From Foreclosed Home To Office: A Doubly Risky Venture

By Benny L. Kass
Saturday, April 5, 2008

Q: I own a small business in Virginia and have been in my industry for 18 years. I rent a building with a month-to-month lease.

With all the foreclosures in the area, I am pondering the idea of buying a small house and converting it to business use. I have excellent credit, so I know I can do this. I am aware of the responsibilities that I will have if I can't call a landlord to fix problems.

However, I an not sure where to start. How does one find homes that are in foreclosure? I am also not sure where to find laws and regulations on opening a small business in a residential area. There are already a few businesses operating out of onetime homes in the area. And is it wiser to own than rent for tax benefits?

A: To find homes in foreclosure, talk with some local banks. They have listings of such properties in their portfolios and would be happy to unload them. Real estate companies in your area probably also have listings of properties that are scheduled for foreclosure. Some brokerages are sponsoring bus tours of these properties. Also, search for "foreclosure properties in Virginia" on the Internet, and you will find many more listings.

I would be cautious, though. Some owners faced with losing their homes have been stripping them bare, taking plumbing and electrical fixtures and anything else that may have salvage value.

If you find a property that is attractive, there are a number of steps you should take:

· Satisfy yourself that the applicable zoning laws will permit you to run your business. Don't rely on what real estate agents tell you -- hire a lawyer with local zoning experience because there are restrictions on the kinds of businesses permitted in residential areas and they vary from place to place. You or your lawyer must review the local regulations and talk with the appropriate zoning officials. You don't want to buy a house only to find out that you cannot use it for your business. Determine not only the current zoning but also whether there are any plans to change the rules. Discuss that with the local planning office.

· Carefully inspect the house, using a professional inspector. Many homeowners in trouble will bury their heads in the sand and be unwilling to allow such inspections. They believe, perhaps naively, that some miracle will occur and they will be able to keep their home. If you cannot have access to the house, walk away.

· Include an appraisal contingency in your contract. Real estate prices are down, and mortgage lenders are becoming conservative. You don't want to find out that the house has been appraised for less than your contract price.

· Include a financing contingency, too. You must disclose to your potential lender that you will be using the property for business. That means you will not get the residential interest rate. That also means some lenders will not want to get involved.

If you have a good business-banking relationship, discuss your situation with your banker before you sign any real estate contract. You want to make sure that you will be able to get a loan.

You asked about the tax benefits of buying. It is generally beneficial to own. But the rent your business pays is also deductible. Your accountant should be able to run some spreadsheets showing the difference between owning and renting. Each case is different, and a general statement about taxation cannot answer your specific questions.

Before you buy, you need to determine how title to the property should be held. Some people would create a limited liability company, or LLC, and put the property in the LLC's name. Such an arrangement can protect your other assets should you or your business be sued.

In general, only the assets of the LLC are at risk if there is a court judgment against the company that exceeds the amount of insurance coverage.

However, to obtain this protection, you have to follow the rules. You cannot mingle your assets with those of the LLC. You have to sign all documents in your capacity as "member" of the LLC and not in your name. And if you put another asset into the LLC, the asset will become at risk.

Even though limited liability companies have been around for more than 20 years, some banks are reluctant to lend to them. So bring this up with your banker.

This is a good time to consider buying residential real estate, and your "pondering" makes sense. But you have raised a number of questions, all of which must be answered to your satisfaction before you take the plunge.

Benny L. Kass is a Washington lawyer. For a free copy of the booklet "A Guide to Settlement on Your New Home," send a self-addressed stamped envelope to Benny L. Kass, 1050 17th St. NW, Suite 1100, Washington, D.C. 20036. Readers may also send questions to him at that address or contact him through his Web site,http://www.kmklawyers.com.


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