Tag: real estate

How Tax Reform Impacts Real Estate

Posted by Simon Filip on

How Tax Reform Impacts Real Estate

The Senate and House have passed similar tax reform plans, but the bill is not yet finalized. Legislators are still working to create a unified bill, and the real estate industry can expect significant changes under the “Tax Cuts and Jobs Act.” Key changes include:

Temporary 100% Bonus Depreciation

House Bill:

Modifies existing bonus depreciation rules under the “PATH Act” by increasing the rate to 100% through the end of 2022. It also makes bonus depreciation applicable to both new and used property, where it currently applies only to new property. The 100% bonus depreciation will not apply to real property trade or business (i.e., commercial and residential real estate).

Senate Bill:

Similar to the House bill, except the 100% bonus depreciation will apply only to new property and to real property trade or business.

Section 179 Expensing

House Bill:

The Section 179 expense limitations for 2018 will increase from $500,000 to $5 million while the phase-out limitations for assets placed in service will be increased from $2 million to $20 million.

Senate Bill:

The Section 179 expense limitations for 2018 will increase from $500,000 to $1 million while the phase-out limitations will increase from $2 million to $2.5 million. Qualified real property eligible for 179 expensing will be expanded to include improvements to certain buildings systems including roofs, HVAC, fire and alarm systems, and security systems.

Real Estate Recovery Periods

House Bill:

No changes to current depreciation recovery periods of 27.5 years for residential and 39 years for non-residential real property.

Senate Bill:

Nonresidential real and residential rental property depreciable lives would be shortened to 25 years.

Like-Kind (1031 Exchanges)

House bill:

1031 exchanges will continue for real property, but not for tangible personal property. CAUTION: The proposed rules will trigger 1245 recapture for tangible personal property.

Senate Bill:

Same as House bill.

An updated version of the Tax Cuts and Jobs Act must be approved by both the Senate and House before going to the president to be signed into law.

We’ve Got Your Back

At KRS, we’ve been tracking tax reform legislation closely and are ready to assist you in your tax planning and preparation when it is finally signed into law. Don’t lose sleep wondering what impact the tax changes will have on your real estate holdings. Contact me at 201.655.7411 or SFilip@krscpas.com.

Update: Tax reform has now been passed into law. Stay up-to-date on how it impacts real estate investors by checking out the New Tax Law Explained! For Real Estate Investors.

Special Tax Allowance for Rental Real Estate Activities

Posted by Simon Filip on

Special Tax Allowance for Rental Real Estate ActivitiesIf a taxpayer fails to qualify as a real estate professional, losses from rental activities may still be deductible. While real estate professionals are afforded beneficial tax treatment enabling them to deduct losses from their real estate activities, real estate nonprofessionals taxpayers may still benefit.

Exception for rental real estate activities with active participation

If a taxpayer or spouse actively participated in a passive rental real estate activity, they may be able to deduct up to $25,000 of loss from the activity from nonpassive income. This special allowance is an exception to the general rule disallowing losses in excess of income from passive activities.

What determines active participation?

A taxpayer actively participated in a rental real estate activity if the taxpayer (and spouse) owned at least 10% of the rental property and made management decisions or arranged for others to provide services. Management decisions that may count as active participation include approving new tenants, deciding on rental terms, and approving expenditures.

Having a property manager will not prevent a taxpayer from meeting the active participation test. A taxpayer’s lack of participation in operations does not preclude qualification as an active participant, as long as the taxpayer is still involved in a significant sense. For example, the service vendors and approving tenants must be approved by the taxpayer before the property manager can commit to a service or lease contract. In other words, the taxpayer is still treated as actively participating if they are involved in meaningful management decisions regarding the rental property.

Maximum special allowance

The maximum special allowance is:

  • $25,000 for single taxpayers and married taxpayers filing jointly
  • $12,500 for married taxpayers who file separate returns
  • $25,000 for a qualifying estate reduced by the special allowance for which the surviving spouse qualified

If the taxpayer’s modified adjusted gross income (MAGI) is $100,000 or less ($50,000 or less if married filing separately), they can deduct losses up to the amount specified above. If MAGI is more than $100,000 (more than $50,000 if married filing separately), the special allowance is limited to 50% of the difference between $150,000 ($75,000 if married filing separately and your MAGI). If MAGI is $150,000 or more ($75,000 if married filing separately), there is no special allowance.

Modified Adjust Gross Income (MAGI)

For purposes of calculating the special allowance for rental real estate activities, modified adjusted gross income is computed by deducting the following items from Adjusted Gross Income (AGI):

  • Any passive loss or passive income
  • Any rental losses (whether or not allowed by IRC § 469(c)(7))
  • IRA, taxable social security
  • One-half of self-employment tax
  • Exclusion under 137 for adoption expenses
  • Student loan interest
  • Exclusion for income from US savings bonds (to pay higher education tuition and fees)
  • Qualified tuition expenses (tax years 2002 and later)
  • Tuition and fees deduction
  • Any overall loss from a PTP (publicly traded partnership)

We’ve got your back

Learn about all the tax benefits you may qualify for if you invest in real estate. Contact me at sfilip@krscpas.com or 201.655.7411.

How Your 1031 Exchange Can Benefit from a “Zero” Deal

Posted by Simon Filip on

In previous blog posts I’ve discussed benefits of entering into a 1031 exchange. Also known as a like-kind or tax deferred exchange, a 1031 exchange affords significant tax benefits to property owners.

How 1031 exchanges benefit from zero cash flow dealsSpecifically, a 1031 exchange allows a taxpayer to sell an investment property and reinvest in replacement property(ies) while deferring ordinary income, depreciation recapture and/or capital gains taxes. By deferring tax on the transaction, taxpayers will have more cash available for reinvestment.

What is a zero cash flow purchase?

In a zero cash flow or “zero” deal, the net operating income on a net-leased property matches the debt service, and the loan amortization matches the term of the lease. If the property is retained for the full term of the lease, there is no debt at the end of the term.

Many real estate investors purchase zeros to offset taxable income from other investments through losses associated with depreciation deductions and interest expenses. These transactions are not without drawbacks, as taxable income will occur when the annual loan amortization exceeds the annual depreciation.

Benefits of a zero in a like kind exchange

One of the largest benefits of a zero in a like kind exchange is the pay-down or re-advance feature, whereby the buyer can access cash from the exchange without triggering gain recognition. Once the property is acquired and the exchange is completed, the loan provides the owner an option to refinance a portion of the equity. The options are exercised within the existing loan documents, and there is no renegotiation of terms with the lender. The proceeds can then be deployed to cash-flowing assets.

For example, a taxpayer has a property worth $10 million, comprised of $4 million in equity and $6 million in debt. She found a zero property that can be purchased for $10 million, putting down $1 million as equity and assuming $9 million of debt. The buyer applies $4 million in cash to purchase the replacement, covering the equity requirement of the 1031 exchange. Of that, $3 million (excess of the $4 million of equity from the down-leg over $1 million of equity required for purchase of the property) is used to pay down the debt balance. The interim debt balance is $6 million, fulfilling the debt requirement of the buyer’s 1031 exchange. After closing, the debt is re-advanced from $6 million to the original $9 million, with loan proceeds of $3 million going to the buyer. The exchange has been completed, income deferred and the taxpayer has extracted $3 million in non-taxable proceeds.

We’ve got your back

If you’re interested in structuring a 1031 exchange as a zero cash flow purchase, be sure to consult a real estate broker who specializes in these investments. You’ll also want to coordinate the deal with your tax advisor so that you’re following all the 1031 exchange rules. That’s where the tax experts here at KRS can help and ensure that you receive the maximum tax benefits. For more information, contact me at 201.655.7411 or sfilip@krscpas.com.

How Does the Net Investment Income Tax Apply to Rental Real Estate?

Posted by Simon Filip on

Taxpayers should be mindful that their rental income may be subject to taxes in addition to ordinary income tax.

What is the Net Investment Income Tax?

Net Investment Income Tax and Rental Real EstateThe Net Investment Income Tax (NIIT) is a surtax that took effect in 2013. The NIIT was intended to boost tax revenue from Medicare payroll taxes on earned income by broadening its reach to unearned investment income.

Net Investment Income Tax basics

The NIIT only applies to certain high-income taxpayers. Specifically, taxpayers with adjusted gross income of more than $200,000 (single filers) or $250,000 (joint filers) are subject to the surtax on investment income that exceeds the thresholds. Note that these amounts are not indexed for inflation.

NIIT imposes a 3.8% surtax on income from investments. Investments includes portfolio income items such as interest, dividends and short-term and long-term capital gains. Royalties, rental income and business income from activities that are treated as passive are also subject to the surtax.  Read my post on passive activities in rental real estate to learn more.

What about self-rentals?

It is common for recipients of rental income, which include taxpayers who own rental properties directly or through pass-through entities (partnerships, LLCs or S Corporations), to also be involved with the business operations conducted on the property. The common scenario is a business owner that also owns the real estate in which he operates. The real estate is held in a separate entity that collects rents from the operating entity. Check out my previous post on IRS rules for self-rentals to learn more.

The NIIT is intended to apply to passive investment income, rather than income generated from an active trade or business. Therefore, it should not penalize a taxpayer who separates its real estate from business operations. This was clarified in an Internal Revenue Bulletin that made it clear that, if an individual derives rental income from a business activity in which the individual is materially participating, the 3.8% tax will not apply.

Does the surtax apply to real estate professionals?

While losses from real estate activities are passive per se, the losses of a real estate professional are considered ordinary losses and available to offset other ordinary income. Net rental income is generally included in the calculation of NIIT and is therefore subject to the 3.8% surtax. There is an exception if the following three conditions are met:

  • the taxpayer is a real estate professional
  • the rental activity rises to the level of trade or business; and
  • the taxpayer materially participates in the trade or business.

If all three of the conditions are met, the income from the rental real estate activity can be excluded from the calculation of net investment income.

What about sales of real estate?

Gains from the disposition of property (other than property held in an active trade or business) is subject to NIIT, including gain on the sale of stocks, bonds, mutual funds and real estate. The gain from the sale of rental property is also subject to NIIT unless the rental activity is part of an active trade or business.

If the real estate activity is considered a passive activity, any gain on the sale of property would generate gain that would be subject to the net investment income tax. However, if the taxpayer qualifies as a real estate professional, and the activity is considered an active trade or business, any gain on the sale of the property may be exempt from the net investment income tax. The characterization of the property for purposes of taxation of the gain on disposition is determined based on the treatment of the property during its operation.

With the 3.8% Medicare surtax on net investment income, real estate professionals should have a renewed focus on tax implications relating to their level of participation in real estate businesses.

We’ve got your back

If you’d like some additional insights into net investment income tax as it relates to real estate investments, contact me at sfilip@krscpas.com or (201) 655-7411.

Allocating Between Land and Building when Acquiring Rental Real Estate

Posted by Simon Filip on

How purchase value is divided up between land and buildings impacts the depreciation tax benefits you get as a real estate owner. Here’s what you need to know.

Depreciation for residential and commercial properties

Apportioning costs between the land and the building for favorable tax treatmentA tax benefit of real estate investing is the tax shelter provided by depreciation. Depreciation is an IRS acknowledgment that assets deteriorate over time. The IRS provides specific depreciable lives for residential and commercial property of 27.5 and 39 years, respectively.  Unlike other expenses, the depreciation deduction is a paper deduction.  You do not have to spend money to be entitled to an annual deduction.

Allocations favorable to taxpayers

When acquiring real estate, a taxpayer is acquiring non-depreciable land and depreciable improvements (excluding raw land, land leases, etc. for this discussion). In transactions that result in a transfer of depreciable property and non-depreciable property such as land and building purchased for a lump sum, the cost must be apportioned between the land and the building (improvements).

Land can never be depreciated. Since land provides no current tax benefit through depreciation deductions, a higher allocation to building is taxpayer-favorable. This results in the common query of how a taxpayer should allocate the purchase price between land and building. The Tax Court has repeatedly ruled that use of the tax assessor’s value to compute a ratio of the value of the land to the building is an acceptable way to allocate the cost.

For example, a taxpayer purchases a property for $1,000,000. The tax assessor’s ratios are 35/65 land to building. Using the tax assessor’s allocation the taxpayer would allocate the purchase price $350,000 and $650,000 to land and building, respectively.

Other acceptable methods used as basis for allocation include a qualified appraisal, insurance coverage on the structure (building), comparable sales of land and site coverage ratio.

Assessor’s allocation vs. taxpayer proposed values

In the recent U.S. Tax Court case, Nielsen v. Commissioner, the court concluded the county assessor’s allocation between land and improvements were more reliable than the taxpayer’s proposed values. Nielsen (the “petitioners”) incorrectly included their entire purchase price as depreciable basis, with no allocation between the improvements and the land.

When the petitioners were challenged they acquiesced and agreed the land should not have been included in their calculation of the depreciable basis. However, the petitioners challenged the accuracy of the Los Angeles County Office of the Assessor’s assessment as being inaccurate and inconsistent. Petitioners relied on alternative methods of valuation, which included the land sales method and the insurance method.  The Tax Court ruled the county assessor’s allocation between land and improvement values was more reliable than the taxpayer’s proposed values.

We’ve got your back

In Nielsen vs. Commissioner, the Tax Court chose the assessor’s allocation over those provided by the taxpayers. However, facts and circumstances may not support the assessor’s allocation in all cases. It is important for a taxpayer to have reliable support and documentation to defend an allocation if it should be challenged.

If you have questions about how to allocate value between land and building, we’re here to help. Contact me at SFilip@krscpas.com or 201.655.7411.

Don’t Be Surprised by a Tax Liability on the Sale of Your Residence

Posted by Simon Filip on

Tax liability on the sale of your residenceRegularly, clients contact me to discuss the tax consequences of selling their primary residence. It seems there is a lot of misinformation floating around that I aim to clarify below.

Rollover proceeds from a sale

It is common for sellers who have been in their homes for quite some time to cite the “old” rollover rule. Before May 7, 1997, taxpayers could avoid paying taxes on profits from the sale of their principal residence by using the proceeds to purchase another home within two years. Sellers over age 55 had the option of a once-in-a-lifetime tax exemption of up to $125,000 of profits.

Home sale gain exclusion

Internal Revenue Code Section 121 replaced the old rollover rule and allowed taxpayers to exclude gains from the disposition of their home if certain requirements are met.

In order to qualify for the gain exclusion, a taxpayer must own and occupy the property as a principal residence for two of the five years immediately preceding the sale. If a taxpayer has more than one home, the gain can only be excluded from the sale of their main home. In cases where there are two homes that are lived in, the main home is generally the one that is lived in the most.

If the requirements are met, taxpayers may be able to exclude up to $250,000 of gain from their income ($500,000 on a joint return) and are not obligated to reinvest the proceeds.

Sale of a multi-family home

I was recently able to provide guidance to married taxpayers who sold their property. This particular property was a side-by-side duplex where the taxpayers occupied one side as their principal residence for approximately 10 years and rented the other. The taxpayer was familiar with the $500,000 exclusion and the gross proceeds were slightly below that amount. During sales negotiations, they were incorrectly advised that the proposed sale of their principal residence with a gain under $500,000 would result in no income taxes owed after the sale. Needless to say, there was an unexpected surprise when I discussed the true income tax consequences with them.

Selling a duplex is conceptually akin to selling two separate properties. The side the taxpayers occupied is afforded the same tax treatment as any other principal residence, which includes the Section 121 gain exclusion up to $500,000 for married taxpayers. However, the investment side of the duplex is subject to capital gains tax and depreciation recapture taxes. In this particular instance, there was approximately $30,000 of combined federal and state income taxes owed as a result of the sale.

Under current law, taxpayers can sell their principal residence and exclude $250,000 of taxable gain ($500,000 for those married filing jointly). The requirements to reinvest the proceeds or to roll them into a new property have been inapplicable for some time. Taxpayers are free to use the proceeds from the sale in any manner without tainting the exclusion.

We’ve got your back

If you have additional questions about the income tax consequences of a residential sale, especially when a portion of the property has been rented out, we’re here to help. Contact me at SFilip@krscpas.com or 201.655.7411.

You can also download my free Tax Tip Sheet for more ways to save taxes when buying or selling a residential property.

Should I Acquire and Hold Rental Real Estate in an LLC?

Posted by Simon Filip on

At KRS, we get this question often from both new and seasoned investors acquiring new properties. Here’s what investors need to consider.

Should you buy and hold rental real estate as an LLC?Limited Liability Company

A limited liability company (LLC) is a legal structure that provides the limited liability features of a corporation and the tax efficiencies and operating flexibilities of a partnership.

The owners of an LLC are referred to as “members.” The members can consist of two or more individuals, corporations, trusts or other LLCs. Unlike a corporation, an LLC is not taxed as a separate business entity. Instead, all profits and losses are “passed through” to each member of the LLC.

A central motivation behind investors forming LLCs is to protect the LLC’s members (owners) from personal liability for debts and claims. At its very root, an LLC is utilized to keep creditors – such as suppliers, lenders or tenants – from legally pursuing the assets of a member. There are exceptions to the limited liability, such as in cases of illegal or fraudulent activity.

Disregarded Entity

LLCs are typically taxed as partnerships, which file separate tax returns. However, a single-member LLC, owned by one individual, does not file a separate tax return, but reports the activity on the tax return of its sole owner (Schedule C for business operations or Schedule E for rental activities). LLCs with one owner are commonly referred to as a “disregarded entity.”

Do I need an LLC?

Many real estate investors and landlords often ask whether they should purchase their rental property in an LLC. I have read numerous articles by attorneys, tax advisors, real estate professionals, and insurance agents with opinions on this matter. I believe there is no “one size fits all” answer. Just as in selecting which property to acquire, where investors consider multiple factors including cash flow, appreciation, capital expenditures, interest rates, proximity to transportation and etc., there are multiple considerations in choosing whether or not to acquire a property in an LLC.

Here are factors investors and landlords should consider when making their decision:

  1. Cost – I have seen clients utilize websites that charge fees as low as $100 to form an LLC (plus state filing fees). It is not uncommon to find an attorney’s fees to form a single-member LLC (including state fees) range from $1,000 to $3,000 depending on the state of formation.
  2. Filing fees – most states have an annual filing fee to keep the LLC in good status. That fee is currently a flat $50 in my home state of New Jersey. However, in New York, the fee can range from $25 to $4,500 depending on gross revenues (disregarded LLCs in New York are subject to a $25 flat fee).
  3. Type of property – the type of property to be purchased impacts risk. For example, a single family rental in a good neighborhood is less risky than a multi-unit property or commercial property.
  4. Financing – it is typically easier to obtain financing as an individual than as a commercial entity (i.e., an LLC).
  5. Interest rates – an individual borrowing to acquire an investment property may pay a higher rate than an LLC borrowing for the same property.
  6. Insurance – an umbrella policy provides coverage beyond the basic property insurance and covers additional risks. Umbrella policies may also pay for attorneys appointed by the insurance company and paid to defend you. Depending on an investor’s risk tolerance, an umbrella policy should be considered whether the acquisition is made with or without an LLC.
  7. Net worth – without an umbrella policy, an individual with a high net worth may be exposing his or her other assets to claims of creditors of his or her rental investment.

Transferring to an LLC

Frequently an investor has already closed on a property and the question arises regarding subsequently transferring the property to an LLC. After the property has been deeded there are concerns that should be reviewed including:

  1. Mortgage – if there is a mortgage on the property, contact the lender. Many mortgages have a “due on sale” clause, which means that if you transfer ownership of the property, the lender could require you to pay the full mortgage amount.
  2. Transfer tax – transfer of real property, depending on state law, may be subject to a transfer tax. Some states may exempt the transfer to a wholly owned LLC.
  3. Title insurance – a review of the title insurance policy should be undertaken to determine if the policy continues after transfer.
  4. Leases – tenant leases should be updated to reflect the LLC, and not the individual, as the owner of the property.

Acquiring real estate in an LLC should be included in an investor’s thought process or deal checklist before an acquisition. As the projects grow in size, value and risk protection afforded by an LLC will likely make their use instinctive.

We’ve got your back

If you have additional questions about rental properties and LLCs, we’re here to help. Contact me at SFilip@krscpas.com or 201.655.7411.

What Is an UPREIT ?

Posted by Simon Filip on

Real Estate Investment Trust basics

An Umbrella Partnership Real Estate Investment Trust (UPREIT) can provide tax deferral benefits to commercial property owners

Real Estate Investment Trusts (REIT) are comparable to mutual funds for real estate investors.

REITs provide an opportunity to invest in large-scale properties and real estate portfolios in the same manner mutual funds offer diversification and professional management to investors in stocks and bonds. REIT investments are touted for diversified income streams and long-term capital appreciation.

Many REITs are traded on major stock exchanges, but there are non-listed public and private REITs as well. REITs are generally segregated into two core categories: Equity REITs and Mortgage REITs. While Equity REITs generate income through rental income streams and sales of the real estate portfolios, Mortgage REITs invest in mortgages or mortgage backed securities tied to commercial and/or residential properties.

Similar to sector-focused mutual funds, REITs have been created to invest in specific real estate asset classes. Some REIT offerings targeting specific asset classes include student housing, nursing homes, storage centers and hospitals.

REIT shareholders receive dividend distributions

Shareholders receive their share of REIT income via dividend distributions. REIT dividend distributions are allocated among ordinary income, capital gains and return of capital, each with a different tax consequence to the recipient.

Most dividends issued by REITs are taxed as ordinary dividends, which are subject to ordinary income tax rates (up to a maximum rate of 39.6%, plus a separate 3.8% surtax on net investment income). However, REIT dividends can qualify for lower rates under certain circumstances, such as in the case of capital gain distributions (20% maximum tax rate plus the 3.8 % surtax on net investment income). Additionally, the capital gains rate applies to a sale of REIT stock (20% capital gains rate plus 3.8% surtax).

What is an UPREIT?

An Umbrella Partnership Real Estate Investment Trust (UPREIT) provides tax deferral benefits to commercial property owners who contribute their real property into a tiered ownership structure that includes an operating partnership and the REIT, which is the other partner of the operating partnership. In exchange for the real property contributed to the UPREIT, the investor receives units in the operating partnership.

When the UPREIT structure is used, the owner contributes property to the partnership in exchange for limited partnership units and a “put” option. Generally, this contribution is a nontaxable transfer.

The owners of limited-partnership units can exercise their put option and convert their units into REIT shares or cash at the REIT’s option. This is generally a taxable event to the unit holder.

Tax deferral opportunities

When a taxpayer sells depreciable real property in a taxable transaction the gain is subject to capital gains tax (currently a maximum of 20%) and depreciation recapture tax (25%). The capital gain tax and depreciation recapture remain deferred as long as the UPREIT holds the property and the investor holds the operating partnership units. The advantage of this structure is that it provides commercial property owners, who might have significant capital gain tax liabilities on the sale of appreciated property, an alternative exit strategy.

It is common for taxpayers to negotiate some sort of standstill agreement where the REIT agrees not to sell the property in a taxable disposition for some period of time, usually five to ten years. If the REIT sell the property in a taxable disposition, it triggers taxable gain to the taxpayer.

The taxable gain is generally deferred when the real estate is transferred to the UPREIT. Generally, the tax deferral lasts until the partnership sells the property in a taxable transaction. However, a taxable event is triggered if the taxpayer converts the operating partnership units to REIT shares or cash.

We’ve got your back

If you have questions about UPREITs or their tax implications, we’re here to help. Contact Simon Filip at SFilip@krscpas.com or 201.655.7411.

Do You Hold Real Estate in a C Corporation?

Posted by Simon Filip on

Here’s why you should think twice about using a C corporation for rental real estate property.

Do you hold real estate in a C corporation?
In practice I have encountered legacy entities that were set up before the rise in popularity of S Corporations or the general acceptance of Limited Liability Companies. Occasionally, there is still the investor who was advised to purchase or is contemplating purchasing, rental real estate in a C Corporation. Utilizing a C Corporation as an entity choice could prove costly.

Real estate and double taxation

A C corporation is not a pass-through entity. Corporate taxable income is initially taxed at the entity level. If the corporation distributes its earnings to shareholders as a dividend, the recipient of the dividend must include it in his or her individual income tax return, where it is again subject to tax.

Individuals invest in real estate for its current income (cash flow) and future value (appreciation). If real estate appreciates in value while owned inside a C corporation and the asset is sold by the corporation, the gain will be taxed at the corporate level at corporate income tax rates. If the C corporation then makes distributions to its shareholders as a dividend, the recipients must include the dividends, where it will be subject to a second level of tax.

Getting real estate out of C corporations

Property owners may hold real estate inside a C corporation because they desire liability projection. It is also possible the entity was inherited from a family member and it already held title to the real estate. The limited liability protection can be offered by the use of S Corporations and Limited Liability Companies (“LLC”), which provide the liability protection of a corporation without the double taxation.

There are options available to address real estate owned by a C Corporation that include:

  1. Distributing the property in kind to the shareholders.
  2. Selling the real estate to the shareholder or an unrelated party
  3. Converting the C Corporation into an S Corporation.

Distributing appreciated real estate to shareholders

A corporation that transfers a real estate deed to one or more shareholders has made a “deemed sale” that is taxable to both the corporation and the shareholders (assuming a non-liquidating transaction). At the corporate level, the distribution is treated as a sale to the shareholders at fair market value. Corporate gain is calculated as the excess of fair market over the corporation’s basis in the real estate. The shareholders that receive the property will be taxed on the full amount of the distribution. If the corporation has current or accumulated earnings and profits, the distribution is treated as a dividend.

Selling appreciated real estate

The sale of the real estate is a taxable event to the corporation. Unlike a “deemed sale” mentioned above, an actual sale generates cash for the corporation to pay the resulting tax. If the proceeds from the sale are not distributed to the shareholders, there will be no tax to the shareholders (along with no cash).

Converting a C corporation into an S corporation

Shareholders can convert a C corporation into a subchapter S Corporation. Unlike the first two options, this can completely avoid double taxation. However, there are potentially costly tax issues that should be addressed including:

  • Built-in gains (“BIG”) tax – if an S Corporation that was formerly a C Corporation sells appreciated real estate, the entity may still pay C Corporation taxes on the appreciation.
  • Excess passive investment income – S Corporations that were formerly C Corporations with passive investment income (which includes rents) in excess of 25% of their gross receipts are assessed a corporate tax at the highest corporate rate.

I will discuss converting from C Corporation to an S Corporation in a later blog post.

If you currently own rental real estate through a C Corporation, you should contact your tax adviser to determine what, if any, action should be taken. More than likely, you will at least need to set up a plan to minimize negative tax implications.

Will President Trump Benefit or Distress Real Estate?

Posted by Simon Filip on

What will Trump's impact be on the real estate industry?The presidential campaigning has finally ceased and the transition to the Trump presidency has begun. Many questions are being asked in real estate circles, but mostly, how will President Trump’s policies impact real estate in this country?

Here are my thoughts.

Immigration

Throughout the presidential campaign, Trump was firm about deporting immigrants. It is quite common that immigrants who come to this country find work in the construction industry.  A large immigrant deportation effort would put pressure on the number of skilled workers available in the real estate industry, especially in residential real estate.

A labor shortage in the construction industry will force builders to compete for skilled workers with higher wages. Those costs would most likely be passed on to buyers in the form of higher new home prices.

Mortgage Interest Deductions

Trump’s tax plan effectively limits the mortgage interest deduction, without eliminating it entirely. This is accomplished by increasing the standard deduction from $6,300 to $15,000.

Under the current system, for example, a homeowner paying mortgage interest of $10,000 would itemize the deduction and receive a greater tax benefit, because their interest deduction would be greater than the standard $6,300 exemption.

Under Trump’s potential changes, however, there would be no need to itemize the $10,000 mortgage interest, as the proposed standard deduction is already greater. Americans therefore may be less incentivized to buy homes as their taxes would not be significantly different than if they had rented.

Real Estate Agents and Brokers

If housing prices soar due to a lack of skilled labor force and the value of a mortgage interest deduction is diminished, residential real estate brokers and agents may find transactions and commissions drying up. A decrease in real estate activity will affect the bottom line for brokers and agents alike.

Commercial Real Estate

I would be doing a disservice to the real estate ‘mogul’ without mentioning the potential impact on commercial real estate.

There is a potential for a pullback on new construction for commercial projects, large residential and mixed-use developments. If the capital markets experience a shock – which could be interest rates, inflation, or regulation – the difficulty of obtaining construction financing coupled with a muddy economic outlook may push some developers to abandon plans for new projects.

What are your thoughts on the Trump presidency and how it will impact the real estate industry?