Tax Planning/Built-in Gains Tax
New client owns 2 rental real estate companies in C Corps:
1. Company A
Book Value is $900k and FMV is $1M
R/E of $1k and I don't believe there are any NOL's, schedule was not provided.
2. Company B
Book Value is $340k and FMV is $2M
R/E of (153k) and I believe there are NOL's, again schedule was not available.
My issues are as follows:
1. Should these properties be converted to an S-Corp effective 1/1/13 and held
for at least 10 years then would they not be subject to the BIG tax?
2. Would it be wise to use up the NOL's on Company B first as they will not roll
forward into the S-Corp?
3. Since Company A does have positive R/E's, should that be distributed through
the C corp as a dividend or roll it into the new S corp? If into the S corp and
it's distributed, it's taxed as a dividend, correct?
I appreciate all your input in advance.
All good questions, predicated on the first issue.
"1. Should these properties be converted to an S-Corp effective 1/1/13 and held
for at least 10 years then would they not be subject to the BIG tax?"
What if. . .
1. What if taxes are different in 10 years than they are right now?
2. What if we consider it NOT an absolute that the proceeds from the sale of the property MUST be given to the individual?
3. What if the properties need to be sold in less than 10 years?
4. What if the properties are positively cash flowing during that 10 years and the taxable revenue is attributed to the individual and taxed at his/her personal tax rate?
5. What if the Long Term cap gain rate changes?
What if number 5: If the Long term cap gain rate goes away and the entire gain on the properties is taxed at whatever the personal income tax rate is, That would be really bad, especially since the client has spent the last 10 years pay personal taxes on the rental revenue too.
What if number 4: Just for point of comparison, if the rentals experienced $30,000 of net revenue as things exist now, as a real corporation, the Federal Tax rate on that would be 15%. If the owner takes it as a distribution through a Sub-S the tax rate would 25, 28, 33, or 35% (assuming no increase in personal tax rates as we approach the fiscal cliff), but the S-corp will still have to attribute 80% of that as "earned" and subject to self employment tax, another 15.3%.
Best case, he makes less than $100,000 elsewhere, and this $30,000 can land in the 25% tax bracket, plus 80% of 15.3%, that is a little over 37%. 15% tax or 37% tax?
What if his income is higher than $100,000 and the income is attributed as an S-corp? that $30,000 may adversely affect his personal deductions because of Phase-out, or might disallow some business deductions because of the AMT.
What if number 3: if we make the switch, there are no choices, period. The transaction is a foregone conclusion.
What if Number 2: What happens if the corporation remains the same and the properties are sold? Then the gain is taxed at corporate rates. The highest corporate tax rate is 34% on net profits that are between $335,000 and $18,333,333. If that is the gain and all we did was to pay the taxes all in that year, then corporation has 66% of the money free and clear to do whatever else the owner might want. That is better than the personal rates on that same amount of personal revenue.
That is assuming that corporate rates don't go down, but there is discussion in Congress of lowering corporate rates to 25% or lower.
Your rebuttal is: but the client will want the money.
Have you actually asked that question without trying to lead to that conclusion?
He/she has been operating a corporation they already know something about managing their wealth in a separate entity, that doesn't have to end.
This line of though is a paradigm shift, so don't be too hasty, call me and we discuss your concerns and objections.