What's your type? Buying business real estate? the legal entity you choose could make a big difference in your tax bill

Entrepreneur, Jan, 2004 by Joan Szabo

WHILE LOCATION, WILL ALWAYS BE IMportant when buying real estate, tax experts say don't neglect to carefully consider the type of business entity you select to own that property.

That's right--for business real estate, you should choose a business entity that will help you save on taxes.

It's almost never a good idea, for example, to use a corporation for the real estate you expect to own in your business because it will likely cost you plenty in taxes, says Maury Golbert, a partner with the New York City accounting and advisory firm Berdon LLP. As you know, with a corporation, earnings are subject to double taxation. First, the corporation pays taxes on income, and then after-tax income is taxed again when it's distributed to shareholders in the form of dividends. The corporation must also pay state and city taxes in many jurisdictions on income from rental real estate.

A better choice for real estate holdings is a limited liability company or a limited liability partnership, says Golbert. An LLC or LLP provides the same liability protection you get with a corporation, but income is taxed only once.

In addition, LLCs and LLPs generally don't pay local taxes on income from rental real estate. Another advantage is the ability to take some of the cash out of property that's appreciated in value. "It's possible to take out a mortgage on the property and distribute excess proceeds directly to the owners without paying a current tax," Golbert says. "But if you try to do that with a corporation, often you'll end up having to pay income tax on the money you've taken out."

What if operation of the property generates losses? With a corporation, your ability to deduct losses is limited. It's actually suspended once losses and distributions exceed the total of your capital contributions plus previously earned but undistributed income. With an LLC or an LLP, these losses will often be allowed because you can increase the tax basis of your interest by your share of company debt.

Another plus is the flexibility an LLC or LLP provides with regard to exit strategies. Corporate distributions of appreciated assets may create an immediate gain for both the corporation and the shareholder, while properly structured similar distributions from LLCs generally do not.

Says Golbert: "With the advantage of the flow-through of losses, the ability to take money out without a current tax, and the better exit strategies, it's a good idea to make an LLC or LLP your first choice of entity."

Great Falls, Virginia, writer JOAN SZABO has reported on tax issues for 17 years.