Tax implications of transfer of property into LLC or Scorp
I've been pondering the possibility of transferring a
rental property I own into an LLC or S-corp.
Presumably this has tax consequences for me on a
personal level and for the entity which receives the
property.
What makes this somewhat interesting is that this roperty
was my personal residence until a couple years ago.
So what I'm trying to figure out is whether or not there's
an angle where I can use the tax excemption for sale
or disposition of my personal residence to avoid taxes
on the transfer and get a step-up on the basis for the
entity receiving the property.
The only mortgage on the property is a HELOC which
I could easily pay off if the bank required it. Though
keeping the HELOC in place would be nice since the
HELOC provides me with easy access to capital.
JeffLaw,
You get high marks for creative thinking, but this strategy just won't pass muster with the IRS.
A single-member LLC and a S-Corporation are both "pass through" entities. As such, if you "sell" your personally owned real estate to either entity, you are really selling to yourself. Since you will still retain beneficial ownership, the IRS does not recognize this as a taxable event.
IIRC: once one has converted personal residence to rental the game is up. There may be a time element here and you don't want to waste your $125k one time exemption if you haven't used it already so talk to your tax expert, not sure, its been awhile.
Why is the transfer being made?
That is the most important question.
The irs considers this a none taxable transfer and that is a good thing.
If serious asset protection is the goal one should transfer assets, no tax due, to LLC, FLPs. This should not incure an income tax. IMHO the LLCs FLPs must have other members and these other members must contribute an asset or assets of value on par with the shares they receive in order for the courts to honor the entity.
Example: You contribute $95K asset. Ltd partner/s contribute $5k asset.
You get 95% share and Ltds 5% share.
The existence of a fully invested ltd partner/ member (not you) is the basis for asset protection using these entities,
not the anonymity that land trusts etc. provide. Anonymity only goes so far.
I should have used the term "contibute". If you actually "sell" for cash or anything other than a par value share there will most likely be tax consequences.
Also, there can be no assumption of debt by the LLC or other. This would be debt relief and taxable.
Hi! Section 121 of the IRC allows the sale of a rental that was your personal residence for 2 of the last 5 years with no tax up to $250 for single and $500K married. In the event your house meets that criteria, you can sell at full market value to Corp and establish new basis I think. You reallize a gain, but there is no tax on gain. Your S corp will depreciate house and flow thru to your tax return personally. I would have a closing with a HUD-1 statement and have the corporation actually purchase the property for tax purposes (carry a note with interest, pay cash to corp, exchange something). With all I's dotted, should pass muster.
> On 2003-02-19 12:46, rse2 wrote:
I> IRC: once one has converted personal residence to
> rental the game is up. There may be a time element
> here and you don't want to waste your $125k one
> time exemption if you haven't used it already so talk
> to your tax expert, not sure, its been awhile.
You're mistaken. First, you qualify if you owned and
occupied a home as your principal residence for
at least two years during the five year period ending
on the date of sale. I meet the ownership and
occupancy test for another 4 months <IMG SRC="images/forum/smilies/icon_smile.gif">
Second, it's not a one time exception. If you meet the
ownership & use tests, then you can avoid taxes on
the gains as long as the sales are at least two years
apart.
Third, the excludable gains are 250000 for single
taxpayers and 500000 for married, filing jointly
taxpayers.
> Why is the transfer being made? That is the most
> important question.
The only reason I'm considering the transfer at this
time would be to shelter gains on the house. By
selling the house to the LLC at market value, I
can shelter all gains I've had on the property to-date.
Plus, the LLC's gets the stepped-up basis for
the property.
I'll have to do some research on the "pass-thru"
entity issue someone else brought up.
Jeff[ Edited by JeffLaw on Date 02/19/2003 ]
Damm, you guys are killing me.
I was following everything and then it seened everyone started talking french or something.
I'm in so.fl, can anyone guide me to a real R.E. accoutant/tax attorney in the area. Really I'll drive anywhere in the state if he's good. ( and taking on new clients )
The guy Im using is nice, I dont need nice I need a Bulldog.
thanks,
Jason
Too right. You clearly understand the time elements and the reasoning behind a sale as opposed to contribution. That is why the why is so important.
Other advice on sale issues seems correct. It's always a good idea to have a CPA walk this kind of thing though. If you respect the sale terms and they are verifiable by uncle you shouldn't have any trouble.
Jefflaw:
Single owner LLCs and trusts are problimatid.
This is a whole nuther seminar but;
LLCs IMHO must have at least one other party involved. The "innocent" member/share holder creates a seperate entity out of the LLC.
Just because one can create a LLC with only one party doesn't mean that the LLC will do you much good.
As other's have said : one party, no transfer = sham. Uncle, plaintiffs and the courts will go through them like a hot knife.
However LLCs with more members all of whom have contributed value to receive their shares, well that is a whole different story with genreally different results for the good guys.
BTW: Jefflaw? Attorney perhaps?
BTW2: why not just sell the thing if it will be tax free?
Quote:
On 2003-02-23 19:30, rse2 wrote:
Jefflaw:
BTW: Jefflaw? Attorney perhaps?
BTW2: why not just sell the thing if it will be tax free?
I'm not an attorney, nor is anyone in my family. I just
happen to have the last name "Law".
I have no need to sell the house right now. It rents
easy and provides good cash flow. I'll sell if/when
I have trouble renting the house or maintenance
costs are consistently overrunning their budget.
Basically there's no need/reason to sell the house
at this time, especially into a buyer's market. The
tsell/ransfer to LLC/Scorp would have been strictly
a means to lower the tax burden in the long term.
Jeff
Well good luck.
Remember there are lots of properties out there. If you can sell this one for tax free cash could you go make some killings or what.
Don't be too much in love with a piece of property. Think of the possibilities with all that cash and all you know!!! You did say it is a buyer's market. Be a buyer.[ Edited by rse2 on Date 02/25/2003 ]
I've got an HELOC on the property that gives me
instant access to most of my equity. I've also
got sufficient cash available to acquire other
properties as they become available.
I'm in love with the property in the sense that it provides
good cash flow, it's easy to rent and having lived in it,
I'm aware of the ongoing and longer term maintenance
issues that are likely to rear their ugly heads.
If the property ever gets hard to rent, the neighborhood
starts to decline, or the recurring expenses of the
property consistently rise faster than the rents, then
I'll end up selling it -- either conventional mortgage or
seller financing.
Jeff
Jeff
JeffLaw,
. You have to remember that entities are generally treated as separate taxpayers (except for a domestic LLC that is 100% owned by another corporation, individual, etc. AND an election to be taxed as a corporation is not made under the "check-the-box" rules). A contribution to the entity is an "exchange" under the Code and it is generally taxable to the seller unless a specific Code Section says it is not. A contribution to a S corporation falls under Section 351 of the Code and is generally non-taxable provided the requirements of that Section are met. However, you have to watch out if you have debt on the property that is more than your basis in the property. In that case the contribution could be taxable. Also, a contribution to a LLC could be treated as a transfer to yourself (if you own 100% of the LLC) and is generally disregarded for tax purposes. However, if there are two persons owning the LLC (or you are married and you live in a community property state such as TX, CA, etc. and have not made an affirmative election that the LLC is your separate marital property instead of community property), the domestic LLC will be generally taxed as as a partnership. While the contribution may still be non-taxable, there are circumstances where the transfer will be taxable (e.g., you get cash back from other partner -- this is known as a disguised sale).
Wow! I have reviewed the previous posts and although the advice is well intentioned and some of it may be correct, I would be hestitant to follow it. This is an area you need competent tax advice, whether it be from a CPA or tax attorney. The last thing you want to have happen is the IRS audit you, disallow your $250,000 (or $500,000) exclusion from capital gains because you did not comply the tax law, and get slapped with a 20% substantial understatement penalty.
1. LLCs and S corporations are not taxed the same way under the Internal Revenue Code ("Code"
2. There are new regulations issued that deal with a sale of a principal residence to a related party (since you own more than 50% of the entity, you need to watch out about the related party rules).
3. One person said that an LLC and an S corporation are considered disregarded entities by the IRS. This is only partly true. The tax law says that a 100% domestically formed LLC is disregarded for tax purposes, meaning the owner of the entity is considered to be the owner of the real estate for federal tax purposes (but not for state law (e.g., liability) purposes). An S corporation is almost always considered a separate entity by the tax code and is not a "disregarded entity" although it is a flow-through entity because only the shareholders pay any tax.
4. Your strategy might not be considered a "sham transaction" as one poster suggested, although that should be a concern. A sham transaction under tax law is one that has no purpose other than tax avoidance. The fact that you use an S corporation does not make it a sham though, because you could have business purposes for the transfer apart from tax savings. However, this is an issue you should discuss with your tax advisor.
5. Rarely should you transfer real estate to a corporation (whether it is a S or C corporation). The reason? It is extremely difficult to get the real estate out of the corporation tax-free (e.g., a distribution of the real estate to you as a shareholder is generally a taxable transaction). The same is not true for an LLC. The LLC is my entity of choice for holding most real estate.
5. I do have to commend you though on your ingenuity and creative thinking. That is how a good tax lawyer thinks up good tax strategies (but the tax lawyer will generally do some tax research, including case law research whether you have a filing position for the strategy). I am glad that you did not ask whether you should hold the real estate in an LLC, S corporation or a land trust.
Land trusts are nearly worthless. They don't save you any taxes and are worthless in most states for asset protection purposes. The state's trust law governs what a court will do with property a creditor is after, while the state's LLC or corporate law will govern when the real estate is held by an LLC or corporation (respectively). Under corporate and LLC law in most states, a personal creditor of a shareholder must "pierce the corporate veil" to get a judgment directly against the real estate. However, in most states, by state statute the personal creditor of a member of an LLC can only obtain a charge order against the member's LLC interest. That is usually the exclusive remedy in most states. A charge order means the creditor is only entitled to distributions made from the LLC to the member when the managing member (or board of governors) declares a distribution. Until that happens, the creditor can get nothing. Since a charge order is usually the exclusive remedy, the creditor cannot foreclose on the real estate in satisfaction of a judgment. However, it may be necessary to have more than one member of the LLC for this strategy to work.
6. You should also look at a state tax effect on the transfer. For example, if you are a resident of TX and transfer a rental property to a corporation or an LLC, the rent will generally be subject to two levels of tax since TX imposes a corporate franchise tax on these entities. In contrast, since TX does not impose a tax on individuals, the transfer to the LLC or corporation would increase your state tax liability. Not a desirable result! In that case, a limited partnership (or a limited liability limited partnership) may be the entity structure of choice.
7. As you can see, answering your question is not as easy as you might have thought. If you plan on investing in real estate, I suggest you find a good CPA or tax attorney to give you advice. The fees they charge you are peanuts compared to the tax liability you could have by doing it alone, or worse yet, following the advice of a real estate investor that is unknowledgeable in the tax law. For example, if the transaction you suggested was challenged by the IRS and you had excluded $500,000 of capital gain (b/c you are married), the IRS will likely assess you a tax of $100,000 (20% capital gains tax rate x $500,000 gain), plus a substantial understatement penalty of $20,000, plus interest from the date of filing of the tax return. That amount can be a shock to the system, especially when you consider you did not receive any case in the deal! On top of that you will have to hire a tax attorney or CPA to represent you in an IRS audit or IRS appeals, or hire a tax attorney to represent you in court to sue the IRS. Add another $20,000 to $30,000 (or more) in CPA or legal expenses and you can see why it is a good idea to talk to your tax advisor.
8. By the way, I am a tax attorney (with 2 LL.M.s in tax law, one from NYU's tax law program) but also a real estate investor. While I could easily evaluate the tax consequences of my own deals, I almost always consult with my CPA and possibly other tax attorneys I know if there is some complication to the transaction. It is always good to get another tax knowledgeable person's view to prevent a myopic view. I learned the hard way when I first started investing, without fully considering the "what ifs" thoroughly. Early in my investing career, even though I was knowledgeable in legal and tax issues, I was emotionally attached to the deal and therefore did not see some of the bad things that could go wrong or did not fully consider some of the negative aspects of the deal.
I hope that helps,
Taxjunkie
Taxjunki
I also am in a similar situation.
Will be renting property currently in my name. I have been advised to transfer title to CORPORATION of some kind as asset protection prior to rental status.
Generally what would you advise to use for asset protection and not cause a undesireable tax event at the same time.
I will be tackeling this issue within next few weeks. Also acquiring other properties in near future and managing as rentals. Any recomendations on what path is lined with the least troubles and best tax treatment .
Vestor
As I indicated in my post above and many others, I rarely recommend my clients take title to real estate in the name of a corporation, whether or not it is an S corp or a C corp for tax purposes.
An LLC is my preferred entity, as it has many ***et protection features and you can usually get the property back out tax-free in the future. Talk to your attorney about your creditors right to charge orders against your LLC interest and the number of members of the LLC to reduce the risk that the court will not disregard the entity. However, before making the transfer, you need to check the laws in your state on "fraudulent conveyances."
This is an area I see too many people try to do it on their own and when they get hit by a lawsuit or a creditor is attempting to put a lien on their ***ets, they find out they should have hired an attorney to set up the structuring correctly in the first place, as their "do it yourself" ***et protection kit they bought in some course was wholly inadequate.
By the way, a corporation by itself is not much of an ***et protection vehicle. If you think it is, I hope one of your creditors is not one of my clients because I will pierce through it as easily as going through a wet paper bag.
Being bulletproof depends not only on the "armour" you are wearing, but knowing who is "shooting" at you, what type of "ammunition" they are using, and from which "direction" they are firing.
Taxjunkie
<I failed to refinance my primary residence with the current low interest rate because my current mortgage has prepayment penalty. However, the penalty will be waived if the loan is paid off through a sale of the house. Can I sell my primary residence to an L.L.C., which owned by me and my spouse, then we pay rent to the L.L.C.? Any suggestions or thoughts? Thanks![ Edited by dwthesis on Date 06/03/2003 ]
I have read the above posts and some of it applies to me. I have a small number of rental properties in my name. I am considering forming an LLC with my spouse purely for operating the rental business and holding ownership to the rental properties. The main reason is the hope of insulating my personal assets if all goes wrong. My props are in NY state. I recently paid off all mortgages to try and make the transfer easier (took out equity on my own home). Any thoughts?[ Edited by spookendoodle on Date 06/06/2003 ]
Taxjunkie - Everyone,
This is what is best about this type of forum! The free exchange of information and advice.
It is posts like Taxjunkies that make me keep coming back to these forums. His several paragraphs have more concise information in them than in several of the REI books that I have read!
In the end you have to get all the information you can and then make your decision - If I were in these two individuals situations, I would be finding a hard charging REI smart attorney and CPA. This forum is a great sounding board, but if you make your heavy duty decisions based soley on the advice given here - watch out.
We should buy Taxjunkie a good lunch for this time/advice.
Stormy
I double checked with the IRS about my previous question. After several calls, I finally reached one of their "advanced" tax advocates. He simply told me that I cannot sell our property to our own company because that will invoke "auditing" from IRS. The reason he gave me is because the ownership does not change at all from our personal names to a company which we own 100% so it is too fishy. However, he provided some options: "transfer" the property to the LLC instead of "selling" to the LLC, or use the rule 1031 to defer the tax temporarily.
Hope this information-sharing helps your situation!