Should I lease or buy? The list of factors that small business owners should consider

At some point, many small business owners question whether they are better off renting space to do business or if it makes sense to buy or build their own building. Since part of the monthly payments on a mortgage loan builds equity in a hopefully appreciating asset, investing in a building generally makes economic sense. However, the analysis is seldom that simple. Other factors including cash flow needs, tax consequences and the availability of capital for a down payment must also be considered. A detailed analysis by an accountant, a tax lawyer and often both should take place to allow the owner to make an informed decision. In addition to economic factors, there are also non-monetary considerations for the busy business owner concerning the time and energy investment needed to manage and maintain a building.The following is a representative list of the kinds of factors considered in the analysis: * Rent and additional rent paid under a lease are fully deductible as a business expense for federal and NYS income tax purposes. * There are recurring premises related expenses, which are common to both owners and renters such as utilities, liability insurance and routine maintenance. Leaving those common expenses aside, the monthly cost for renting space is frequently less than a mortgage payment by an owner. * While tenants usually have certain maintenance responsibilities, many of the time consuming headaches associated with owning and managing a building are handled by landlords. A tenant can devote more time and attention than an owner to the needs of its principal business as well as family and other pursuits than an owner. * Commercial lenders for mortgage loans to acquire an existing building or for a construction loan on a new build often require an equity injection of 20-25% of the overall cost. For a $1 million building, the purchaser must have between $200,000 to $250,000 to invest in the building. For start-ups or newer businesses, the size of the required down payment can be a real problem. * In addition to the equity injection, there are a variety of soft costs and closing costs associated with originating a new mortgage loan including, without limitation, loan fees, appraisal fees, environmental site assessments, mortgage tax, title insurance, bank and borrower attorney fees and other expenses. In the aggregate, the soft costs and closing costs can be considerable. * Mortgage interest, real estate taxes, insurance premiums and maintenance costs are deductible as business expenses by the owner of real property held for the production of income. Such deductions will reduce the taxable income resulting from the rents paid to the owner. * Although renters can depreciate permanent improvements they make to business property, owners of commercial buildings can depreciate the entire building. This results in the owner recovering the cost of the building by taking annual depreciation deductions. With certain exceptions, commercial buildings are 39-year assets which means that the owner can take an annual depreciation deduction equal to 1/39th of the acquisition cost on each year's tax return. * New builds are expensive. Construction costs have risen rapidly in the last two years. Drywall, metal studs, concrete, blacktop and more than any of these, copper wiring, have undergone fairly large price increases. Construction costs of new commercial buildings have risen to between $150 and $200 per s/f, considerably higher than such costs were only a few short years ago. * New construction can cost more than the "appraised value" of the completed building when compared with the available local inventory of existing commercial space. The result can increase the equity injection which must be made by a buyer for the luxury of having brand new space specifically designed for their business. For these reasons, an existing building, even one requiring some renovations, may be more cost effective to the business owner. * Upon the sale of a building, the seller will naturally have to pay tax on any gain realized from the sale. Currently, the tax on capital gains is 15%. Sellers are often also required to pay depreciation "recapture." This means that any depreciation deductions that are taken in excess of the depreciation that would be allowed under the straight line cost recovery method is taxed as ordinary income and any gain attributable to un-recaptured depreciation is taxed at a 25% rate. Various scenarios depending on the amount of gain on the sale, the amount of depreciation previously taken and how long the asset has been owned also affect the analysis under these rules. In addition, capital gains tax and depreciation recapture may be deferred by a seller by engaging in a like-kind exchange for other investment real property upon the meeting of certain criteria. Again, a competent tax advisor should be consulted. The foregoing are examples of the factors to be considered. Before deciding to buy rather than lease, the small business owner is well advised to fully analyze all costs so that the true cost of the investment and the likely return on the investment can be determined. Roger Ross is a member of Hurwitz & Fine, P.C., Buffalo, N.Y.