Exit Planning for Businesses with Commercial Real Estate Holdings

When it comes to exiting a business that owns commercial real estate, the process can be more intricate due to the unique considerations of real estate assets. Whether your clients are at the early stages or the peak of their business growth cycle, having a well- thought-out exit strategy is crucial. This strategy serves as a roadmap for making key business decisions and sets a clear target for all their efforts.

Here's a detailed look at various strategies for businesses with commercial real estate holdings:

Tax Implications of Selling an Investment Property

Exiting an investment property differs significantly from exiting a business due to the numerous tax implications associated with divesting commercial real estate investments. This is particularly true when these assets have appreciated substantially since their acquisition.

The sale of appreciated assets can lead to significant capital gains taxes. For instance, if a property with a basis of $250,000 is sold for $1 million, a 20% capital gains tax rate would result in a tax liability of $150,000.

Selling Real Estate with the Business and Completing a 1031 Exchange

One exit strategy is for your clients to sell their real estate holdings alongside their businesses while mitigating tax exposure through a 1031 exchange. This exchange allows landlords to defer all capital gains taxes by reinvesting the sale proceeds into a like-kind replacement property. While the delayed exchange is the most common, there are four different kinds of exchanges.

However, this strategy entails ongoing landlord and management responsibilities. Depending on the commercial lease structure, your client might be responsible for building repairs, tenant negotiations, property marketing, and more. While this allows your clients to retain significant control over their investment assets, managing a commercial property requires continuous capital and time commitments.

Exiting Actively Managed Investment Real Estate for Passive Real Estate Investments

For clients looking to disengage from active real estate management, selling their property and completing a 1031 exchange into passive investments like Delaware Statutory Trusts (DSTs) is an option. This allows them to defer capital gains and depreciation recapture taxes without the need for direct involvement in property management. However, DSTs are typically illiquid with a holding period between seven and ten years.

Alternative Passive Investment Options

Another avenue for passive income without direct property management is investing in Real Estate Investment Trusts (REITs) or crowdfunding platforms. However, these options are not eligible for 1031 exchange treatment and offer limited tax advantages compared to direct property ownership.

Comprehensive Exit Strategies

When crafting an exit strategy for a business with commercial real estate holdings, it's essential to consider various factors:

  • Long-Term Goals: Align the exit strategy with the long-term goals of your clients. Whether they aim for immediate liquidity or long-term income generation can significantly impact the choice of exit strategy.
  • Market Conditions: The real estate market conditions at the time of exit can influence the decision to sell of hold the property. It's crucial to assess market trends and potential future developments.
  • Succession Planning: If the business is family-owned or has potential successors, the exit strategy might involve transferring the real estate assets to the next generation rather than selling them.
  • Legal and Financial Considerations: Consult with legal and financial advisors to understand the implications of each exit strategy. This includes tax consequences, legal liabilities, and financial projections.
  • Contingency Planning: Prepare for unforeseen circumstances by having contingency plans in place. This could involve having multiple potential buyers or alternative investment options if the initial plan doesn't materialize.

Exploring More

Businesses with commercial real estate holdings require careful planning and preparation when considering an exit strategy. The choice between selling the property with the business, completing a 1031 exchange into passive investments, or exploring other passive investment options depends on various factors, including tax implications, management responsibilities, and long-term goals. It's crucial to weigh these options carefully and seek professional advice to ensure a successful and profitable exit. If you're exploring exit strategies for your business with commercial real estate holdings, don't hesitate to reach out to us for expert guidance and support. Our team is here to help you navigate the complexities and make informed decisions for a smooth transition. Contact us today to discuss your options and take the first step towards a successful exit strategy.