Leasing to an Owned C-Corp which then leases to third party?

Question

Hi all,

I came across an article detailing why a C-Corp should never own property, but should opt to lease it instead. (https://www.thetaxadviser.com/issues/2018/sep/leas...)  This led me to think of a scenario. Not sure how viable this is, or if I'm missing a vital piece of information.

Scenario:

I own a multi-family property as an individual (or pass-through LLC).

I lease out the entire property to my C-Corporation, receiving as low as possible (without legal violation) of a rate on it. This would be taxed at individual income tax brackets (for sake of simplicity lets assume highest tax bracket 37%).

The C-Corporation then (sub)-leases individual units to third-party renters. At this level, C-Corporation would pay a lesser tax (corporate tax rate of 21%).

Am I missing something obvious here? If not, why don't people do this?

Thanks!

Nur

Wayne Brooks · Answer

As far as I know, an S Corp an deduct all the same expenses and operating costs as a C Corp.  The article you linked seems to perhaps have advantages where a business enterprise is involv d....looks like overkill and perhaps fruitl ss in the case of real estate al9ne.

Eamonn McElroy · Answer

@Nur Al Sharif But you're not doing what is described in the Tax Adviser article.  You're describing a very different situation.

To use actual numbers: Are you saying LLC rents the real estate asset to the C Corp for $1,000/month?  The C Corp then subleases to a third party for $1,000/month?  Again, where is the legal or tax advantage for entering into this transaction structure, which will complicate your tax returns and add to administrative overhead?

"So if everything written above is correct, we can then say that the tax obligations (on both rent income and capital gain) are the same as what it would be under the traditional alternative (simply using a pass-through entity)."

Maybe, maybe not.  You're very much in "pay a professional" territory here.  This is a complicated question with no simple answer.  All facts and circumstances need to be considered.

Nur Al Sharif · Answer

Hey guys, thank you all for the responses. I have re-written this which may alleviate some confusion as I previously did not write it very well. See below please:

Theroetically, can my siblings and I do what this article explains: https://www.thetaxadviser.com/issues/2018/sep/leas...

What we’d be doing is lease real estate or other property to a closely held C Corporation (controlled and owned entirely by us), either as individuals or through an entity we create to facilitate this transaction.

We would lease our property at as close to a realistic FMV as possible, and our C Corp (in the case of rental property for example) would lease this out to tenants. The rental income would pass-through the C Corp to us (perhaps keeping a minimal profit for itself) as rent, thereby foregoing payroll/SE tax (that would have been paid on wages distributed from the C Corp to ourselves), and most importantly dividend distributions, since all the income would have been passed-through as rent. The C Corp would forego paying corporate tax on a significant sum since most of the revenue would have been expensed in rental payments to us. (There would also be no double taxation of sale or liquidation of said property because the C-Corp never owns or has the deed to the property).

So if everything written above is correct, we can then say that the tax obligations (on both rent income and capital gain) are the same as what it would be under the traditional alternative (simply using a pass-through entity).

If this is indeed the case, are there any benefits to be reaped from operating under a C-Corp in this manner? For example, gaining the ability to deduct health insurance, travel, entertainment, etc. while S-Corps and LLCs cannot? Any alternative benefits available to C-Corps that aren't to LLCs?

Thank you!

Eamonn McElroy · Answer

@Wayne Brooks "If your c Corp pays you the essential net income on the property, what’s the advantage?"

Exactly.

Eamonn McElroy · Answer

As @Aaron Klatt mentioned, profit is potentially doubled taxed when you dividend it out or remove it via salary (but now you're subjecting what should be rental real estate income to FICA in the latter case).

Self-rental rules under the Sec 469 regs also need to be considered as do passive activity rules for the C Corp.

Wayne Brooks · Answer

If your c Corp pays you the essential net income on the property, what’s the advantage?

Nur Al Sharif · Answer

@Aaron Klatt thanks for the response. wouldn't there be a sizable deduction for the C-Corps tax basis (because they have that large operating expense being  the lease that C-Corp pays me as an individual)?

Or in a slightly varied scenario - the C-Corp leases the property at market rate (from individual), and then leases out the units again at market rate (implying that there would be no operating gain), wouldn't the C-Corp's tax basis be $0?

If true, this structure would 1) provide a very similar if not identical tax obligation on operating income and 2) remove double-tax on capital gain (seeing as the C-Corp never actually owns the deed of the property)?

Aaron K. · Answer

You would be double taxed, the C corp gets taxed as its own entity any profits are then paid to you to be taxed again instead of using a pass through like an LLC in the first place