Real estate tax strategies for businesses
In working with our C corporation (C corp) clients, we often recommend that real estate be held outside of the C Corp for tax savings opportunities. The following presents an overview of the benefits of holding real estate assets in a Limited Liability Company (LLC) rather than in a C Corp.
- The LLC provides the same liability protection as a C Corp.
- When real estate is sold by a C Corp, the gain on the sale will be subject to double taxation – once at the C Corp level and then again when the after-tax proceeds are distributed to the stockholders. Gain on the sale of real estate owned by an LLC is only subject to one level of tax when the gain passes through to the members.
- A C Corp may be subject to less favorable tax rate when paying tax on the gain from the sale of real estate. The gain is taxed at the full C Corp tax rate which was 35% prior to the 2017 Tax cuts and Jobs Act (TCJA). While the current C Corp rate is 21%, there is draft legislation proposing to increase the rate to as high as 28%. Gains from the sale of real estate by an LLC are generally taxed at favorite capital gains rates of 15%, 20%, or 25%, assuming the gain qualifies for long-term capital gain treatment.
- C Corp distributions to stockholders of the after-tax proceeds from a sale of real estate are also subject to the 3.8% Net Investment Income Tax. This is not always the case with the sale of real estate by LLCs, depending on whether a member is passive or nonpassive in the LLC.
- If the real estate is refinanced, the distribution of the refinance proceeds to the shareholders of the C Corp are usually subject to tax. In most cases the distribution of refinancing proceeds to the members of an LLC can be done on a tax deferred basis.
- The tax structure of LLCs is more flexible than that of a C Corp, which is critical for owning real estate due to the ever-evolving landscape of deal structures and tax regulations.
- Distributing real estate out of a C Corp is a taxable event and is usually subject to double taxation. An LLC can distribute real estate out to its member on a tax deferred basis.
- Owning real estate in a C Corp can complicate the sale of the business. In today’s markets, many buyers of businesses want to acquire the operating business and not the real estate. Instead, they would prefer to lease the real estate back from the owners. As mentioned above, the distribution of the real estate out of the C Corp to the shareholders prior to a sale is a taxable event subject to double taxation. If the C Corp sells the business but retains the real estate, the same double taxation issues would exist. In addition, certain penalty taxes such as the personal holding company tax could apply. As a result, owning the real estate in an LLC outside of the C Corp can help facilitate the sale of the business and produce higher after-tax proceeds.
- There is also an estate planning advantage to owning real estate in an LLC under current tax law. If a stockholder of a C Corp dies and the C Corp owns real estate, there is no step up in tax basis for the real estate owned by the C Corp even though the C Corp stock was included in the estate of the C Corp stockholder. The step up in basis is attributed to the C Corp stock itself, often trapping the benefit until far down the road when the C Corp is liquidated or the stock is sold. On the other hand, if a member of an LLC dies holding an interest in an LLC that owns real estate, under current partnership tax rules, the LLC has the ability to step up the tax basis of the assets in the LLC to the fair market value of the LLC included in the LLC member’s estate. This step up in basis results in higher depreciation deductions and/or reduced gain on sale for the portion of the LLC owned by the member’s estate or their heirs.
S Corp real estate ownership considerations
Even though S Corps are not subject to double taxation, some of the other pitfalls related to ownership of real estate by a corporation still apply.
A transfer of the real estate out of the corporation to its stockholders is a taxable transaction. If an S Corp refinances the real estate, the corporation may not be able to distribute the proceeds on a tax deferred basis if the stockholders do not have enough basis to receive the distribution. In addition, the S Corp would not get a step up in basis for the value of real estate owned by the corporation when a stockholder dies. Like C corps, the step up would be trapped in the S Corp stock itself.
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The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.