Implication of Real Estate in a Partnership Vs S-Corporation

Key differences in holding a real estate in a partnership vs an s-corporation (s-corp) is noted when the real estate is sold or inherited, and gain is recognizable or deferrable.

Gain on Sale of business or real estate: In an s-corp when the business along with the real estate is sold, or the real estate asset of the company is sold, or the real estate is distributed to its shareholders in all circumstances a taxable event will be triggered at the s-corp level. In contrast if a real estate held in a partnership is sold in a 1031 exchange or distributed to its partners, it does not trigger a gain on sale at the partnership level or to the partners. The tax is deferred until the sale of the real estate by the individual partners.

Step up basis in an inheritance: Under IRS code for an individual taxpayer or a partner in a partnership the fair value of the real estate property on the date of death becomes the basis of inheritance to the heir(s) and no capital gain on appreciation is recognized. However, if the property is held in an s-corp, the appreciation of the value of the property is attributed to the company’s stocks and does not step up the basis of the property if sold and would trigger a taxable event at the s-corp level. This provides little tax planning option for the heir(s).

Debt Leverage and Shield: It is quite common for real estate owners to obtain a loan when purchasing a real estate property. The leverage helps in higher percentage return when the value of the property appreciates. However, a debt increases the cost basis of the property owned in a partnership but not so in an s-corp. The debt acts as a shield in gain calculation for a partnership as its basis is increased to the extent of the debt, but not so in an s-corp.

Thus, you can see that there are definite tax disadvantages of holding a real estate in an s-corp. As you are planning a real estate acquisition for personal or investment purposes you need to be mindful of the ownership structure. You need to consult with your tax advisor. Read this white paper along with along with papers on Real Estate Rental Income, and Exception Ruling for Passive Activity for Physicians included on this website at www.shahcpaus.com/real-estate-rental-and-construction/. If you have any further question, feel free to contact Kislay Shah CPA at 646-328-1326 or kislay@shahcpaus.com.