Discussion:Reasons to transfer real estate into an S Corp

-Sole shareholder establishes S Corp 2005.
-Buys 4 real estate properties in own name, one of which already has 1031'd in 2005
-Wants to transfer them into S Corp

I don't see any of this as an issue, but for some reason, a long time ago, I remember hearing that there can be implications to the shareholders re: the sale of real estate property.

Any feedback is appreciated!

I spoke with real estate attorney friend of mine and he told me that anytime he has a client who has residential real estate investment property, he does advise them to transfer the property into an S Corp or LLC for the added liability protection.

Sorry. Off soapbox now.

Here's the main problems. What if the S election is blown? Or if the tax landscape changes and you don't want it to be an S anymore? Or, it's time to sell the biz and you'd like to keep the RE as rental property? Now you can't sell the stock, at least easily? And why wouldn't you rather take the maximum reasonable rent out of the S so that you can reduce the amount of profit and salary subject to PR taxes? And...just getting started here! What if you expand the building or something, or the S activity income falls off and you fall into the passive activity rules, which I believe still disqualify the S if more than 25% of receipts are rent...It's hard to remember all the traps since we just don't do this. But those of us who have a corp owning real estate...ouch it is trouble. I have one where we have actually planned the escape by deciding the husband will die first and transferring all the stock to him from the 50/50 with his wife so she can get the step up on his death. You see, the farm/nursery that they ran and some CPA firm stuck into the corp back in the 60's turned into their personal residence. Imagine how much gain there is after all those years? Just a lot of dumb stuff to deal with, and most of it's expensive to the client.

An LLC is fine as long as it is a SMLLC (single member) or a partnership LLC but, generally, NOT an S corp LLC for all the reasons stated above.

Any client that comes through my door is advised to set up a SMLLC or partnership LLC to own real estate. NEVER, EVER (to quote JR1) in an S corp, NEVER,...just does not make sense...with a SMLLC or a partnerhip you can move the assets around or distribute but you just can't do that with a Corp without incurring potential tax on a deemed sale on distribution.

I've heard comments like JR1's "it's malpractice to put RE in an S Corp" - Anyone else got cleints who are amatuer RE investors? A few are starting to look more like dealers - I'd love to see a forum just on RE amatuers and how to help them be pros... I'd appreciate any feedback. Thanks.

Thank you.

I don't believe this is an issue IF the corp has always been an S corp...?

Should I worry about this? Am I going to have a problem with Excess Net Passive Income Tax?

Excess Net Passive only applies IF the S corp was previously a C corp with accumulated E&P.

I don't think I would be concerned with salary v distributions with commercial rental.

Maybe someone else has some thoughts or a different opinion.

Bottom line - The s-corp sells the real estate and the capital gain flows out to the shareholder. The only issue out in CA is the 1 1/2% tax. Even on a NNN lease the FMV of rent doesn't cover interest and depreciation. For discussion purposes the taxpayer intends to keep the real estate.

Blrgcpa - We still have passive losses which don't offset the nonpassive income.

I am looking at BNA's Tax Management Portfolio, 549-2nd, Passive Loss Rules. Check out page A-40 (although my book is not the most current) re exceptions to treatment as a rental activity. It discusses the situation that you present: an S corp with a business renting property owned by another entity. Ownership of the real estate and business is separate for liability purposes. Ownership of both entities is identical. Taxpayer will be whipsawed by passive loss rules if he does not meet one of the exceptions to the defn of a rental activity.

If the rental and business activity are grouped as one activity, then the taxpayer should be able to claim the deductions based upon meeting material participation in the business. If they are treated as two separate activities, then he will have to meet the material participation rules in both to treat both as other than passive activities.

If you don't have access to BNA, check out 1.469-1T(e)(3)(ii)(F) and 1.469-1T(e)(3)(vii) and 1.469-4(d)(1)(i)(C). These are references from BNA; I don't have time to check them now, but they should get you started.

Assuming that the rental of the building to the business meets an exception to the definition of a rental activity, then if the rental and business activity are grouped as one activity, the taxpayer should be able to claim the real estate deductions based upon meeting material participation in the business. If they are treated as two separate activities, but the rental still meets the exception, then he will have to meet the material participation rules in both activities to treat both as other than passive activities.

NEVER EVER, ok?

JAD's response appears to only apply if the rental generates income not a loss. The IRS doesn't want you artifically converting nonpassive income to passive to offset passive losses from a different activity. In this situation I can't come up with a really great reason to not have the S-corp own the real estate. If the the taxpayer wants to sell the building the S-corp sells it and the gain passes thru just as if the individual had sold it. The taxpayer doesn't need the basis from the mortgage. And, if the taxpayer sells the business they would do it as an asset sale not a stock sale anyway.

JR what about "never say never"

JR, I appreciate your input and I agree with you when somebody asks about what entity to use for real estate I "always" say LLC. But this situation got me thinking. The reality of the rental market in southern Ca is that most new rentals with say 20% down end up breaking even or having negative cash flow for the first couple of years. Add depreciation and you have your loss. The big bomb waiting out there seems to be blowing the S-election but honestly how often have you seen this happen? Especially with a single shareholder S-corp.

It works the same way with a MMLLC taxed as a partnership: all partnership income is netted, and naturally had this client not formed his S Corp in 1991, he might have availed himself of two MMLLCs, making wife his partner.

input

Sorry, Brenda, I have no advice for this topic.

Brenda, you need to do some research on this, but I don't believe the death of the original owner would have any effect on the 10-year recognition period (IRC Sec. 1374(d)(7)(A)). I haven't read the regulations, though.

Has anyone ever transferred to an LLC what is invloved?

Thanks for your thoughts in advance!

Also, for more discussions on RE in a corp, refer to the recap/category page linked at the very top of this discussion.

To get more useful responses to your question, you might want to mention how the rentals are being held now, and how you would anticipate the LLC would be owned.

The property is currently owned by the husband and wife with all income and expenses being reported directly on E. I would assume the LLC would be owned 50/50 by the husband and wife. Some other information is that they have 3 children that they plan to leave the RE to in the future.

I think maybe NYC won't tax the gain on the sale of re if a single member llc, but

if form a partnership, then NYC will tax the gain on disposition of the properties down the road.

Can anyone comment on this?

PS. The devil made me say that!

One advantage is the very likely possibility that the owner may want to sell the real estate separately from the business some day.

Also they may want to have different owners.

Also, the attorney may advise that it's a good idea to isolate the two enterprises in terms of liability.

I'm sure some of the other contributors may have more to say on this, plus there probably are other discussions.

NENNE HORE IAC

NENNE HORE IAC

Just chant over and over.

But, I don't see any real reasons not to hold RE in an S-Corp. In fact, using an S Corp to own the RE can dramatically reduce taxes in certain situations. The only "real" reason listed above was blowing the S election, but that only happens with a C turned S. An "always S" won't have its election terminated because of passive activity income. (If I'm wrong, please cite sources.)

S-Corp had potential creditor issues. S-corp also owned valuable (and unemcumbered) real estate. Shareholder was concerned that creditors could attach to the real estate, so he wanted to get the real estate out of the corp by way of a shareholder distribution. In this case, the distribution would have created a non-deductible loss at the corp level...yet this loss would reduce shareholder basis (which is how most commentators believe the non-deductible loss should be handled for basis purposes). And, of course, had the property appreciated, there'd be a corp gain (pass-thru) to deal with. So, in a nutshell, we're back to the same problem that corporate ownership of real estate presents - you have issues getting real estate out of out the corporate solution if you ever need to.

My client has one lot of unimproved land that has FMV significantly lower than the basis and he had taken money out from his s-corp beyond his basis.

It is safe to say the value of the land will not go up beyond the price he paid for within several years. My client has cash flow problem and is asking me if it is beneficial to transfer his RE to his s-corp to increase his basis.

The mortgage of the RE is about 80% of the basis. Is it still not advisable?

I suggest you read Sec 362(e)(2).

The mortgage of the RE is about 80% of the basis.

And then read 357(c).

I had a client revoke his S election mid 2010. Last spring I prepared an 8332 for the client and attached a letter begging to be taxed as a partnership rather than a C corporation.

An individual from Covington called and asked if the 1120S that was filed was a final 1120S. He then stated that the IRS revocation of the S election turned the entity into an LLC taxed as a partnership. Therefore, that our filing of the Form 8832 in April was causing some confusion. He indicated that "now" the IRS is treating revoked S elections of LLCs as a revocation of an election to be taxed as an association.

Without bothering to tell anyone?

Actually there are two elections involved in deciding to be treated as an S Corp and I guess absent specific direction the IRS is deciding which one is being revoked.

For an analysis of the law see KatieJ's comments in Discussion:S-Termination & Wait Period

I do it all the time. It's the only practical way to shield a nonresident alien who owns U.S. real estate from U.S. estate and gift taxes.

Never ever, no not ever, say never.

Would NJ taxes (income and transfer) change depending upon the method?