Brian Borawski CPA, PC

Archive for the ‘Capital Losses’ Category

Many people feel that the two absolutes in life are death and taxes.  In my experience, if there’s something that comes to close to a third absolute it’s that you should never hold real estate within a structure that’s taxed as a corporation.  I can give you some examples of where it works out okay but still not as well as under a structure taxed as a partnership but I can give you a few different examples of where you can have some disastrous tax circumstances when holding real estate in a corporation.  The primary pair of reasons are basis rules and distribution rules.  As always, I’m keeping this simple so if you have a specific situation that applies to you, be sure to contact a professional.

Let’s say you get a great deal on a property.  You’re able to buy a $1 million piece of property for $500,000 and because of the great purchase price, you’re able to finance the entire $500,000 with  a bank loan.  Let’s take a look at what happens in two years when you try to distribute this piece of property out of your legal entity.

If you bought the property under an LLC that’s taxed as a partnership, you’d be in pretty good shape.  You’d probably (it would depend on the bank note) be able to pass through any losses from the partnership because your debt has given you basis.  In two years, if you distribute the property out of the LLC, it’s a tax free transaction and the property would come through with its basis and carrying period intact.

If you bought the property under a C-Corporation, you’d have a mess.  When you distribute property, it’s the same as if you sold it then distributed the proceeds so you’d have about a $500,000 gain that the C-Corporation would have to pay (plus any depreciation that you took in those two years).  On top of that, the distribution would be taxable to the shareholder at the value of the property or in this case, $1,000,000.  Those two layers of tax that will chew into that $500,000 in savings you picked up when you bought the property pretty quickly.

While not as bad as the C-Corporation example, if you had put it under a corporation that had made a Subchapter S election, you’d still have some tax to pay.  You wouldn’t have any basis in the corporation because the debt from the bank note isn’t eligible as basis.  You’d have the capital gains hit that would occur at the S-Corporation level (which would ultimately flow through to the owner’s personal return) but not the second layer of tax because the dividend would come through half tax free and half as a taxable S-Corp distribution because you’ve established some basis when the capital gain was taxed but not enough to cover the entire $1 million.

In short, putting into an LLC is pretty much a no lose situation.  Putting into a corporate structure, you could have a tax mess on your hands.  Be sure to discuss your personal situation with you tax adviser.

This is a twist on my New Forms series because while Schedule D (the form where you report capital gains) has changed, they’ve also modified Form 1099-B as well as added a new form.  First off, just by looking at the new Schedule D, you notice the form has changed quite a bit and there’s several references to a Form 8949.  No longer do you report the detail of the your capital gains and losses on Schedule D but you do it on Form 8949 and this information then flows into the more streamlined Schedule D.

And then this all ties into the revised Form 1099-B.  Now brokerage firms are required to report cost basis.  This is just one more way the IRS is cracking down on things.  Before, this information wasn’t reported to the IRS and it was left up to you to compute.  Since the IRS isn’t very trusting these days, cost basis is now being reported to the IRS so they can make sure you’re reporting the full extent of your gain.  On a good note, since everything is right there on the Form 1099-B, it’ll make filling out the form a little easier because you just drop the appropriate numbers into the right boxes.