My parents purchased the building in which they run a restaurant, but they haven’t incorporated. They need to invest in a better sprinkler system that's going to cost them thousands of dollars. Will incorporating help them absorb the cost of this investment?
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Whether or not your parents incorporate their business should not impact the after-tax cost of this investment.
But that doesn’t mean your parents shouldn’t incorporate their business, says certified public accountant John Sauder, director of entrepreneurial business services for Clifton Gunderson LLP in Peoria, Illinois. For liability purposes, he explains, any restaurant should be held in a separate legal entity, such as a C corporation or a limited liability corporation (LLC). That will shield the owner’s personal assets in the event of any legal claims against the business.
In fact, Sauder says, your parents should probably create two separate legal entities — one for the restaurant business itself and a second that would own the building and grounds on which it operates. Putting the real estate into a second legal entity would further isolate that asset in the event of a legal claim.
A single-owner LLC would be a good vehicle for this, Sauder says, as it would not require filing a separate income tax return. Instead, your parents could just report the activity of the LLC directly on their personal tax return.
As for that sprinkler investment, Sauder says it can probably be classified as a repair rather than a capital improvement, making it fully tax-deductible in the year it’s made — assuming the entity that makes the investment is sufficiently profitable. Most likely, he says, that entity will be the restaurant itself, under the legal structure proposed above. In that case, the restaurant should buy and install the sprinkler system rather than the real estate LLC.