Discussion:S corporation real estate distribution

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Discussion Forum Index --> Tax Questions --> S corporation real estate distribution

TIMBO (talk|edits) said:

29 July 2008
I have a client who has an S coporation(created as an Inc) that owned real estate that is being depreciated. They transferred the building into a new LLC in order to get a better rate on a loan and no other reason. This was a lender requirement in order to do the loan. No cash was given to the shareholders. This just occurred so I have not made an LLC election. Therefore, I have options on the type of entity the LLC can elect to be. The 6 shareholders are the same for both entities. I am trying to determine if this could be a nontaxable distribution or if it has to be treated as a sale. I have researched section 351 and it appears it may qualify for this treatment.

Kevinh5 (talk|edits) said:

29 July 2008
this might ought to be in the 'tax questions' forum instead of the accounting forum. I've moved it so that the corporation experts can weigh in and help you.

1) Do you have a Built In Gains Tax issue??? When you state that the S Corp was 'created as an Inc' I don't know whether you mean that it was started as a C Corp.

2) Distributing the property out to the shareholders is a taxable event. Their subsequent contribution to an LLC or LLC taxed as a corp should not be taxable, (unless there is debt relief or unless it doesn't qualify for ยง351).

3) What if the S corp owned the LLC? Then it passed the real estate out to the SMLLC. That wouldn't seem to be a taxable event.

4) I think there are some threads on here from a few months ago about corporate reorganizations. Those would be good to review.

WillyB (talk|edits) said:

30 July 2008
Under Kevin's 2), Yes..unless you can fit this transaction into the reorganization provisions of Sec 368, the distribution of real estate will be taxable to the extent that it is appreciated (Sec. 311(b)non-liquidating or Sec. 336 if the old corporation is liquidated).

Are there other assets remaining in the distributing corporation? Can it be liquidated?

Having the S corp own the LLC would be another way of avoiding gain recognition by making the distribution a non-event, taxwise. This is if the S Corporation can be the owner of the LLC. However, I suspect that the Bank would not approve a corporate real property owner for the loan. That would scuttle the SMLLC approach.

If there is little or no remaining property in the S Corporation the transaction may qualify as a F reorganization. You could elect for the LLC be treated as an association taxed as a corporation. The old corporation attributes would just carry over . See Rev Ruling 64-250.

If the old corporation cannot be liquidated for some reason so that you have two entities surviving, a spin-off might be effected. You would have to meet the general requirements for a spin-off; active business activities, continuity, business purpose, etc, which are more restrictive than for an F reorganization. See Rev. Ruling 72-320, where a spin-off into an S corporation was allowed.

General editorial comment: If you have to get too aggressive or creative to structure a tax-free result, given the new preparer penalties and OPC enthusiasum in applying same, you might consider how far you wish to "stick your neck out" for a client(s) who gives you such an after-the-fact transactional problem.

Kevinh5 (talk|edits) said:

30 July 2008
But do take DonnieCastleman's advice: do it with love. "Man it's a bummer that you have to pay all those taxes. I wish that you'd consult me first next time you do anything important, so that I can help you." I like Donnie's attitude.

JR1 (talk|edits) said:

July 30, 2008
Oh, this is one of those 'oh, crap' days. No, there is no 351 for removing FROM a corp, and there is no 'distribution' of assets other than cash that's non taxable. This is a deemed sale, for fair market value, and full gain recognition and payment of tax. Sorry. UNLESS, as Willy suggests, you can have that LLC elect corp taxation, and then perhaps you're ok......

JAD (talk|edits) said:

30 July 2008
Timbo, you said, "this just occurred..." To expand on WillyB's post, why not just liquidate the S corp? Do it this year, the same year as the distribution of real estate. The presumed gain on the distribution of the real estate will increase the basis in the stock, and the liquidation should result in a capital loss for the shareholders. Do not delay. You don't want the gain on distribution of real estate in this year and the capital loss on the liquidation of the stock in next year. Also, if real estate includes a lot of 1245 property, there will be ordinary income due to depreciation recapture, and you may wind up with excess capital loss anyway. Make sure to crunch the numbers.

This is wrong. See below.

Kevinh5 (talk|edits) said:

30 July 2008
JAD, I'm not so sure about all that.

basis in stock would be increased by gain from deemed sale, but distribution would reduce the basis, result should still be taxable income. I don't get where the 'loss' comes from.

Riley2 (talk|edits) said:

30 July 2008
Agree with Kevin that a liquidation will result in a tax on the difference between the fmv of the real estate and the basis in the property. Don't believe there would be a loss on liquidation unless the stock was inherited.

JAD (talk|edits) said:

30 July 2008
You are right Kevin & Riley, I missed a step. That's what I get for speaking up before crunching my own numbers!

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