Avoid Owning Real Estate in a Corp

Tony Nitti, writing for Forbes, wrote a great article earlier this year that clearly explains Why You Should Never Hold Real Estate In A Corporation. Following is a summary of the primary reasons, contrasted with owning real estate in a partnership:

Capital Contributions: If an individual transfers real property to a corporation in exchange for stock, they must own 80% of the vote and value of the corporation immediately after the transfer; otherwise, a gain must be recognized and tax paid on the difference between the individual's basis in the property and the fair market value. In contrast, "appreciated property can be contributed to a partnership in exchange for a partnership interest [as small as a 1%] without triggering any gain."

Contributions of Property Subject to a Mortgage: Even if a contribution of real property to a corporation is otherwise exempt from gain, if the property is subject to a mortgage, "and the corporation assumes that liability as part of the transfer, the transfer triggers gain to the extent the liability exceeds the tax basis of the property." In contrast, it is "much less likely that a partner contributing leveraged property to a partnership will recognize gain" due to the inside and outside basis rules of partnership taxation.

Sale or Distribution: While it is possible to contribute real property to a corporation without being required to pay tax, the same is not true for getting the property out. If appreciated property is distributed from a corporation, "the corporation recognizes gain as if it had sold the property for its fair market value." The same treatment applies if the property is actually sold by the corporation. Furthermore, withdrawing the sales proceeds from a C-Corporation can result in double taxation to the shareholder. In the case of a distribution from an S-Corp, "the distribution will not be taxed a second time at the shareholder level..., [however the shareholder] cannot take the property out of the corporation without incurring a tax bill." In contrast, "when a partnership distributes property to a partner in a current distribution, generally no gain or loss is recognized by either the partnership or the partner;" only basis adjustments are required.

In addition to the problems listed above, owning real estate within a taxable entity other than a partnership can result in loss limitations, lost step-up in basis of the underlying assets upon the death of a shareholder, and lost step-up in basis for the purchaser of an interest in a corporation owning appreciated assets. It is almost always better to own real estate in a partnership or disregarded entity.

Posted in: C-Corp,Income Tax,S-Corp