Discussion:Real Estate from S-corp to LLC

S-corp has 4 buildings with 4 branches of their business running in each one. Purchased in 1990, 2000, 2004 and 2005. Two were bought individually but shown on the corporate books and depreciated in the corp, and 2 were bought by the corporation.

Due to liability concerns they decided to spin each building off to a separate LLC. The 2 that were titled individually were so titled right before they spun them off. Everything is owned 50/50.

1- What problems are there regarding the buildings being owned individually but reported on the s-corp? Would it be best to show this as a loan or contribution at the time of purchase?

2 - Is there any way to avoid Sec 311 gain on either the properties that are titled in the name of the corporation, or shareholders(as they have been shown on corp balance sheet and depreciated)? I assume that the net FMV will be more than 2006 income, so that making it a "distribution of property" will not work. Is there a way to structure this under 351? Thank you.

Alternatively, if the S corporation has not been dissolved, maybe you can simply put the brakes on the transaction and treat as a drop down into single-member LLC's and continue to report on the S Corp return...(I have not considered any legal issues here, just shooting off ideas)...

The original corporation (let's call it A Corp.) contributes each property it owns to a newly-formed corporation (call then P1 corp. and P2 corp.), and then immediately distributes all of the P1 and P2 stock to A's stockholders pro rata. That's a D reorganization and described in sec. 355. No gain or loss is recognized, and P1 and P2 elect to be S corporations.

Are we sure that the individually titled properties are not owned by the corporation for tax purposes?

When you say A spins to P1 and P2, can this be an LLC, and are you saying it can be an LLC, but they must elect to be taxed as a corporation?

In effect this is about what happened, that the property is now owned by the LLC which is owned in the same percentage as A corp. Can they just have minutes drawn up accordingly or do they need to elect something onthe tax return. All this is GREATLY appreciated.

The spun-off companies, P1 and P2, must be "corporations" for tax purposes. That can be done with an actual state-law corporation, or with an LLC (or ordinary partnership, trust, LLP, etc., etc.) that checks the box: as far as the IRS is concerned, they're all corporations and it doesn't matter which you use. There's likely to be little non-tax reason to care, either. If the plan was to put them in LLC's, it was probably anticipated that those would be taxed as partnerships (or disregarded if they ended up with single owners); that won't be possible if you what I'm suggesting.

Yes, you end up with the spun-off companies owned in the same proportions as the original A Corp. It is important to carry out all of the corporate steps -- forming the subsidiaries, formally transferring title, and distributing the stock in P1 and P2 to A's stockholders. I leave all questions about filings to you professionals.

If the answer is the former, how do you account for an S Corporation taking depreciation deductions for assets owned by individuals? Is there some kind of "deemed" contribution to the S Corporation (substance over form)? How did the assets get into the S corporation?

If the answer is the latter, this means that the S corp acquired the assets and the "spin off" was accomplished via a distribution to the shareholders who then contributed the properties to LLC's [under this structure I'm not sure there is any escape from Sec. 311(b)].

There is absolutely zero doubt that an LLC which checks the box is a "corporation" within the meaning of the Code. The IRS cannot fail to follow its own regs, no matter how much anyone here may dislike them

Everything about this is messy. You are assuming they realized that a corporation was a separate entity from themselves. 2 properties were bought personally and while being depreciated on the corporation, retained title by individuals. So that when they were deeded over to the new LLC's 2 were deeded from individuals and 2 were deeded from the S-corp.

I suppose I will have to assume that the 2 that were titled by indiv. were effectively contributed to the corp in the past. How else can I get it back from the corp after it had been depreciated on the corps books?

Based on your input, I will have to elect corp filing status for the 4 LLC's. I will have to have the operating S-corp pay the LLC's rent. Does and LLC taxed as a corp need to pay officer salaries? I believe so, although it can be minimal as they are just managing a rental.

Final question - Do the new LLC's depreciate as a new asset, using the net book value on the old corp, or do I just move over the entire accum depr and old basis in the new LLC/s-corp? Thanks

Some comments:

1. Ownership of the two individually-titled properties: although title to the property is a key element, it is not the only factor in determining ownership for tax purposes - a "benefits and burdens" analysis might produce a different result depending on other facts (is the S corporation paying property taxes, mortgage, maintenance?, etc...);
2. Because the individually-titled properties have been reflected on the S Corp tax returns, presumably you will have to record an M-2 adjustment ("Other Decrease") to get the assets (and related liabilities) off the returns without showing a distribution (or sale). Depending on the size of the adjustment, this could raise the audit flags;
3. Corporate-titled properties: with respect to the 2006 "spin-off" to the LLC's, it appears that you have a couple of options (i) recognize a 311(b) gain on the distribution of the assets, or (ii) check the box on the LLC's to make them corporations in order to accomplish a 355 spin-off. If (ii) is applicable, this could work provided that you make the check-the-box election in a timely manner - you haven't indicated the dates of formation for the LLC's, so it's not clear if this is still possible [note: if (i) is applicable, checking-the-box on the LLC's makes no sense (you have already recognized the gain once, checking the box only puts the taxpayers right back in the same position)].
4. As for depreciable basis with respect to a 355 spin off - assuming that you qualify for one - you would treat as carryover basis.

Now that I am getting into the numbers, I see that the mortgages against some of the properties are more than the net book cost (cost - accum depr) for 2 of the 4 properties.

• One owned personally has cost 634,000 and loan 884,000
• One owned by corp has cost 344,000 and loan 417,000
• One owned by corp has cost 1,096,000 and loan 901,000
• One owned personally has cost 1,416,000 and loan 1,279,000

I was able to get S-election for the two with the corp ownership.

My question is how I would book this on the old corp and on the new entities. Would I book the net between the cost and loans as "property distribution" or "shareholders contribution" depending on whether the loan was more or less than basis? Or some other way?

On the new entities, would I book the cost and accum depr as of transfer date,and loan payable, and make the balance members contribution for LLC's taxed as ptnship, or I dont know what on the LLC's taxed as S-corps? What would I put the net to? Thanks again.