All Forum Posts by: Andrew Abeyta

You are confusing the legal laws under which an organization is structured, which is nearly always dictated by a given state, with the federal tax structure that the entity is operating under, which is dictated under the Feds.

For income tax purposes an LLC is most often either a disregarded entity (wholly owned), or a Partnership (multiple owners). That said, an LLC could elect to be treated for US Tax purposes as an S-Corporation or a Corporation. An LLC is not a federal tax structure, it is a State derived structure to limit liability.

It is not the change of being an "Inc" to an "LLC" that is triggering the deemed gain that we are warning you of. It is the change in tax structure from an S-Corporation to a disregarded entity (what an LLC wholly owned by you would be for tax purposes). It is the removal of the assets within the Corporate Tax Structure to a Non Corporate Tax Structure.

The article you cited is entirely about changing the state legal structure, the article does not discuss any of the ramifications of also changing the federal tax structure.

It's all starting to make sense now -- thank you.

You identified my confusion.

So, while my (reasonable) goal is to move the ownership of the property from the corporation to a pass-through entity, it is exactly that process that triggers to the capital gains liability, right?

And, there is no legal way around that? Even thought the s-corp is in many ways just me, and a new LLC would in many ways be just me?

Exactly it - it is that process of moving the property from a corporation to a pass through entity that will trigger that gain, and it is NOT the conversion of that entity for state law purposes to an LLC that triggers the gain.

While you might think of this wholly owned S-Corp as "just you", for tax purposes it is entirely separate from you.

As you surmise, there is no way to avoid the deemed gain on transferring it out of the Federal corporate structure, into a pass through structure.

There are potential ways to to transfer out the future appreciation while leaving the bulk of the 'old' appreciation in the S-Corp, but no way to get that 'old' appreciation out of the corp without triggering a gain.

Last item to reiterate - this gain is at the S-level, so it’ll give rise to S/H basis (while simultaneously reducing basis via the distribution). If there’s no tax basis remaining in the property, which I presume is the case given it’s 50 years old, this would be a complete wash for basis purposes.

That said, if you have stock basis and this is the sole asset of the S-Corp, consider (1) dissolving the S-Corp in the same year and (2) pursuing a cost seg on the property once it’s in your new LLC.

An important note is that the value of the distribution to you is the basis you’ll receive in the property. If the FMV at the date of distribution is $1M, that will be the tax basis to you (assuming FMV exceeds Net tax basis).

The depreciation you’ll receive from said cost seg may mitigate the gain, especially if the majority of gain is 1231. This may inherently allow an allowable offset of PAL, when ordinarily the cost seg depreciation would be subject to some possible suspensions.

Three things to be HIGHLY aware of if one pursues this route.

One - he did note he has $0 of tax basis in the S-Corp. Assuming the building has land basis, there would be a gain on distribution in excess of basis. IE $1m real estate value,, $100k of land basis - $900k gain. $900k gain increases $0 of S-Corp stock basis to $900k. Then distributes $1m of proceeds - recognizes $1m gain on distribution in excess of basis.

Second - IRC 1239. When property is distributed from an S-Corporation, and is depreciable in the hands of the acquirer, that gain is (very likely) going to be ORDINARY - ouch! No 1231 treatment.

Third, with the cost seg study, you only get bonus depreciation if you didn't previously have an interest in the property. I've only dealt with this directly for partnerships, but it doesn't seem like a far leap that this also would apply to distributions from an S-Corp. If my initial guess is right (someone else feel free to research), no bonus depreciation would be allowed. In my example of a $1m building, the taxpayer recognizes $1m of gain, much of that ordinary, and then maybe gets a $100k depreciation adjustment on the outside....so they are getting nailed with $900k of mostly ordinary income.

Great stuff!
Gain would be $100K on excess of basis. He would take the $1M distribution and would have a $900K gain on the corp side on the distribution of appreciating property. Thus excess basis (land value would be the gain), are are you saying he gets no basis on the gain? A little fuzzy on that point.

I’ve never seen 1245 recap on real estate before, ordinarily (no pun intended) this would be 1250 unrecap and *only on the historical depreciation taken*.

If he bought it for $300K, took $200K depreciation down to the bone and the rest is land, that $900K gain would be $200K unrecap 1250 and the other $700K would be … 1231! It’s essentially a “deemed sale”.

Fair point on the cost seg! I specifically excluded *bonus* from that prior post for that very reason of ineligibility, however, if the cost seg carves out 20% of the basis as 5-year, 20% as 7-yr, 20% as 15-year and the remainder as 39 year (assuming commercial), that’d still front one heck of a depreciation deduction using MACRS 200% DDB.

Will still be some net gain, but that would dramatically dramatically reduce the cash he’d have to fork out to uncle sam… PLUS … he’d have new depreciation again! Joy at last. Right now i’m sure this rental is a taxable income cow, as it’s fully depreciated.

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Quote from @Kory Reynolds:

Quote from @Joseph Skoler:

Quote from @Kory Reynolds:

I agree fully with Andrew.

The article you cited is entirely about changing the state legal structure, the article does not discuss any of the ramifications of also changing the federal tax structure.

While you might think of this wholly owned S-Corp as "just you", for tax purposes it is entirely separate from you.

As you surmise, there is no way to avoid the deemed gain on transferring it out of the Federal corporate structure, into a pass through structure.

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Agreed with @Kory Reynolds’s points, great stuff here.

Joseph - I’d advise your CPA take a look at IRC 301(b) and its corresponding regs. This is reiterated in Subchapter S via IRC 1368(a). They can also dive in to IRC 311(b) and 1371(a). All very important stuff, and areas of scrutiny.

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Quote from @Joseph Skoler:

Thank you so much!

I can’t say I fully understand the issues of basis but it is clear that it would be better in multiple ways if the property were held by an llc.

Does this article about migrating assets from a corp to an llc apply here:

https://bbcincorp.com/offshore/articles/convert-c-corp-to-ll...

Not entirely. LLC is not an "entity structure", it's a legal structure. An LLC can be taxed as a Partnership, S Corp or C Corp. The mentioned issue is *a tax issue*.

Distributing assets from Subchapter C to Subchapter K, or in your case Subchapter S to Subchapter K is what will cause the gain recognition event upon distributing of said assets from the corporation.

Notice that the article doesn’t cover asset distributions (only the exchanging of stock).

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Quote from @Jason Watson:

All good advice. You are stuck. Basically any distribution of assets to the shareholders is done at fair market value. #1 reason we don't put appreciating assets in S Corps. #2 reason is that rentals already bypass self-employment taxes (usually) which is the primary benefit of an S Corp (reduce SE tax plus PTET possibility).

There is zero harm leaving it in the S Corp just don't revoke your election.

Great comment ^ would agree with everything here.

The only potential problem you might have would be if you ever want to bring on other investors / partners down the road.

You are FAR less likely to market real estate well (from an investor’s perspective) because:

1. they won’t be able to get a step up in basis on the assets, meaning no extra depreciation to them!

2. they won’t get debt basis! More likely to run afoul loss suspension rules if they are leveraged.

3. when you pass, the beneficiaries would get a “step up on the stock”, not the assets. Now, that might be moot as they can always dissolve the entity and distribute the property in the year they inherit this, but it will be imperative for the beneficiaries to understand THEY NEED TO DO SOMETHING, or else you’re simply giving them the same problem if they do nothing.

To reinforce @Jason Watson’s comment: corporations are downright unpleasant for appreciating long-term assets.

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Quote from @Joseph Skoler:

Quote from @Andrew Abeyta:

To your last question, that will depend on if you believe the property will continue appreciating.

If you deal with it today, the "gain" is on today's value. If you wait to do this in 10 years (at which point you've likely depreciated it to nothing and it has a higher FMV), you can expect the same *type* of problem with perhaps 2-3x the tax bill of doing it today.

BEST TIMING:

1. Ideally, if you *have* basis in your S-Corporation, you can dissolve it in the same year you distribute, thus you’ll have a cap loss to help alleviate the cap gain.

Gain likely won’t be mainly ordinary if the bulk of depreciation is on the 27.5 year or 39 year lives. You’re likely dealing with a mix of 1250 unrecap and 1231 gain.

2. If you’re a passive owner in this S-Corp and have PAL’s, the above will potentially free these up

3. Do this on a down year where values have dropped for whatever reason (we might be in that environment right now given interest rates).

4. If you have loss-position assets (ie stocks, bonds, etc..) talk to your CPA to see if the year of deemed sale will be a good time to sell the other assets and thus harvest the losses.

I'm sorry I'm being slow.

Here is what I don't understand: Isn't it true that whether the property is owned by a s-corp, or a SMLLC, or in my personal name, I would owe the same capital gains on the sale of the property?

If so, what is the benefit of moving it out of the s-corp?

I have not taken any depreciation on this property.

It was held in this corp since 1967 and the tax returns show a "land" value of $15,000, carried over for many years. It has several small homes on it and has a much higher value.

Tax returns (1120s) show a stock (and debt) basis of $0.

Thank you.

No worries! On the *sale*, yes, that’s true. But in an S-Corp, if you simply *transfer* it to another entity that you own (like a SMLLC), the IRS will treat that transfer as if you sold it to yourself.

This is the disconnect.

If you originally held the property in a SMLLC, or a partnership, and transferred it to another SMLLC or partnership (IRC 721), there would be no deemed sale (all else being equal. There may be instances of gain to recognize if it’s deemed a disguised sale, but for simplicity sake, the assumption is this is just a straight transfer)

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Quote from @Viviana Nicolosi:

Hi all! I'll try to keep this short. We have had an STR for just under one year, but we have not qualified (per our accountant) for the STR loophole so we have not cost-seg'd it. I keep hearing how people are cost segregating, but I have pushed my accountant numerous times on this and he just saying that if we did the cost seg, all of that depreciation would just go into a reserve that would then be applied when we sell the home. His stance is that there would be no point as any depreciation would just be carried forward to future years. I think I have figured out why we do not qualify for the STR loophole and why my accountant keeps saying we would not get any money back if we front-end depreciated the home: I have a property management company in place. Now, that is why I am here on BP to ask you all the following: I am getting rid of my current PM at the end of May (in just a few weeks) and I will be hosting the home with a co-host who will act as my new "property manager". Since I will now be the host on Airbnb, does this count as materially participating and can I finally take the STR loophole? Has anyone else done this where they were the host with a co-host who oversaw the property, but they were still able to cost-seg and take the loophole? What am I missing here?? Thank you!

The easiest metrics to hit will be the ones other CPAs have mentioned:

- Spend more than 500 hours on the short-term rental business.

- Do substantially everything for the short-term rental business.

- Spend more than 100 hours on the activity, with no other individual surpassing your time commitment.

The third is the easiest to hit.. Hit #3, get the green light from your CPA, and cost seg away! NOTE - the STR loophole will end up hurting more than helping if you hold this property for many years after cost segging. You're likely going to be on the hook for S/E income on it once be depreciation and losses have been exhausted, so, just be cognizant of the overall picture!

- RE CPA in CA

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Quote from @Joseph Skoler:

Quote from @Kory Reynolds:

The answer...you can't.

Removing any appreciated property from an S-Corporation triggers a deemed gain on those assets by the S-Corporation (hence also by you) - it's as though you sold it at fair market value, so you get the joy of paying the taxes on the appreciation while receiving no cash. The other joy you can have is that if you have a very low basis in your S-Corporation given it was previously a C-Corp for decades, you could end up up with a distribution in excess of your stock basis, thus triggering a gain there as well. The icing on top of these joys - to the extent the property is depreciable in the hands of the recipient - it is an ORDINARY gain, and not a capital gain. Even better...you can't take bonus depreciation on your newly acquired asset to help offset gain since it was acquired from a related party.

There is a way to effectively transfer out the future appreciation, but your historical appreciation is stuck in the Corporation - you can't get that out without triggering that gain. Still depending on your estate planning, going through these jumps to save your historical appreciation (thus also a step up in the real estate upon death) could be worth it.

Thank you so very much for the clarification. I can't say I fully understand, but I certainly get the main point: Transferring the asset out of the S-corp will be a (capital) gain triggering event.

I think (because I don't remember exactly) that in 2017 I changed the election of the corp from C to S in order avoid double taxation in the case of selling the property. But I'm not clear on how that would have been.

I have no intention of selling this property anytime soon (or even in my lifetime).

But, I don't understand why and how I would benefit from moving it out of the S-corp now? Wouldn't the same capital gains tax liability exist if I kept the property in the s-corp and sold it in 10 years vs. moving it out of the s-corp (into my personal name or an LLC) and selling it in 10 years?

Thank you.

To your last question, that will depend on if you believe the property will continue appreciating.

BEST TIMING:

1. Ideally, if you *have* basis in your S-Corporation, you can dissolve it in the same year you distribute, thus you’ll have a cap loss to help alleviate the cap gain.

Gain likely won’t be mainly ordinary if the bulk of depreciation is on the 27.5 year or 39 year lives. You’re likely dealing with a mix of 1250 unrecap and 1231 gain.

2. If you’re a passive owner in this S-Corp and have PAL’s, the above will potentially free these up

3. Do this on a down year where values have dropped for whatever reason (we might be in that environment right now given interest rates).

4. If you have loss-position assets (ie stocks, bonds, etc..) talk to your CPA to see if the year of deemed sale will be a good time to sell the other assets and thus harvest the losses.

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Quote from @Nathan Gesner:

Quote from @Joseph Skoler:

I have a piece of real estate owned by an s-corp (of which I am the sole shareholder).

It has appreciated substantially in the decades that I've owned it.

I would like to transfer it to an LLC (of which I would be the sole member).

But, I want to make sure I don't trigger the recognition of a capital gain.

How can I do that?

Thank you!

If you still have a mortgage, contact the lender to ensure the transfer will not trigger a "due on sale" clause. It almost never happens, but it is worth asking.

Beyond that, all you need to do is record a new deed. Visit your county office and explain what you want to do. They should be able to provide you with instructions for creating a Quit Claim Deed, transferring the property from one entity to another. Because there is no "sale" or transfer of funds, there will be no capital gains.

Unfortunately this wouldn’t work! Else you’d have everyone using S-Corps with real estate holdings and paying themselves salaries.

Corporations are TERRIBLE for appreciating assets (ie real estatate), because deeding the property out of the corp would be a deemed sale for corporate tax law purposes. You would need an appraisal, or some sort of FMV as of the date of transfer, which would essentially be your proceeds.

Please don’t make the same mistake twice!! Make sure you leave that new LLC as a disregarded entity, or if you bring investors on with you, make sure it’s taxed as a partnership (subject to Subchapter K).

The only way to mitigate cap gains would be if the property appraised very close to its net tax basis.

The other strategy at your disposal is to dissolve the S-Corp in the same year (though you really need to be in-line with your CPA on this one)… you should have more tax basis post- deemed sale, and that basis would help you achieve a capital loss on dissolution of your corporation.

Talk to your CPA my friend!!

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Quote from @Aden Brust:

@Bill B. Okay that makes sense thank you. I just want to make sure I understand correctly, so even though she will be receiving a lump sum in 3 years from the balloon payment (it is an investment property she's selling me, not primary residence), she can't 1031 that because technically when she sold it to me today she became the bank and no longer owns the property, so basically the lump sum paid to her at the end, is the same as a bank making money and therefore taxed as income tax? Or would it still be capital gains tax because it is proceeds from that property? I totally understand if you can't answer this, as these may be questions for my cpa who I am calling tomorrow! Thanks for the response!

You absolutely can use an installment sale in conjunction with a 1031 exchange... though I’m not sure if this is the answer to the current predicament.. we handle these all the time, especially on straddled year 1031 exchanges.

- REI CPA

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All Forum Posts by: Andrew Abeyta

Andrew Abeyta has started 1 posts and replied 26 times.

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