SPOTLIGHT Exit Strategy Basics BUSINESS be amazed at how many business owners just never get around to actually doing it. Talking about it is not good enough, and it’s too late when you suddenly wake up on the wrong side of the dirt! Incidentally, life insurance is not gener- ally considered to be a good investment, although there are so many different types of coverage that you may have access to a policy that offers accumulation of cash values. The policy may even earn inter- est, which can sometimes partially offset the premiums. Consider life insurance primarily as a defensive strategy rather than an investment. Again, seek guid- ance from your licensed insurance agent, financial planner, accountant and/or other relevant adviser. Retirement Planning and Investments One common exit strategy is to use the profits from your business to fund your personal retirement investments. This approach is appealing for at least two reasons. First, you will possibly reduce your business and personal tax liability, depending upon your business struc- ture. You could effectively have the busi- ness (directly or indirectly) fund your retirement investments such as 401(k) s or IRAs, using profits that would oth- erwise be used to pay taxes. Look at the aſter-tax impact of various options and avoid or defer tax liabilities until your tax rates may be lower. The second reason this approach is appealing is that you are building your retirement fund separately and, thus, insulating it from your business. For those who don’t want to have their re- tirement dependent on the ultimate suc- cessful sale of their business, this can be a desirable option. 10 In many instances, personal retire- ment accounts are protected (exempt) from lawsuits, bankruptcy and certain other liability risks. This can be an effec- tive way to protect some of your personal assets and retirement savings, but check with your legal adviser for liability issues. Another common approach (if your business has a retail and/or warehouse location) is to buy your building(s) per- sonally and then lease/rent the premises back to your business entity. Under this scenario, the business is indirectly paying the mortgage (which is a tax-deductible expense for the business) for your personal investment in a building. The expecta- tion is that your building is likely to be worth more when the time comes to sell it, perhaps as part of, or even the founda- tion of, your retirement and exit strategy. Your lease would typically also require the business to pay for maintenance and repairs. Frankly, especially if you own a building over decades, don’t be surprised if your building can be sold more easily and profitably than your business. This reminds me of when I would ask small business owners who sold their business at retirement (and also sold their building) the rhetorical question, “What business were you in?” As expected, they would typically reply, “The XYZ business or industry.” But more oſten than not, the numbers would suggest that their primary business was actually real estate investment, which was funded by their XYZ business! Think about banks, gas stations, fast-food restaurants, drug stores and other businesses that own well-located buildings. The cash flow from the business pays the mortgage on the building, which increases in value over time. Such buildings are often held by a separate SAFE & VAULT TECHNOLOGY | March/April 2022 real estate holding entity that may be owned or controlled by owner individuals and may be leased back to the operating company. The building owners may be able to avail of the accelerated depreciation of the building (creating a phantom loss for tax purposes) and, thus, offset some or all of their personal income tax liability. Remember, depreciation is a deductible business expense, but nobody ever writes a check to pay for it! Back in the late 1980s, I was executive vice president of a real estate syndication firm whose portfolio included thousands of apartments and dozens of shopping centers (in eight states), which were owned by more than 100 limited partnerships. These financial instruments were sophis- ticated, regulated securities that offered higher-income investors tax shelters of up to as much as a five-to-one write off for every dollar they invested. This was accomplished largely by ap- portioning the accelerated depreciation (which resulted in an on-paper income loss) from the limited partnership’s owned real estate. Thus, a doctor with a high in- come could use his/her share of the loss from one or more limited partnerships to reduce or entirely offset their personal income tax liability. Indeed, it was not uncommon for some wealthy investors to actually receive a check from the IRS, whereas they would have otherwise had a personal income tax liability of several hundred thousand dol- lars for that tax year. This may be too much information, but the point is that investors have been using accelerated depreciation of real estate as a legal income tax shelter mechanism for decades. Although some of the laws and tax regulations have changed over time, if you own a building, you can use the same fundamental method. www.savta.org
