I would record a deed in the name of the S-Corp, pay any transfer taxes that may apply, get insurance in the S-Corp name, and open a checking account and have all rental income paid into the S-Corp checking account and pay all expenses out of it. I don’t see how the IRS could attack this if it is truly run as a separate entity and the transaction uses arm’s length pricing.
Ilyce and Sam respond: S corporations are set up to pass corporate income, losses, deductions and credits through to their shareholders. The issue for this property owner is that he wanted to get a stepped-up cost basis for the property by selling it to a corporation, and he wanted to do it while he was eligible to claim the property as his primary residence (in order to keep up to $250,000 in profits from the sale of the home tax-free).
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Your suggestion might work if he was selling the property and there was a valid business purpose for holding the property in the name of a corporation. Without a valid business purpose, the IRS could view the sale as a sham. There are also other ramifications to the transfer to the corporation: increased real estate taxes, loss of real estate tax benefits for individual homeowners, and even state tax issues, among other things. The best bet is for the owner to work with qualified tax and real estate attorneys to understand all options that are on the table.
Comment: In your article about an owner who wanted to use an LLC to manipulate the tax benefits associated with his home, you indicated that the income tax exclusion was $250,000 for a single person and $500,000 for a married couple. That is incorrect. The $250,000 and $500,000 exclusion apply to capital gains tax, not income tax. They are treated separately. You should clarify this in the article.
Ilyce and Sam respond: Assuming this is the same story, we do write “the IRS gives you the benefit of not having to pay federal income taxes on up to $250,000 of profit on the sale of your primary residence. … If you’re married, you get to exclude $500,000 in profits from federal income taxes.” You can see the whole story on Sam’s website, LawProblems.com. If you mean that we should clarify the point that the seller won’t pay capital gains taxes on the sale, you are correct. But in the end, if the homeowner pays no capital gains taxes on the sale of the home, they’re just not paying more taxes to the IRS due to the sale.
Comment: Your recent article ignores that the Net Investment Tax only applies to income above $250,000 for a married couple filing jointly. I know you included a disclaimer, “Of course, there may be other factors in your tax return that will change these numbers”, but this ignores one of the most crucial aspects of the Net Investment Income Tax rule, which is that NIIT applies only to modified adjusted gross income above $250,000. See: irs.gov/newsroom/questions-and-answers-on-the-net-investment-income-tax. Or did I miss some fact in the article that distinguishes this rule?
Ilyce and Sam respond: Thanks to all those who wrote in about the Net Investment Income Tax. The NIIT falls under Section 1411 of the Internal Revenue Code. Since 2013, it has applied an extra 3.8 percent tax to “certain net investment income of individuals, estates and trusts that have income above the statutory threshold amounts.”
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The tax is levied if the individual or married couple has Net Investment Income and has modified adjusted gross income (AGI) over a certain amount, currently $250,000 for a married couple filing jointly or a qualifying widow or widower with dependent child, $200,000 for a single taxpayer or head of household, or $125,000 for a married couple filing separately.
According to the IRS, the definition of Net Investment Income includes (but is certainly not limited to) interest, dividends, capital gains, rental and royalty income, non-qualified annuities and other income. It does not include wages, unemployment compensation, operating income from a nonpassive business, Social Security benefits, alimony, self-employment income, distributions from certain Qualified retirement plans (like 403(b) or 457(b), and others.
If you have gains from selling investment real estate or any property that is not your primary residence, it counts toward your total Net Investment Income.
When it comes to complicated topics like these, we usually mention that homeowners or real estate investors discuss their tax strategy and legal options with a tax preparer, tax, estate or real estate attorney. And, to your point, details do matter.
Thanks for your comments.
Ilyce Glink is the author of “100 Questions Every First-Time Home Buyer Should Ask” (Fourth Edition). She is also the CEO of Best Money Moves, an app that employers provide to employees to measure and dial down financial stress. Samuel J. Tamkin is a Chicago-based real estate attorney. Contact them through her website, bestmoneymoves.com.
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