Mixed-Use Assets

April 13, 2006

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In some instances, the small business owner will personally own mixed-use assets, used for both personal and business purposes. Good examples are a home where the owner has a home-based business, a computer and an automobile.

This can expose the business to application of the alter ego theory when a creditor seeks to pierce the veil of limited liability.

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A personal residence should never be transferred to a business entity. Doing so will result in the loss of the homestead exemption.

Further, the small business owner should consider personally owning certain "tools of the trade," including a personal automobile, office equipment and furniture, and then leasing these assets to the business entity. This also ensures that the exemption for this category of assets will continue to be available to the owner. Of course, such arrangements must be properly authorized by the entity, and in the form of a written agreement between the owner and the entity.

With assets that are personally owned, but have mixed uses, the best approach is as follows:

The owner should pay the general expenses associated with the asset from his personal accounts. The entity should then, pursuant to a written agreement between the entity and the owner, reimburse the owner for the business portion of these expenses. Records must be kept of the business usage. For a home, the relative square footage of the business office can be used. For a computer, a log evidencing hours of business usage and personal usage is appropriate. For an automobile, a record of business miles and total mileage driven is required.
Where a particular expense can be directly attributed in its entirety to the business, this expense should be paid from the business account.

John Smith, sole owner a limited liability company (LLC), uses his personally owned automobile for both personal and business purposes. He records the automobile's mileage at the beginning and end of the year. In one year, he drives 18,000 miles. His log shows he drove 12,000 business miles. This represents two-thirds of the automobile's total usage.

Smith should pay the general operating costs for the vehicle from his personal accounts, because he owns the vehicle personally. Smith should form a written agreement with the LLC, wherein the LLC will reimburse Smith for two-thirds of all operating expenses associated with the vehicle. This can be done on a weekly, biweekly or monthly basis.

If Smith incurs an expense solely attributable to business usage (e.g., a parking fee or toll on a business trip), this expense should be paid directly from the business's accounts.

Note that the objective here is the separation of the owner's and the entity's financial affairs, so as to prevent an application of the alter ego theory. However, keep in mind that, although tax planning is not the objective here, for tax purposes, a one-owner LLC is a "disregarded entity." Thus, for tax purposes, reimbursement from the entity serves no purpose. For tax purposes, the owner and the entity are one and the same.