When I first started out about 15 years ago my business partner put two properties into an S Corp. The two properties are owned outright no debt. My question is how can I convert this into an LLC? I realize now it never should have been an S Corp but I need to get creative here>
Can I simply sell to a new entity? Should I mortgage to the maximum and then transfer to a new entity? Any advice is welcome.
The S Corp is a Delaware Entity
The properties are in Florida and Minnesota
How much built in gain do the properties have in them now?
Selling the properties to a new LLC would trigger that built in gain to the S Corp (i.e., sale price would need to be at an arms length price). Distributing the properties would also trigger the built in gain so knowing how much it is important.
You will get a stepped up property tax basis at the cost of immediate gain recognition on the properties sold by or distributed from the S Corp.
Unfortunately you are probably stuck with the bad planning. The only way to remove the property from the S-Corp would be to take a distribution which would essentially sell it to yourself at FMV. Not a good result.
Trying to convert your legal entity to an LLC would not have any effect if it is even allowed in DE. You are still stuck with your tax problem of filing returns as an S-Corporation. Changing your entity would not avoid the problem you currently have.
LLCs can elect different tax treatment but your only options as a corporation are regular C-Corp tax rates or the S-Corp tax structure. You could try to revoke your S-election but that would be a horrible idea.
Someone may try to recommend contributing your shares to an LLC however a LLC (filing as a partnership) is not a permissible S-Corporation shareholder.
Setting up your entity correctly in the beginning was really the only way of avoiding this problem. I presume you want to leverage up but you won't have any basis for distributions. You can continue to use the S-Corp and take on debt but you can't take a distribution without reporting a gain if you run out of basis.
Outside the box idea. Have your Scorp take a loan/mortgage on the property from your new LLC and then let the LLC foreclose on the property for non payment. Get professional help and look at your options for the cleanest and least expensive. Many factors need to be considered.
You need to speak to an attorney, but your best bet will likely be to create an LLC and have a merger then dissolve the Scorp.
Thank you. This is what I was hearing . Last question would then be if I pulled the cash out to purchase additional property And push that purchase in another llc. Would I be ok?
No matter what it is still a sale at the fair market value. You have to be careful of related party transactions especially if you are trying to avoid a distribution and reported sale.
@Matt Walden There's also the option that you buy the s-corp with the new LLC. Not sure why you want to dissolve move if it's holding only 2 props. The taxes in my unprofessional knowledge is s-corps and llc tax if elected the same is the same structure/tax pay output.
To CPAs: Why can't someone, such as an entity be able to sell to another one in non-FMV, we all have seen distressed properties from individuals being sold on a steep discount, etc, why not the same as entity-entity? I mean, taxes have been paid and collected (property tax and what not). I've seen some businesses "eat" other businesses (in this case an LLC eating an s-corp), and dissolving the former entity. If say LLC loans Corp for 10k on a 100k property, and as suggested, foreclose on it, will it not be the same? Better yet, if LLC loans Corp 10k with right to move title if not paid in 6 months, then LLC re-finances the loans while Corp dissolves due to no business transaction/could not pay LLC, will that not work?
Matt - no that would not work. If you refinanced to purchase another property that property would have to remain in the corp. As mentioned above putting it in another entity would be a distribution at fmv and unfortunately debt does not give you basis in the S-corp like it would in a partnership.
@Manolo As I mentioned before an LLC filing as a partnership cannot own an S-Corp.
As far as your other comments - rules and traps are in place to avoid abuse. There are related party rules for almost everything because it is easier to scheme against the IRS with people you trust.
What you listed may seem to make sense but none of it works, for many reasons.
I am not a CPA, but is it possible to modify the S-Corp to be an LLC as well? I had my account create a S-Corp that was also an LLC if that makes any sense. Hopefully he did this correctly, but if so it made the most sense to me for what I was trying to accomplish a few years back. It wasn't to own a property, but rather a business that I wanted additional protection on.
I agree in putting properties in an LLC (that is always my choice and what I have seen). Sometimes multiple LLC's depending on the size and structure of the deal and investors involved to property the ownership group, management and even renovation portion. For larger deals in the 20 million plus, it almost gets silly, but the added protection is needed of course.
I am not a CPA by any means, so do not take this as advice, I was more curious myself and thought John Woodrich may have some insight into this and structuring multiple LLC's in larger transactions with multiple partners. I am always hungry to learn more on this subject :-).
@Michael Tempel Your situation is likely different, you probably had an LLC and an entity classification election was filed so you now file taxes as an S-Corporation. From a legal standpoint you still have an LLC but for tax purposes you are filing as if you are an S-Corporation. A legal corporation can file taxes as a regular corporation or as an S-Corporation, that is it. They cannot elect to be treated as a partnership for tax purposes.
There are several ways to structure LLCs but it really depends on what the goals are. Some people use a different LLC for each property with a parent company to ease filing requirements but depending on how you run them you may not be afforded additional protection. Others use tiered partnerships to allow for partners to transfer their interests without normal closing and title work. There are really a lot of options and it boils down to how much work you want to spend separating the entities and how much protection you are concerned about. There is likely a podcast or blog post on structuring companies.