to
compete; (3) lease value for the below market lease of the
office; and (4) client patient lists and files. The medical
practice acquired will generally have similar components of
value. To balance this exchange each separate component is
matched up with its like kind counterpart. A surplus in one of
the exchange groups is not taxable as the Regulations allow for
trading up in value. Any deficiency – going down in value –
would be taxable as “boot.”

The Regulations provide the non-yielding rule that goodwill
and going concern value in one business can never be like in
kind to goodwill and going concern value in another business.
In the example of the medical practice exchange, the client
patient lists and files would probably be viewed by the IRS as
goodwill, and should not be included in the exchange. A
prudent tax planner would attempt to allocate value to the
depreciable or amortizable personal property, such as the
medical equipment and office fixtures, to avoid this problem.
Additional personal property not eligible for exchange
treatment is inventory. The inventory of a business is held for
resale and does not fall within the definition of Section 1031
property.

Anyone considering deferring tax under IRC Section 1031
should obtain competent tax/legal advice before proceeding
with a transaction. A mistake can be costly.

Business Property Insurance: Protect Your Business from Disasters

No matter how detailed your business plans are, tragedies come unannounced. If you are not prepared, chances are that a natural disaster or unforeseen legal or financial trouble will threaten to sink your business. In order to avoid disasters, you should have business property insurance coverage for fixed and moveable assets related to your business. Business interruption insurance will help you recover from calamities, and help you recover the losses.

Types of Business Property Insurance:

When opting for insurance coverage for your business, you can either get a combined protection policy or opt for separate insurance policies. The type of coverage varies depending on what is being covered.

1) Floods:

If your business is located in a flood prone area, then you need to get business property insurance that will cover it against flood damage. For this, you will need to find out how many times the area has been flooded.

2) Earthquake:

Earthquakes can strike at any time and there is no way to predict them. For this reason, many insurance companies do not offer earthquake insurance as part of standard business property insurance package. To get earthquake insurance, you will probably have to buy a separate policy and pay a separate deductible. In addition, earthquake insurance typically does not protect businesses against loss of profits caused by damage to property; it simply covers the actual value of the property.

3) Crime:

A special Terrorism Risk Insurance is available for businesses. This insurance does not cover employees who may be injured through acts of terrorism at the workplace.

Combined Business Property Insurance:

Business property insurance is either combined or separate. Under the terms of the separate business property insurance, only the actual value of the property insured is covered. You will not be compensated for loss of profits due to accident or crime, just the loss of property value. This is the reason business owners prefer combined business property insurance.

Combined business property insurance includes property insurance as well as liability risks. It covers the damage caused to other parties through fires or other accidents on your property and injuries caused by faulty equipment.

When opting for comprehensive business property insurance, you should make sure you also have adequate coverage for worker’s injuries, business disruption and general liability. Unless your business is covered on all fronts, just having business property insurance will not offer protection enough.

Protecting your assets from natural disasters, crime, theft and liability can save you a lot of worry later. These situations can stop your profits in their tracks, but business property insurance can help your business recover faster. If you wish to know more about the kind of business property insurance that is the best for your business, see your local small business consultant.