Residential Rental - LLC - taxed as Scorp - Need assistance

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Residential Rental - LLC - taxed as Scorp - Need assistance

Raj Kumar
Investor · Charlotte, NC · Member since 2014 · 12 posts · 4 votes

I have few residential rental properties, for which me and my wife are on mortgage but did deed transfer to LLC. But as for filing taxes we elected as S-Corp, it's been few years we have this set up, but learned that it's not a good set up. I want to see how I can correct it, did anyone been through this path and got them corrected, what are the tax implications and what's the right way to get out of this structure and keep it simple, I'm fine just dissolving llc/scorp and just keep the properties on our name.

Please guide or provide CPA/attorney contacts who can help.

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Ashish AcharyaBusiness Member
CPA, CFP®, PFS · FL · Member since 2017 · 5k+ posts · 3k+ votes
4y
Originally posted by @Raj Kumar:

I have few residential rental properties, for which me and my wife are on mortgage but did deed transfer to LLC. But as for filing taxes we elected as S-Corp, it's been few years we have this set up, but learned that it's not a good set up. I want to see how I can correct it, did anyone been through this path and got them corrected, what are the tax implications and what's the right way to get out of this structure and keep it simple, I'm fine just dissolving llc/scorp and just keep the properties on our name.

Please guide or provide CPA/attorney contacts who can help.

Just revoking the S-election is not going to solve your problems. The asset will be deemed sold at FMV when distributed out of the S-corp. That will create phantom income and you will pay taxes on that.

It is a little more complicated than his but you would need professional guidance. 

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  • Jim KennedyPro Member
    Accountant · Cherry Hill, NJ · Member since 2016 · 173 posts · 201 votes
    4y

    If you are an LLC you probably lucked out. All you have to do to go from an S to a partnership (or single member LLC) is notify the Fed and State governments that you made that change. You don't need a new company. Your LLC is still your LLC. All it did was decide it wanted to be treated differently for tax purposes. You retain the original Fed ID#, and that's it. Form 8832 helps you do this: https://www.irs.gov/forms-pubs... and it doesn't ask for much information either: https://www.irs.gov/pub/irs-pd...  

    The tax side is not complicated once you understand the above information. However, the legal side may call for a little more work. I am not a lawyer and cannot give legal advice, so you might want to check with an attorney to see if you need to file a state registration form, maybe amend your current state registration, and oh yes, pay a fee. States always have a fee. Can't live without a fee, right?

    The tax differences are that you can no longer take a salary. In an S COrp the officer(s) are required to take reasonable compensation. Not so in a partnership, so if you have a payroll company, you can let them go. In a partnership, you take no deductible compensation at all. All the net income flows thru to your personal return. real estate is largely passive, so you pay only income tax, and not social security like you did in the S Corp days of your life. That alone is a 15.3% increase in your cash flow!! However, you need to watch out and keep an eye on your income, in case you need to make an estimate payment. Not making when could cause you to owe come $/15, and if its big enough, you could be assessed a penalty for underpaying and another one for not paying quarterly estimates, and then have interest tacked on to all that.

    And yes, if you buy and hold get out of an S Corp ASAP!

    Jim Kennedy 

    1Reply
  • Raj Kumar
    OP
    Investor · Charlotte, NC · Member since 2014 · 12 posts · 4 votes
    4y

    @Jim Kennedy THANK YOU!! 


    So, I have to fill this form and notify Fed & State that I want my LLC be treated as LLC and not Scorp, will there be any reason I have to wait for next year or can I do it before end of year so come next year I can file 2021 taxes as LLC.

    0Reply
  • Raj Kumar
    OP
    Investor · Charlotte, NC · Member since 2014 · 12 posts · 4 votes
    4y

    Just to add, my LLC is 50-50 partnership, me and wife, is it still the same form?

    0Reply
  • Jim KennedyPro Member
    Accountant · Cherry Hill, NJ · Member since 2016 · 173 posts · 201 votes
    4y

    Thanks Raj. 

    If you go from S corp to partnership under your LLC umbrella, you may want to do it on 1/1. When you chage business entities, you have to close your books on the day of change and start a new set of companiy's books. If you close your books tomorrow, your 1120S will be for the short year from 1/1/121 to 12/17/21, and your partnership will report on the short inital year also from 12/18 to 12/31. Do you really want to go thru all that additional bookkeeping? Also, frequently, filing an 1120S and a 1065 are two separate engagements that could cost you two separate billings. Why do that if you don't have to? From only the few sentences you posted, it sounds like you'd do better with the 1/1 change - but continue doing your homework now.

    Hope that helps. Happy investing!

    Jim Kennedy

    1Reply
  • Raj Kumar
    OP
    Investor · Charlotte, NC · Member since 2014 · 12 posts · 4 votes
    4y

    @Jim Kennedy Thanks for  your guidance!! 

    0Reply
  • Greg O'BrienBusiness Member
    Accountant · Boston, MA · Member since 2019 · 386 posts · 336 votes
    4y

    @Raj Kumar you should see guidance here. An S corp revocation does not work that way with RE. Further, your trapped assets could be taxed.

    See IRC 336. If you do as suggested, you’ll likely be hit with a nasty tax bill.

    Further, a complicated S Corp inversion could be possible here but you’d need a legal/tax counsel

    Simply revoking an S election cannot bring you to a partnership, tax free. You actually become a c corp for a moment then you elect partnership (2 steps).

    Sometimes with RE trapped in an S, best bet is to hold it and dont make the same mistake again!

    3Reply
  • Ashish AcharyaBusiness Member
    CPA, CFP®, PFS · FL · Member since 2017 · 5k+ posts · 3k+ votes
    4y
    Originally posted by @Raj Kumar:

    I have few residential rental properties, for which me and my wife are on mortgage but did deed transfer to LLC. But as for filing taxes we elected as S-Corp, it's been few years we have this set up, but learned that it's not a good set up. I want to see how I can correct it, did anyone been through this path and got them corrected, what are the tax implications and what's the right way to get out of this structure and keep it simple, I'm fine just dissolving llc/scorp and just keep the properties on our name.

    Please guide or provide CPA/attorney contacts who can help.

    Just revoking the S-election is not going to solve your problems. The asset will be deemed sold at FMV when distributed out of the S-corp. That will create phantom income and you will pay taxes on that.

    It is a little more complicated than his but you would need professional guidance. 

    [email protected]941-914-7779
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  • Jermaine Southern
    Investor · Phoenix, AZ · Member since 2016 · 11 posts · 8 votes
    4y

    Sorry, Jim Kennedy, totally missed the real issue with the S-corp revocation. When you move the real estate from the S-corp to a partnership it's considered a distribution to the "NEW" Partners AKA YOU. That distribution is considered cash at FMV. So appreciated real estate FMV of $1M and original costs of $300k will have a long term taxable gain of $700k. If the real estate has lost value FMV of $100k and original cost of $300k you don't get to take the loss. Your new basis is $100k. That's why you don't put real estate in S-corps.

    3Reply
  • Jim KennedyPro Member
    Accountant · Cherry Hill, NJ · Member since 2016 · 173 posts · 201 votes
    4y

    @Jermaine Southern and others,  I appreciate everybody's comments, but they don't apply here. They are correct IF you start a new business (ie a partnership or S corp not in an LLC) and IF you bring appreciated properties over from another already existing business (ie a partnership or S corp not in an LLC) but such is not the case here. There is ONE business with one EIN, and mortgages are still attached to the same company and the owners are still the same. It is only changing its structure. It retains the same assets, it retains the same owners, it merely changes its election for taxation, so this is a non taxable event triggering neither gain nor loss. 

    Jim Kennedy

    1Reply
  • Greg O'BrienBusiness Member
    Accountant · Boston, MA · Member since 2019 · 386 posts · 336 votes
    4y

    @Jim Kennedy you cannot from S Corp to Partnership as described in one step. You mechanically write a Revocation letter first. Follow reg sec 301.7701

    The entity becomes a C Corp first, even if it was a legal LLC.

    1Reply
  • Raj Patel
    Investor · Greenville, NC · Member since 2017 · 12 posts · 6 votes
    4y

    @Raj Kumar sounds like the majority is in agreement - you should meet with a professional tax advisor. I'm all for doing things on your own, but when it comes to an issue such as yours, paying a professional is going to be worth it's weight in gold. Also, while you are meeting with, and establishing CPA services with, your future Tax Advisor you should also look into whether you qualify for Real Estate Professional status as this has tax benefits (I am not a tax professional so please do your own research on this).

    0Reply
  • Jim KennedyPro Member
    Accountant · Cherry Hill, NJ · Member since 2016 · 173 posts · 201 votes
    4y

    @Greg O'Brien You and others are missing something.  You are correct IF you start a new business (ie a partnership or S corp not in an LLC) and IF you bring appreciated properties over from another already existing business (ie a partnership or S corp not in an LLC) but such is not the case here. There is ONE business with one EIN, and mortgages are still attached to the same company and the owners are still the same. It is only changing its structure. It retains the same assets, it retains the same owners, it merely changes its election for taxation, so this is a non taxable event triggering neither gain nor loss.

    Jim Kennedy

    0Reply
  • Greg O'BrienBusiness Member
    Accountant · Boston, MA · Member since 2019 · 386 posts · 336 votes
    4y

    @Jim Kennedy could you please show us on Form 8832 where you go from S Corp to MMLLC?

    S corp revocations have always had the same mechanism:

    1) You write a letter to the IRS (and now it goes into a pile of unopened mail lol).

    2) IRS approves a revocation date. Your entity, tax wise, now becomes a C Corp. This often confused people but that is what the law says.

    How do the S corp assets get to the C corp (tax wise)?

    3) File Form 8832, if necessary, to go from C Corp to a Partnership.

    Form 8832 does not allow for you to go from S to MMLLC.

    The IRS says so themselves: https://www.irs.gov/forms-pubs/revoking-a-subchapter-s-election

    2Reply
  • Natalie KolodijBusiness Member
    Moderator
    Tax Strategist| National Tax Educator| Accepting New Clients · Member since 2014 · 3k+ posts · 4k+ votes
    4y

    If Mutliple tax pros disagree with one I'd go with the majority. 

    But just to be safe- hire your own. 

    Podcast Guest on Show Pay Less Tax to the IRS This Year With THESE Real Estate Tax Strategies
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  • Natalie KolodijBusiness Member
    Moderator
    Tax Strategist| National Tax Educator| Accepting New Clients · Member since 2014 · 3k+ posts · 4k+ votes
    4y

    https://www.upcounsel.com/s-corp-termination-tax-return#:~:text=After%20the%20status%20has%20been,at%20the%20fair%20market%20value.&text=When%20a%20business%20receives%20cash,on%20that%20transaction%20is%20easy.


    https://www.thetaxadviser.com/...

    Podcast Guest on Show Pay Less Tax to the IRS This Year With THESE Real Estate Tax Strategies
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  • Steven Hamilton IIPro Member
    Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
    4y
    Originally posted by @Jim Kennedy:

    @Jermaine Southern and others,  I appreciate everybody's comments, but they don't apply here. They are correct IF you start a new business (ie a partnership or S corp not in an LLC) and IF you bring appreciated properties over from another already existing business (ie a partnership or S corp not in an LLC) but such is not the case here. There is ONE business with one EIN, and mortgages are still attached to the same company and the owners are still the same. It is only changing its structure. It retains the same assets, it retains the same owners, it merely changes its election for taxation, so this is a non taxable event triggering neither gain nor loss. 

    Jim Kennedy

    You're wrong, it is better to admit it as we all make mistakes instead of digging your heels in. Do not give incorrect advice. This is Taxation of entities 101 and basics any accountant specializing in RE should understand. Ashish and others are correct. It's a deemed sale at FMV.

    I literally teach this to other professionals.

    While not substantial authority the publications even give this guidance.

    here:

    https://www.irs.gov/businesses...

    And here:

    "Corporation to partnership. An election to change classification from a corporation to a partnership will be treated as if the corporation distributed all of its assets and liabilities to its shareholders in liquidation and the shareholders then immediately contributed all of the distributed assets and liabilities to a new partnership.

    For more information, see Contribution of Property in Pub. 541 and Distributions to Shareholders in Pub. 542."

    @natalie Kolodij covered it too.

    [email protected]224-381-2660
    0Reply
  • Raj Kumar
    OP
    Investor · Charlotte, NC · Member since 2014 · 12 posts · 4 votes
    4y

    Thank you all for detailed responses. 

    Whats best course of action for me, leave the rentals in Scorp? 

    If I have to leverage equity built in due to rental appreciation and pay off, what right way to do it?

    1Reply
  • Steven Hamilton IIPro Member
    Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
    4y

    It depends upon your entire tax situation. You need to consult with someone competent like @Natalie Kolodij or @jake Hottenrott.

    It is worth the money consider what the advice or experience you already have is. Do not buy more RE in that entity.

    [email protected]224-381-2660
    1Reply
  • Seidy Lasker
    Realtor · Phoenix, AZ · Member since 2020 · 79 posts · 37 votes
    4y

    @Greg O'Brien

    Can the IRS track this without an audit of the s-corp? From their side, they just see a S-corp revocation and the LLC is still the owner of the property.

    1Reply
  • Greg O'BrienBusiness Member
    Accountant · Boston, MA · Member since 2019 · 386 posts · 336 votes
    4y

    @Seidy Lasker honestly who knows. Its hard to guess but is it unreasonable to think their computer matching systems looks at the balance sheet Sch L of any S Corp that does a Revocation? Maybe.

    0Reply
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