In matters of taxation, “form” consistently trumps “substance”. In-fact, there is an entire industry of lawyers and specialists dedicated to the study and application of these forms. Like chemists or biologists they analyze the different ways they interact with stimuli (tax laws) and the forces of nature (the IRS) governing them. Much has been learned from these studies and today with the right person’s help, you can avoid many of the arduous taxes which befall the unsuspecting. One of the more clear and poignant lessons learned is also one which many people may find themselves in violation of: Do Not Buy Real Estate as a C-Corporation!
We all learned in business school that c-corporations are taxed twice, once on income received at the corporate entity level and another time on income distributed to shareholders or employees at an individual level. In real estate the same rule applies on its two sources of income, direct income and appreciation. The catch is, if you are a c-corporation, you don’t have to own real estate directly, you can hold title to it in a tax friendly LLC or s-corporation. The advantage of each is that income is only taxed once when it is distributed at the individual level, you skip a whole level of taxation! So if you own a c-corporation and are acquiring any real estate, consult a specialist and ensure you are not taken advantage of by the IRS.
Now, let’s say someone, “Mr. Bowie” for example, owns real estate in a c-corporation and after realizing his folly wishes to transfer it to an s-corporation or LCC. Is there anything he can do? The answer is: YES. The real estate can still be transferred to a more tax friendly entity; however, certain rules apply:
1. As was said before, real estate earns income both directly and through appreciation. The direct income is realized immediately when it is received, and thus in the above example would have already been taxed at the corporate entity level, thus subject to double taxation (translation: there is nothing Mr. Bowie can do about the direct income received while a c-corporation).
We all learned in business school that c-corporations are taxed twice, once on income received at the corporate entity level and another time on income distributed to shareholders or employees at an individual level. In real estate the same rule applies on its two sources of income, direct income and appreciation. The catch is, if you are a c-corporation, you don’t have to own real estate directly, you can hold title to it in a tax friendly LLC or s-corporation. The advantage of each is that income is only taxed once when it is distributed at the individual level, you skip a whole level of taxation! So if you own a c-corporation and are acquiring any real estate, consult a specialist and ensure you are not taken advantage of by the IRS.
Now, let’s say someone, “Mr. Bowie” for example, owns real estate in a c-corporation and after realizing his folly wishes to transfer it to an s-corporation or LCC. Is there anything he can do? The answer is: YES. The real estate can still be transferred to a more tax friendly entity; however, certain rules apply:
1. As was said before, real estate earns income both directly and through appreciation. The direct income is realized immediately when it is received, and thus in the above example would have already been taxed at the corporate entity level, thus subject to double taxation (translation: there is nothing Mr. Bowie can do about the direct income received while a c-corporation).
2. However, the appreciation is another matter. Income from appreciation is only realized at the properties sale and since that has not happened yet, can be avoided. The problem is the IRS has made a rule stating you have to wait 10 years after placing the property in an LLC or s-corporation before you can sell it and avoid the double tax. However, the law has oddly been changed recently; shortening the time period to 7 years but only if the transfer is made in 2009 or 2010. If transferred in either 2009 or 2010 Mr. Bowie would only have to wait 7 years before selling.
What is obvious from all this, is that the form in which you do business is of the most paramount importance. Furthermore, there are people who have spent their whole lives studying these topics and are ready to help those in need. Do not hesitate to contact one of these people or do research on your own, a single call could make a huge difference. Remember, with the IRS you get only one chance to make a good first impression.
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What is obvious from all this, is that the form in which you do business is of the most paramount importance. Furthermore, there are people who have spent their whole lives studying these topics and are ready to help those in need. Do not hesitate to contact one of these people or do research on your own, a single call could make a huge difference. Remember, with the IRS you get only one chance to make a good first impression.
