Years ago (from the 1950s to the late 70s), it was the custom to put real estate in a separate corporation (R/E Corp.), which would then lease the real estate to the corporation operating the business. It was a lousy tax idea then, and it still is a lousy idea today. In fact, if I were to ever write a tax bible, the First Commandment would be, “Thou shalt not put real estate into a corporation.”
Why?... Well, now we are looking at a potential tax disaster. The R/E Corp. is making a substantial cash profit and pays its tax, but the only way you can get your hands on the after-tax R/E Corp. profit is to declare a nondeductible dividend and pay a second tax – personally. Like I said, lousy.
If you have this problem, gather ‘round. There is a way out, and this is a true war story. A Midwest business owner (let’s call him Joe) came to my office for a second opinion on his estate tax plan. While looking over Joe’s tax data and other documents, we discovered the real estate-trapped-in-the-corporation problem.
Here’s what we did. We had R/E Corp. declare a dividend of $250,000 (numbers are rounded for convenience), payable in cash of $100,000 and a note for $150,000. This reduced the retained earnings of R/E Corp. to zero. R/E Corp. then elected S corporation status, which enables Joe to be taxed only once on all future corporate profits.
Joe had to pay tax immediately on the $250,000 (about $45,000, including state income tax), but the $100,000 covered the tax liability and Joe slipped $55,000 into his pocket. R/E Corp. will pay off the 150,000 note to Joe in less than three years. Best of all, because R/E Corp. is now an S corporation, all of its future profits will be taxed to Joe only once and he can put all of those nice R/E corp. profit dollars into his own pocket. Great!
One warning: Getting real estate out of your corporation is a complex area of the law and this article does not begin to spell out all of the rules and traps for the unwary. Get competent professional help. There are huge tax dollars to be saved.
Irv Blackman is a certified public accountant who lives part-time on Marco Island and specializes in estate planning, business succession and asset protection. E-mail him at email@example.com or call 417-9732. His Web site is taxsecretsofthewealthy.com.