Many taxpayers own a business and they also own the real estate and building in which they run their business. Over time, this real estate may appreciate significantly, while the debt on the property is reduced from years of paying down the mortgage. This can represent a large, concentrated piece of a taxpayer’s net worth. These taxpayers may come to realize that they have too many eggs in one basket, and have too much risk exposure if that one property falls in value.
Diversify & Position Yourself for Retirement
As the taxpayer gets up in years and is looking to retire, they may want to diversify their wealth (and lessen their risk exposure) by selling the real estate, but still have their business continue to stay in the property as a tenant on a long-term fixed lease. The advantage for the taxpayer is that they can 1031 exchange their hard-earned equity into a more safe and diverse portfolio of like-kind properties in different geographic localities and in different business segments such as:
The advantage for their buyer is that the buyer gets a good property with a steady reliable tenant already in place on a long-term fixed lease that both parties can rely on.
1031 the Real Estate…Then Sell the Business
If the taxpayer is also considering selling their business, the buyer of the business would not have to purchase the real estate, and could get into the business with a lower down payment, because they would not have to qualify for a loan on the real estate. The buyer of the business would also have the certainty of being able to assume the long-term fixed lease and continue to run the business where it has been located.
Cash is King for 1031 Exchanges of Real Estate
Generally if you are selling real estate, you want to receive cash on the barrelhead so you can reinvest ALL of your equity through a 1031 exchange into your new replacement properties. So selling to a strong unrelated cash buyer is often more desirable than trying to sell both the real estate and the business to one buyer, who may already be stretching their finances just to purchase the business.
Getting Top Dollar By Splitting the Sales
In order to get the top price on the sale of a business, it is not uncommon to have seller-back financing with the seller getting their proceeds over a long period of time. That’s fine of the sale of the business; however, because of the requirements for 1031 exchanges (see Napkin Test), seller-back financing of the real estate is a much less attractive option for a taxpayer looking to defer all of the gains from the real estate. It’s often better to split the sale of the business from the sale of the underlying real estate in order to maximize both the financial returns and tax efficiency for the seller.