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For real estate investors, the use of an entity to hold commercial or rental properties is generally a good idea, however, the choice of the entity an investor uses is very important, and in this segment of my multi-article review of this topic, I tell you why you should never own real estate in an S Corp in Hartford, CT (or anyplace else for that matter!).
Use of an entity to hold property is very important. It:
- · Can shield you as the owner from personal liability;
- · Protect your personal information from being shared with tenants; and
- · Enable you to make part interest gifts to your children and descendents as part of your estate plan.
When choosing an entity form to hold your real estate, a flow-through entity is usually chosen because it avoids an entity level tax and the income, gain and loss all flow-through to the owner’s individual income tax return. Flow through entities include partnerships, limited liability companies (in most states) and Subchapter S Corporations (referred to as S Corps). Most investors know not to place real estate in a C Corp because of the corporate level tax.
But beware: though S Corps are a flow through entity for income and expense information, it acts as a C Corp for purposes of the sale of assets. What this means is that if the real estate is ever distributed to the owner or sold to a third party it will be treated as if it was sold by a C Corp and the proceeds distributed as dividends to the shareholders, and it is why you should never own real estate in an S Corp in Hartford, CT!
The reason for this is the default rules under Subchapter S of the Internal Revenue Code are to a C Corp, not a partnership, and therefore any distribution of an asset to the shareholder is treated as a sale to a third party and taxed at corporate tax rates. This ends up being a major area of confusion with both taxpayers and tax professionals alike. S Corporations are not Partnerships they are corporations!
So what if an investor already has his or her property in an S Corp?
Unfortunately we run into this more than you would guess, and there is not much that can be done. Either the distribution of the real estate or the sale of the real estate will trigger a corporate level gain (with corporate level tax) and a secondary tax on the net proceeds on the taxpayer’s return.
With the economic downturn, if the real estate has fallen in value enough it may be possible to distribute it and minimize the taxable gain, but an analysis would have to be done by a tax professional to determine what, if any, tax would be due.
If you should have any questions or concerns about why you should never own real estate in an S Corp in Hartford, CT, I would be happy to help. Please feel free to contact me anytime at (860) 657-9040 or e-mail me at egreen@convicerpercy.com.
Eric L. Green, Esq.
Tax Counsel
Convicer & Percy LLP
Phone: (860) 657-9040
E-Mail: egreen@convicerpercy.com
Website: www.convicerpercy.com
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