By Andrew Hunzicker, CEO, DOPE CFO
Real-Estate as it Pertains to Obtaining a Cannabis License
One of the greatest challenges that Cannabis business owners face is finding a place to operate. Just because Cannabis is legal doesn’t mean that local authorities will allow operators in their jurisdiction. Then there’s zoning and dealing with the community at large to approve an incoming Cannabis business.
And keep in mind, one of the first things that Cannabis licensing authorities ask from applicants is whether a location has been identified and if the permitting process is done. Yet, finding an approved location happens before there is any guarantee of a license, so there is a huge amount of liability and financial entanglement involved early on.
Since the licensing process can be a huge game of hurry-up-and-wait, having a strategy and utilizing an accountant that understands tax and liability, how 280E effects real estate, how to prepare and maintain your financials for the licensing process, and how to properly account for all of the expenditures and investments that are incurred before the doors open will be vital.
Are You Subject to 280E if You Lease Property to a Cannabis Company?
One of the first questions to ask when you purchase land and want to lease acreage out to Cannabis growers is, “are they subject to 280E?”
In simple terms, 280E says no deduction or credit shall be allowed for any amount paid or incurred during the taxable year on any trader business if such business consists of trafficking and controlled substances within the meeting of schedules 1 and 2 of the controlled substances acts.
So, right off the bat, we know that 280E focuses on business, not just a legal entity. The tax code doesn’t mention anything about no deduction for a legal entity if that legal entity sells pot or heroin, it says a business, – that’s a critical point.
Another essential question is, “what is trafficking?” Typically, we view trafficking as someone growing or selling Cannabis. However, it also could be defined as transporting Cannabis, which can apply to distribution and delivery companies if they take possession and are making a markup on the product.
But when you’re looking at this from a tax perspective when you take a position on your tax return, you might be right and you might be wrong. You may not know the answer until the IRS shows up. So, you can explore more aggressive or conservative positions, but there’s not always a right or wrong answer. So why is trafficking relevant to real estate transactions? Aside from its important distinction for tax purposes, it’s essential for landowners who are leasing to Cannabis companies to know where they stand in terms of liability.
Let’s say you own a piece of land and a Cannabis company comes to lease your estate, are you liable for trafficking at this point? It appears at this basic level, there is minimal legal risk for landowners.
But what if you already own land and decide to open a dispensary? Well, that’s where things can get tricky, as often seen in Cannabis court cases. So, what’s the problem? The problem is that some Cannabis business owners are trying to set up multiple entities to own the land, then lease it back to the dispensary, which they also own, and then get out of tax liability that way. That’s generally not going to work.
But How Does Real-Estate Fit in?
If someone is leasing real estate to a Cannabis dispensary owner, the organizations will not be considered one economic entity if there are different owners (between lessor and lessee).
But, if the landowner is the same owner as the dispensary, both businesses will likely be subject to 280E. If the non-canna businesses are not compliant due to lack of correct accounting treatment, or are not substantial or profitable, you’re going to run into problems with the IRS, as they will not pass the test to be considered separate entities, regardless of how the business is structured.
In fact, your business could get hit with double taxation, because if you have two entities, you could create phantom income and expenses (that are subject to tax). It’s not real, in other words, to the owner, and you’re just booking income and expenses in areas to get a tax benefit, which could cost you more in the long run had you just applied the right treatment to the income.
Reasons Why You Would Put Your Cannabis Real Estate into a Separate Entity
While it may not make sense to try to get around 280E using separate entities to hold real estate, there may be benefits with regard to protecting assets. It’s important to really assess what’s more important, or even feasible: protecting assets or minimizing taxes? And do the goals of various investors conflict with each other? Often, trying to achieve both goals can result in conflicting outcomes, so in the case of Cannabis companies, utilizing separate entities may not be the best strategy to minimize taxes. Do not forget that protecting assets can be just as important and valuable.
The trouble some find themselves in is they think that they are saving money on taxes by using separate entities, but they are not. Inadvertently, by prioritizing tax savings, they are exposing themselves to more liability.
As far as entity structures go, we need to look at the goals and tax positions of all the owner/investor groups and each answer will depend on their unique situations. It is often wise to consider forming a C-Corp structure because it reduces the audit risk for investors, taxation can be fairly neutral or beneficial compared to an LLC at exit, among other reasons. For example, in the event of bankruptcy, the C-corp can file, and it wouldn’t flow through to the owner and affect the real estate holdings since they’d be separated.
Considerations for Leasing Versus Owning Property for Cannabis Businesses
There is no one size fits all answer on the lease versus buy decision. You are going to actually have to put a calculator to it and figure out what is going on, and which is the best way to go for each particular situation.
When it comes to leases, you’re going to have to think about accounting, and so for GAAP accounting, there are new lease standards that have been released from the FASB. The new lease standards indicate that most leases are going to end up on the balance sheet. So in the old days if you’re a small company and you lease a piece of equipment, you just debited lease expenses and credited cash every month when the new standard comes into effect.
There’s quite a lot to think about and as we’ve noted above, not understanding how 280E relates to leasing or buying real estate for Cannabis use could lead to some explosive penalties and consequences.
Andrew Hunzicker has over 30 years of experience in accounting and tax services, and is an expert in cannabis startups, CFO services, turnaround and high-growth strategies, capital sourcing, mergers, exits, and wealth protection. https://www.dopecfo.us/