What should I do with my commercial building?

Question

Hi, All.

I'm super new to this. I have a residential and a commercial property, both with great long-term tenants.

The predicament: I'm subleasing the commercial building. I'll get it under my name in 2 years.

It's insured for over $1mill. I was thinking of refinancing it when it's under my name and cashing out to pay my house I live in and the rental house, then investing in a newly built duplex.

What do you guys think?

Kate Sanchez · Answer

@Toby Tobe  Just be sure the refi cash flow still supports your goals. Excited to see how the duplex investment turns out!

Dylan Brown · Answer

@Bill B. is spot on with the basis issues.Of course, a deal like this is hard to turn down - you will just need to be very mindful of the tax implications of having a property with a low basis.

Properties with a low basis like this are also ones that you have to be very mindful of the entity structure you receive the property ownership with because there are certain entities (mainly C and S corps) that can cause unrealized gains to be triggered inadvertently during future ownership transfers that may have otherwise been tax free if a different entity was involved.

Bill B. · Answer

I missed the part about a family transfer.

If this is a gift, or you are paying way less than it’s worth. Make sure your father in law declares the gift and/or pays his share of the taxes. (The IRS is wary of tax burden shifting.) You will also inherit a very low cost basis (his actual cost basis which could be insanely low, or your artificially low value if you’re lucky.) making any eventual sale a tax landmine. This is the kind of transfer that’s usually done at time of death to avoid all the taxes. Just keep that way smarter than me CPA involved BEFORE you do any transfer, they SHOULD have an idea of the impact on each of you.

Bill B. · Answer

Wouldn’t the commercial property be the most expensive loan with the shortest terms? Why would you pay off lower interest, longer term debt with higher interest, shorter term debt? This is exactly how the current commercial debt problem started.  (3-5-7 year loan terms forcing people to find new financing while rates have doubled.) take all the 30 year debt you can while limiting short term debt.

You’d be better off getting max leverage on your home and the rental home to lower the debt on the commercial property.

Dylan Brown · Answer

A lot of this depends on how you are acquiring the building. When your sublease is up, are you acquiring it through a separate purchase transaction or is it written into the lease terms as some purchase option?

My answer will be dependent on the structure of the acquisition of the building and your ultimate basis in the building (and how it is financed).

Generally, the cash out refinance you are talking about is a good approach as long as you keep a healthy leverage ratio (I see too many people over extend themselves in hopes of growing their portfolio).

One thing to keep in mind if you take the refinance route is that you may not be able to deduct all of the interest expense on the new refinanced note if you are using some of the proceeds to pay off debts on personal properties.

Make sure you are talking with your CPA about interest tracing any time you are planning to do a cash out refinance as there are some lesser known ways to structure it so that all of the interest is deductible if you time everything right.

Toby Tobe · Answer

Thank you guys! I'm soaking in all the knowledge you're providing.  You guys are awesome!

Dylan Brown · Answer

Great context.  And what a great deal!I tend to agree with @Bill B. on his comments related to the flexibility of commercial lending versus leveraging your existing assets.You just need to look at your entire portfolio, determine the amount of leverage you are comfortable with (for me I try to stay below 50% LTV for my portfolio, but that is more conservative than most others who are starting out).If you still have equity to tap into on properties that could qualify for 30 year financing, I would go that route first and only tap into the commercial building's equity after exhausting all traditional residential lending avenues.The transfer from family will certainly present some unique challenges for tax reporting, I am happy to be a resource for you there.  I will DM you!

Toby Tobe · Answer

Thank you for your comments. I can really use your guys' experience.

So, the building has to be under my father-in-law's name for the next two years, then we'll transfer it under my name afterwards. There won't be any liens on it. I'll just be paying him back roughly 1/3 of what the building is worth. I'll need to get it appraised for sure. I figured there's a lot I can pull out of the building in two years. I was just wanting to knock out some monthly bills and start acquiring more property. A CPA will definitely be beneficial.

Thanks, again.

What should I do with my commercial building?

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