All Forum Posts by: Joseph Skoler

I agree fully with Andrew.

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.

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).

 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.

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.