Q: I am looking to purchase a building in which to operate my business. Should I use a separate entity to own the building?

A: In most situations, yes. Holding the building in the same entity that operates your business may be convenient; however, there are several reasons why a separate entity is generally preferable.

Many businesses are taxed as C corporations, making it tax inefficient to hold assets like real estate that can appreciate greatly over time. When a corporation’s real property is sold, any gain is subject to double taxation. First, the business must pay the applicable corporate tax, and second the owners must pay another tax on the distribution of the net proceeds. In contrast, owning the real property in a separate entity allows you to use a pass-through entity, such as a limited liability company (“LLC”) taxed as a disregarded entity (if there is a single owner) or a partnership (if there are multiple owners). The LLC leases the property to the business and when the property is sold it is only taxed once.

Even if your business is an LLC, consider separating the operating assets from the real property for asset protection. For example, if a person trips in the building, the business assets may be better protected if there is a lawsuit. Conversely, if the business files for bankruptcy, the real property is protected from creditors, unless it is pledged as collateral for business debt. (Legal separation of the entities does not alleviate the need for adequate liability insurance for both entities.)

Owning real property through a separate entity also provides you with more options for business growth and succession planning. For example, you can offer equity interests in the business to investors or provide employee incentive plans without diluting your ownership of the real property. You can also customize your estate planning strategy, such as gifting the business to family members taking over the operations or selling it to a third party, and holding the real property so that you continue to receive the stream of rental income into your retirement. Further, you might elect to gift the business and the real property to separate beneficiaries.

While holding real property separately provides many advantages, you should consult your accounting, wealth management, and legal advisors to determine the best approach for your specific situation.