Real Estate Out Of Your Corporation

If you have real estate in your corporation, raise your hand and keep reading. About once a month someone calls the office asking, "How can I get real estate out of my corporation without being taxed to death?"

Actually, we could write a small book about the various facts and circumstances that impact the process of removing real estate from a corporation. The book would ask many questions, like, Is it a C corporation or an S corporation? Are there retained earnings? How much? How much has the real estate appreciated? Each additional fact might change the tax strategy, so to cover all the possibilities is beyond the scope of this column. Instead, the following example represents the circumstances and solution for more than 95 percent of calls.

Joe owns Success Co., a C corporation with a large amount of retained earnings and one or more pieces of real estate that have significantly appreciated in value. Most of the time the real estate has a building on it, but it could be vacant. If Success Co. is an S corporation, it has a large amount of old C corporation earnings frozen in place and has the same real estate facts.

Here's the easy six step process:

1. Joe forms a family limited partnership (FLIP) outside of Success Co. Then, Success Co. contributes vacant land (if the land is improved, Success keeps the improvements as leasehold improvements) to the FLIP. The land is worth $1 million (of course, it could be any amount). In exchange, Success Co. receives ownership of 99 percent of the FLIP and limited partnership interests. Joe contributes $10,000 in cash to the FLIP for a 1 percent general partnership interest. As the general partner, Joe makes all the decisions.
2. Success Co. leases the real estate from the FLIP for $100,000 per year.
3. An independent appraiser values the FLIP interest (after applying a 40 percent discount for general lack of marketability) at $600,000. Yes, the $1 million land is only worth $600,000—because it is in the FLIP for tax purposes.
4. Success Co. contributes its limited FLIP interests to a charitable lead trust (CLT) with the following terms: The FLIP will pay $99,000 per year to the CLT for eight years. (NOTE: Typically the CLT then makes contributions to Joe's Family Foundation). Let's pause to follow the money. Success pays $100,000 rent to the FLIP and the FLIP pays $99,000 to the CLT, which makes contributions to Joe's Foundation.
5. According to IRS tables, the value of the annuity (the $99,000 to be received for eight years by the CLT) is $569,000. So, the value of the remainder interest (the part of the FLIP still owned by Success Co. immediately after the gift of the FLIP to the CRT) is only $31,000. (The $600,000 discounted value of the land, minus the $569,000 value of the eight-year annuity gifted to the CLT, leaves $31,000 as the value of the remainder interest.) Simply put, Success Co. owns an asset that according to the IRS is worth $31,000. Joe's children buy the $31,000 interest from Success Co.
6. After eight years the CLT ends. Joe's children now own the 99 percent of the limited FLIP interests. The FLIP owns the real estate. The CLT and Success Co. are out of the picture. Better yet, the real estate is out of the corporation. And there is a bonus: The real estate also is out of Joe's estate. The entire transaction is tax-free to the FLIP, the CLT, Success Co. (might owe tax on the $31,000 sale), Joe and the kids.

 This is an easy way to get real estate—tax free—out of a corporation, but you must use experienced advisors who know how to dot the I's and cross the T's.