Can You Sell Your House to Your Business?

Selling a personal residence to one’s own business involves transferring property ownership from an individual to a legal entity they control. This transaction triggers specific legal, financial, and tax implications for both parties. Careful planning and adherence to regulations are essential to ensure legitimacy and avoid scrutiny from tax authorities.

Understanding the Purpose of the Sale

Individuals often sell their personal residence to their business to optimize operations or financial strategy. One common reason is to establish a dedicated office space, formalizing the property’s use for business activities and providing a professional environment for clients or employees.

Another purpose is to convert the property into a rental asset, allowing the business to generate income from the owner or other tenants. This diversifies income streams and builds equity within the company’s asset portfolio. Businesses may also acquire real estate for specific operational needs, such as storage or manufacturing. Owning the property provides stability and control, eliminating concerns about lease renewals or rent increases. Any such strategic move must have a valid business purpose and be properly documented to withstand examination from tax authorities.

Key Preparations Before the Sale

Careful preparation is essential before an individual sells a personal residence to their business, particularly concerning valuation, business structure, and financing.

Valuation

Establishing the property’s fair market value (FMV) is a foundational step. This is the price at which the property would trade between a willing buyer and seller. The Internal Revenue Service (IRS) scrutinizes related-party sales not at FMV, which can lead to adverse tax consequences. Professional appraisals determine FMV using methods such as:
The sales comparison approach, which analyzes recent sales of similar properties.
The income approach, which values income-generating properties based on potential future cash flows.
The cost approach, which estimates value by considering the cost to replace the property.

Business Structure

The business’s legal structure significantly influences its ability to acquire and hold real estate. A sole proprietorship offers no personal liability protection. A single-member Limited Liability Company (LLC) provides liability protection but is often disregarded for federal tax purposes, with income reported on the individual’s tax return. C corporations and S corporations offer liability protection, but C corporations face potential “double taxation.” Partnerships and multi-member LLCs are common for real estate ownership, offering liability protection and pass-through taxation.

Financing

Securing financing is another preparatory step, as the business must demonstrate its capacity to acquire the property. Businesses can use cash reserves or pursue traditional commercial real estate loans from banks, which typically offer fixed or variable interest rates over terms of 5 to 20 years. Government-backed options, such as Small Business Administration (SBA) 7(a) or 504 loans, can provide favorable terms, including lower down payments and longer repayment periods. Owner financing, where the individual lends funds to their business, is also an option, but it requires formal loan agreements with clear terms, interest rates, and repayment schedules to be considered legitimate by tax authorities.

Executing the Transaction

The transfer of property ownership from the individual to the business involves several procedural actions.

Sale Agreement

The process begins with drafting a formal sale agreement. This legally binding document outlines the transaction’s specific terms and conditions, including the purchase price, property description, and any contingencies. Even as a related-party transaction, the agreement should mimic an arm’s-length deal, clearly identifying the individual as the seller and the business entity as the buyer.

Deed Execution

The next step is preparing and executing a deed, the legal instrument that officially transfers title. Common types include a warranty deed, which offers the most protection by guaranteeing clear title, or a quitclaim deed, which transfers only the seller’s existing interest without guarantees. The deed must accurately describe the property, identify both the grantor (seller) and grantee (buyer), and include the consideration paid. It requires the grantor’s signature and must be notarized.

Closing Process

A professional closing process, typically facilitated by a title company or real estate attorney, ensures all legal requirements are met. This usually includes a title search to verify legal ownership and identify any liens or encumbrances. Title insurance is often obtained to protect the buyer and any lender against unforeseen claims or defects in the title.

Recording the Deed

After the deed is executed and all conditions are satisfied, it must be recorded with the county recorder’s office where the property is located. This recording places the change of ownership into the public record, providing notice to all third parties of the business’s new ownership. Proper recordation is crucial for establishing the business’s legal claim to the property.

Tax Implications for Both Parties

The sale of a personal residence to a business involves distinct tax consequences for both the individual seller and the business buyer.

For the Individual Seller

The primary consideration is capital gains tax. Individuals may be eligible for the Section 121 exclusion, allowing them to exclude up to $250,000 of gain ($500,000 for married couples filing jointly) if they owned and used the home as their primary residence for at least two of the five years preceding the sale. Selling to a related party generally does not negate this exclusion for the residential portion. However, if any part of the home was used for business purposes, such as a dedicated home office, the gain attributable to that business use may not be excludable under Section 121.

If the individual previously claimed home office deductions using the actual expense method, they may face depreciation recapture. Any depreciation claimed after May 6, 1997, must be recaptured and taxed at a special rate, typically 25%, upon sale. This applies even if the Section 121 exclusion covers the remaining gain on the residential portion. Using the simplified home office deduction method avoids this recapture. The individual must allocate the sale price and basis between the residential and business portions to accurately determine taxable gain and any depreciation recapture.

For the Business Buyer

The transaction establishes a new tax basis in the acquired property, which includes the purchase price plus certain acquisition costs like legal fees and transfer taxes. This basis is crucial for calculating future depreciation deductions and determining gain or loss if the business later sells the property. The business can depreciate the building structure, but not the land, over its useful life. Nonresidential real property is typically depreciated over 39 years, while residential rental property is depreciated over 27.5 years, as outlined in Internal Revenue Code Section 168.

The business can deduct various operating expenses related to the property, including property taxes, mortgage interest, utilities, insurance, and maintenance. These deductions reduce the business’s taxable income. If the business holds the property as a rental, even if leased back to the owner, income and expenses may be subject to passive activity rules under Internal Revenue Code Section 469. Generally, losses from passive activities can only offset passive income, unless the owner qualifies as a “real estate professional” or meets specific active participation exceptions.

Ongoing Considerations After the Sale

After the property transfer, the relationship between the individual and their business evolves, requiring new operational and compliance practices.

Landlord-Tenant Relationship

If the individual continues to use the property, a formal landlord-tenant relationship should be established between the business (as landlord) and the individual (as tenant). This involves a written lease agreement outlining terms such as rent, payment schedule, maintenance responsibilities, and occupancy duration. This formal arrangement ensures the legitimacy of business expense deductions and maintains a clear separation between personal and business activities.

Record-Keeping and Compliance

Meticulous record-keeping and compliance are paramount for the business. It must maintain detailed records of all property income and associated expenses, including property taxes, insurance, utilities, and maintenance. Documentation, such as invoices and receipts, should be kept for several years to substantiate deductions and income reported on tax returns. Compliance with evolving regulations, like beneficial ownership information reporting requirements, is also necessary.

Personal Use Limitations

Continued personal use of the property by the owner can introduce complexities and limit deductible expenses. If the business holds the property as a rental and the owner uses it personally for a certain number of days, the property may fall under “vacation home rules” (Internal Revenue Code Section 280A). These rules can limit deductible expenses to the gross rental income, potentially disallowing losses. Careful tracking of personal versus business use days is important for compliance.

Future Sale by Business

Should the business eventually sell the property, it will face its own tax implications. The sale triggers capital gains or losses at the business level, calculated based on the business’s adjusted basis (original cost minus accumulated depreciation). Any prior depreciation deductions will be subject to recapture upon sale, meaning that portion of the gain will be taxed as ordinary income. The specific tax treatment depends on the business’s entity type; for pass-through entities, gains and losses flow through to the owners’ personal tax returns, while C corporations pay tax at the corporate level.