(whose idea was this, anyway?)
For tax year 2013, the most recent reporting year, there were a little over 4.25 million S Corporation tax returns filed. This form of business ownership still seems to be the most popular, though the Limited Liability Company is coming on strong with about 2.2 million currently filing tax returns. The clear reason for the popularity of the S Corp business form is the tax structure, or, rather, the lack of one. Removing tax at the corporate level is especially appealing to the owners of closely held businesses for many reasons. With the tax benefits delivered to S Corporations come a number of restrictions: S Corps are limited to no more than 100 shareholders all of whom must be U. S. citizens or resident aliens; there must be only one class of stock; normal corporate record keeping must take place; and, most importantly, S Corps are really not suitable for holding assets that may appreciate.
The last statement is the one on which to focus. I receive any number of calls a year that involve an S Corp that own highly appreciated, low basis real estate as its major asset. Of course, the question is either, “how do we get this out without paying tax?” or “can we donate our shares to a Charitable Remainder Trust or Pooled Income Fund and then sell the property (or the shares?” Beside wanting to shoot the accountant or attorney who created the structure, I usually just throw my hands up in frustration.
There are a few solutions, but they’re complicated and imperfect. Most clients settle for paying the tax or undertaking some post sale mitigation strategies. One strategy involves having the S Corp form an LLC and transfer the property into the LLC, then contribute the LLC interests to either the PIF or a term of tears CRT. Or, using the same structure and having the units sold to a PPLI policy for a long term, interest only note. This still doesn’t get the low basis asset “out” of the S Corp but it may ease or delay tax. Of course, the S Corp has to stick around and function for a long time since a liquidation could cause recognition of gain.
In a perfect world, no one would ever use an S Corp to hold real estate ever again. Alas, that’s not the case. What is needed are creative ideas for S Corps that own appreciated assets that we wished they didn’t own.
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