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Shareholder Basis

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Level 3

Hello,

I have a couple of questions regarding real estate investments in a S Corp:

1. Can someone please tell me if down payments on rental real estate increase shareholder basis?   

2. Also, what about closing costs paid out of pocket by shareholder and not the S Corporation?  Do they increase shareholder basis?

3. Are real estate investments reported on Form 8825?

Thank you!

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20 Replies 20
Highlighted
Level 15

A. Real estate should not be held in a corporation.

1. No.

2. Will the corporation treat this as a loan from shareholder or contributed capital?

3. Rental real estate activity (income and expenses) is reported on Form 8825.


ex-AllStar
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Level 15
What if it is a "flip" house?

ex-AllStar
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Highlighted
Level 3

Thank you!

Re: #2:  I was thinking they would treat it as contributed capital.

Also, I neglected to mention that this is an LLC electing to be taxed as an S Corp.  Does that change anything?

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Highlighted
Level 15

Contributed capital increases the shareholder's basis.

LLC taxed as S Corp doesn't make a difference - for your questions. Should have left it as an LLC.


ex-AllStar
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Level 3

I just found out additional information:

1.  Properties were purchased in shareholder's name then transferred into the LLC/S-corp's name.

2.  Property loans are in shareholder's name, but the LLC/S-corp pays the monthly loan payments. 

Re: #1 above:  Do I show the properties as additional capital contributions?

Re:  #2 above:  I'm not quite sure how to show the loan and the payments?  Is it a loan to the LLC/S-corp from the Shareholder?

Thank you for your help...

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Highlighted
Level 12

I think this is what you told us you learned:

A corporation owns real estate that has debt on it, because the corporation allowed an individual to pledge the property against the borrowing; this is more like cosigning debt. The property was put into the LLC-corporation without any debt instrument (liability) transferring along with the property (asset).

The business is making payments on behalf of the shareholder on what is Personal debt. The corporation has no note payable between any other party; not the mortgage lender and not even the shareholder.

You never addressed: Are other people involved, or just this one person?

Is the real estate title/deed in the name of the corporation?

Is the insurance in the name of the corporation?

Is the mortgage in the name of the corporation?

Is the escrow in the name of the corporation?

Does the Lender know that the Borrower doesn't own the real property that they think is securing that debt?

When did all of this happen, and who gave them guidance?

Oh, wow. I don't know that anyone can help with this mess. It's so wrong.

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Level 3

Hi,

YES, it is messy!  And I'm trying to help my client clean this up.  This is a new client for me so I'm learning more about the situation as I go.  You are correct in that the corporation has no note payable between anyone. To answer your questions:

1.  Husband and Wife are the shareholders.

2. Property is in the name of the corporation (I mentioned this in my last reply)

3. Insurance: I don't know, but will ask

4. Mortgage is in shareholder's name (I mentioned this in my last reply)

5. Escrow - I don't know

6. I don't know, but will ask.

7.  This all happened in 2019.  I don't know who gave the shareholder guidance.  I didn't think that mattered at this point.  I'm assuming prior CPA, or maybe he made these decisions on his own. 

I'm hoping to get some guidance from you, or another very experienced corporate tax preparer.

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Highlighted
Level 15

It is theoretically possible that shareholder transferred real estate to S Corp "subject to" the mortgage. In which case, contributed capital = FMV real estate less mortgage balance. 

Shareholder's basis for this capital contribution = Basis real estate less mortgage balance.


ex-AllStar
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Level 3

Yes, that is possible, but I'm not optimistic.  Keeping my fingers crossed.   I'm waiting to hear back...

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Highlighted
Level 12

Are you just now working on the 2019 1120S?

"In which case, contributed capital = FMV real estate less mortgage balance."

Wouldn't that make the loan payments distributions on behalf of the shareholders, even if paid to the mortgage company? But that should not happen without at least one of them getting payroll.

We don't know about the property ownership or laws in this State. It seems someone needs to know if there is the ability to use strategies such as wrap-around mortgage, quit claim deed, if the shareholders need to "sell" the rest of the property to the corporation, what the lender will require or if they will allow your shareholder(s) to assign the mortgage to a third party (the corporation), or if all of this discovery means it will blow up, anyway.

And I don't know what you could execute and backdate, legally, say to Dec 31, 2019, so it falls in that tax year.

 

I would recommend finding a mentor CPA locally that can help unwind this.

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"Level Up" is a gaming function, not a real life function.
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Level 3

Lots to find out!

Yes, just working on the 1120S now. 

Makes accounting sense to treat the loan payments as distributions.  

Do you happen to know of a thorough/helpful class on taxation for corporations?  I've tried some, but it can be difficult to get answers to questions like these.  I've taken Master CPE, but that was all self study.  I'd like to be able to ask questions of the presenter.

I haven't found a mentor that can help with questions like this as of yet, but I'm trying.  Some people don't want to bother helping.  Oh well, I'll keep trying!

Thank you for your help!

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Highlighted
Level 12

@sjrcpa 

Is it too late for them to revoke S Corp status for 2019?

https://www.irs.gov/forms-pubs/revoking-a-subchapter-s-election

 

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"Level Up" is a gaming function, not a real life function.
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Level 15

Yes. Had to have been done by March 16, 2019 according to that. (I would have though March 15.)


ex-AllStar
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Level 3

Yes, that would have been nice!

Is the S corp mostly a bad idea for rental investments b/c there's additional tax for passive income (the 25% threshold)?

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Level 12

S Corp requires Payroll. That's the first rule I point out to S corp "operators."

Just google this phrase:

why not hold real estate in an s corporation

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Level 3

Thank you and yes, I realize that, but that's the case for all S Corps no matter what industry. 

I'm just wondering what the main reason is for not holding rental real estate investments in an S Corp.

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Level 3

Yes, I have googled that phrase and received some guidance.  I've noticed that sometimes those articles leave out important information.  It's nice to hear from tax preparers that are doing this day in and day out.

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Level 12

Basis is the initial cost of something, whether it is paid by funds, loans, or both. Since you describe that the real estate is owned by the Corp (as pointed out, this is a bad arrangement),  your shareholder has no basis in the real estate owned by the corporation.

Let's not use the word Basis for the corporation/shareholder relationship for purposes of this discussion. Let's use the word Equity for "shareholder's investment in the corporation" and Liability for "the corporation owes something to someone."

1. Downpayments are part of how something is being paid for, but are not what it cost. Funds are part of Assets (money on hand), even if it is borrowed money. Using money on hand as downpayment would reduce the amount needed to borrow to cover that cost. Think of the downpayment as part of the funds being paid, but the timing is different; they didn't pay in full all at once. Paid in Advance = downpayment. Until it gets applied, it still is the corporation's funds, so it is their Asset, whether still in their bank or in the hands of the escrow company waiting on closing. Then, money (the asset) gets invested into the property (the asset); this shows you nothing has changed from the perspective of the balance sheet. That amount as Value no longer is in the form of Money; it's now Property. Basis is nowhere in this paragraph. This paragraph is just the movement of Money.

2. You didn't state if there is only this one shareholder. sjrcpa has the other part for your consideration and explanation to get the help you seek.

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Level 3

Thank you!  I'm still gathering more information from the client.  I might have an additional question.

Also, I neglected to mention that this is an LLC electing to be taxed as an S Corp.  Does that change anything?

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Level 12

Here's the main issue: Payroll. They've made a bit of a mess.

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