Selling Primary Residence to S-corp to convert to rental property

[Greg Pratt]

I’m already expecting responses of “Never ever ever hold real estate within an S-corp”, however this particular scenario might be a little different, and I’m also open to other options.

I purchased a property 10 years ago for $200K that needed a lot of work. I moved into it as my primary residence have been fixing it up over the years. In a few months renovations will be complete and I’m trying to figure out what to do with the property. I will be moving in with my girlfriend so it will no longer be my primary residence. The easiest option would be to sell it and claim the ‘up to $250K’ Section 121 exclusion. I will have put in $125K in renovations, and lets say it sells for $550K. 550K – (200K + 125K) = 225K in gains.

But what I really want to do is keep this as a Long term rental (more than 10 years). I have 5 other long term rentals that I’ve acquired and fixed up over the years so this house would fit in with that strategy. However, I realize by doing this, if/when I decide to sell it later(> 10 years), I will miss out on the 121 exclusion since I won’t have lived in it 2 of the past 5 years. I started doing some research online and came across this article that explains the strategy of selling the house to a newly created S-corp.

https://bradfordtaxinstitute.com/Content/Sell-Home-to-S-Corporation.aspx (you can sign up for free to read the article)

After reading the article, I felt that this was a good plan. I could sell my house to my new S-corp for 550K(or whatever the appraisal says – this would prove the FMV) and then when the house is eventually sold to someone else, the cost basis would be 550K instead of 325K (200K + 125K renovations).

However the more research I do, it seems everyone says NOT to hold real estate in an S-corp for varying reasons, but the biggest reason being when it comes time to sell. Unfortunately the article above doesn’t talk about this!

Any suggestions or things to look out for with the idea of selling to the S-corp? A couple questions I have in mind that I don’t know the answer to…

• -Do I need to pay myself a ‘reasonable salary’ from the S-corp? What would be a reasonable salary if all I’m doing is collecting rent?
• -Can the S-corp deduct real estate tax, repairs, etc just like I deduct these expenses from my other rental properties.

[Michael Plaks]

@Greg Pratt

Thumbs up on you taking the effort to explore your options.

First, there are two errors in the comments posted by @Cameron Skinner. Related party rules do not stop this exclusion, known as Section 121. (Technical details: that limitation only applies to sales of "remainder interest" - which is not the case here.) Also, the tax reform did not change the rule to 5 out of 8 years. It was in one of the proposals, but not in the final bill. The rule remains 2 out of 5.

Second, it is possible to sell to an S-corp or C-corp if it is structured as a bona fide sale - i.e. the same as it would be with an unrelated party.

Third, you do not need a salary if your S-corp simply holds a rental property. And you can take all the deductions.

Fourth, there're indeed potential complications with both S-corp and C-corp holding rentals which is a separate topic. They should not outweigh the benefits of erasing $250k of gain.

If you want more details past this intro - you would probably need an actual consultation with an expert.