Business Real Estate: Who Should Own It?

If I wrote a bible of taxation, the first commandment would be, "thou shalt not put real estate into a corporation."

At least a dozen times a year, readers of this column ask us to do a tax consultation (usually for transfer/succession/estate planning), and we find business real estate in a separate "C" corporation (sometimes in an "S" corporation) and leased to the operating corporation. Often, the real estate is owned by the operating corporation. This is a tax disaster waiting to happen.

Someday, when you try to get the real estate (invariably, depreciated down to a low tax basis and appreciated in value) out of the corporation, you will run into a double tax. The first tax will hit the corporation when the real estate is sold (or transferred to the stockholders). The problem is that the sales proceeds are stuck inside the corporation, and you can only get at those proceeds via a dividend or a corporate liquidation. Both are subject to a second tax. A transfer of the property to the stockholders also triggers a double tax.

So what's the answer? Imagine a business owner, Joe, who is married to Mary. Joe should put the title in his name at the time the real estate is purchased. Here are some of the tax goodies that may come Joe's way over time:

1. When Joe retires, the rent he collects is not subject to Social Security tax (or other payroll taxes), nor does the rental income interfere with his Social Security benefits.
2. Joe can borrow (tax-free) against the property if he needs cash.
3. A sale of the property is subject to only one capital gains tax. Joe can report on the installment method if he takes back a mortgage for a portion of the purchase price.
4. When Joe dies, his heirs get a raised basis. Say Joe bought the property 25 years ago for $100,000, and it has fully depreciated to $20,000 (the cost of the land). The value of the property on his date of death is $620,000. The built-in $600,000 of profit escapes income tax forever. And Mary now owns the real estate (free of income and estate taxes) with a new tax basis of $620,000, just as if she had bought the property for that price. She can depreciate the property (except for the value of the land using her new $620,000 tax basis, which will shelter her rental income).
5. The property can be put into a Family Limited Partnership (FLIP), which has many tax and non-tax benefits. For example, a $1 million piece of real estate transferred to a tax FLIP can receive a discount of about $350,000 for estate tax purposes. The estate tax savings could be as high as $192,000.

When Mary dies, the law allows her to repeat the raised-tax-basis trick all over again when she leaves the property to her kids.

Now you know why owning real estate in a corporation is not only a tax trap, but it also prevents you from reaping a tax harvest during your life, after your death and beyond.

Want to learn more tax tricks that will save you a bundle? Read our special reports. Write to: Book Division, Blackman Kallick Bartelstein LLP, 10 South Riverside Plaza, Suite 900, Chicago, Illinois 60606.