When opening a new restaurant concept or location, one of the first decisions restaurant owners will make is whether to buy or lease the property. The choice restaurant operators land on will have tax ramifications down the road. Here are some pros and cons to consider before leasing or buying.
Not being the property owner affords restaurant operators more flexibility. Depending on the terms of your lease, if you find the location isn’t optimal for your business plan, moving to a different location is easier. If you find your lease terms unmanageable, you can renegotiate.
With leasing, there are no down payments, freeing up cash for renovations and investments. Your costs are stable and predictable.
When you rent, you can deduct your lease payments. If your restaurant signed a triple net lease (meaning the property owner pays the mortgage and you pay everything else), you are paying the property taxes, utilities and other bills. Those payments are also deductible.
When you are leasing and pay out of pocket for tenant improvements, if those improvements are on a 15-year property, you can deduct the QIP improvements over 15 years. Also, because the space is a 15-year property, it is eligible for bonus depreciation. You could theoretically expense most or nearly all tenant improvements in the year they are placed into service.
However, there’s a catch. If the property owner pays for these improvements, they reap the tax rewards, not you. The property owner is providing the funds to make improvements, so you can’t take a tax deduction on those expenditures.
Not owning the land and buildings your restaurant is built on can put you at a disadvantage. As a lessor, you are at the whim of the property manager. If they decide to sell, that could be a problem. If there are issues with the building itself, like repairs, and the property owner is not responsive, it can be difficult to resolve the problem quickly.
When you decide to purchase commercial real estate, you are not just in the restaurant business. You are now in the real estate business as well. Another upside, purchasing real estate is an investment in your restaurant's future.
When you choose to buy, you opt for the long game. Over time, commercial spaces will likely gain in value, and the equity you build with increased property value can be tapped for future business ventures.
With no property owner to be accountable to, you have more control over the use and maintenance of the property. Owning the building also provides future revenue as an investment property if you choose to relocate or close and lease the building out to new commercial tenants.
If you have a mortgage on the restaurant property, the interest payments are tax deductible. However, principal payments are not tax deductible. Like the triple net lease, you can also take taxes and utility deductions when you own the property.
The downside to ownership is added expenses leasing wouldn’t incur. You may struggle to find financing for commercial real estate loans and pay a high-interest rate. You’ll likely need to carry more property and liability insurance and pay prepayment penalties on the loan. The one bright side to the added expenses of ownership is that many of those expenses will be tax deductible.
Whether you buy or lease commercial real estate, there are tax benefits. Here are a few mutual benefits.
Bonus depreciation applies to qualified business property with a useful life of 20 years or less. It applies to buildings, equipment, furniture, fixtures, computer software and machinery.
The property does not even have to be new. For example, if you buy used kitchen appliances for a restaurant remodel, you can apply bonus depreciation to the purchase price.
The beauty of bonus depreciation is you can take deductions for all eligible property even if the value of the deduction is below your tax obligation. The drawback is you cannot choose which five-year asset to apply bonus deprecation to.
Section 179 is like bonus depreciation, allowing restaurant owners to write off new or used assets in the current year. However, the 179 write-off comes with limits. These limits are updated every year by the IRS.
The caps are high enough that small businesses are usually unaffected, but large franchise groups will likely hit the ceiling. With 179, you cannot go below the caps, but you can choose which assets to apply the write-off to. Your restaurant CPA will walk you through all eligible assets to determine which strategy will maximize your tax deductions.
To fully benefit from bonus depreciation and Section 179, your restaurant CPA may suggest a cost segregation study. While there is an upfront cost for the study, the tax benefits could well outweigh the financial investment.
Commercial real estate generally depreciates over 39 years. When you buy your restaurant property, you are not just buying the building. You are buying the sidewalks and patios, fencing and plumbing fixtures, carpeting and more. All of which depreciate over that same 39-year period.
Cost segregation studies look at each element to determine if it is eligible for accelerated depreciation over five, seven or 15 years. With bonus depreciation, you could write off 80% of the costs of renovations and upgrades made to your restaurant property in 2023.
A viable compromise between leasing and buying is the lease back. If you own commercial real estate and do not want the responsibility of ownership anymore, or you’re worried about where the CRE market is heading and want to cash out, restaurants can sell commercial real estate and lease it back.
The benefits to the leaseback mean there’s no hassle with owning real estate, and you can cash out if the commercial properties appreciate, all while staying put in a location that works for your restaurant business. Your real estate agent can walk you through the process.
Whether you choose to become a real estate investor, buy commercial real estate property or lease your restaurant property, there are tax deduction opportunities to offset your tax liability. Your restaurant CPA and commercial real estate industry specialist can help you find the right strategy for your financial situation.
If you have questions on buying or leasing real estate for your restaurant, please contact your Baker Tilly restaurant advisor.