Does This Real Estate Return Need to be Amended? | USTaxAid

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Does This Real Estate Return Need to be Amended?

Written by Diane Kennedy, CPA on November 11, 2022

I received this question at USTaxAid recently. If you have a tax question, here are some ways to Get Your Tax Answer.

This is the question:

I have client that owns investment real estate; some he owns personally, and some in joint ventures. But all the properties are reported on an s corp tax return that client owns, but s corp does not have title to any of the properties. Need help unpacking this situation. Since the s corp does not own any of the properties I don’t think the assets should be on s corp books and claiming depreciation. But I don’t know how to remedy this issue.

Answer:

There are a couple of ways to approach this problem. I’d first want to look at whether the S Corporation is the best structure for the real estate. Generally, speaking I don’t like putting appreciating assets inside a corporation. In an S Corporation, you have an issue if you ever need to move the assets outside the S Corporation.

As an example, say you and your friend, Fred, start an S Corporation to buy properties. Ten years down the road, you decide to split up the assets and go your own way. Now we have a problem. In order to distribute out the assets, you need to do this at fair market value. That means that you and Fred will have to pay tax as if you had sold the assets.

The first issue with holding real estate inside an S Corporation is that you get locked into a structure that may not work for you in the future.

Secondly, your heirs won’t inherit step up basis on the real estate held inside the S Corporation. They will get a step-up basis in the shares, but they lose that benefit for the properties if there is an S Corporation holding the assets.

If this is a fairly new situation and the statute of limitations has not yet run, it may be better to file amendments for the past years. It will mean an S Corporation amendment and one or more individual tax return amendments. You can then report the real estate with the proper owners of record. You may want to move them into single member LLCs or multi member LLCs, as appropriate. Just be aware that some states don’t give good asset protection for single member LLCs.

How much asset protection will a single member LLC really give you?

Otherwise, you may want to say that the S Corporation actually had the rights of ownership of the properties by doing a seller wrap sale. In a wrap, the buyer’s name doesn’t go on the title and instead their rights are contractual. The seller continues to hold title.

I think the first step is figure out what the best answer would be and see what options you have for your client, based on how long this has been reported.

This is going to take some work!

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