Hi Sean,
Thank you for answering me the questions about the Foreign Investment Brokerage account.
I have another question. Basically, my buddy owns a few investment properties under LLC X.
For whatever reason, he decided to seize LLC X, and started LLC Y. He has filed a Quit Claim Deeds to transfer all his LLC X Properties to LLC Y.
I understand that he could use a Tax Free Exchange to transfer properties from LLC X to LLC Y since he is the sole owner of both the LLCs.
The question I have is. How is the Tax Free Exchange need to be filed?
For example, I am a homeowner, I sell my current house, and buy another house. All the gain from the first home can be deferred until I sell the second home if I file a Tax Free Exchange on my tax return on the same tax year the first home is sold, and the second home is purchase.
It gets a little complicated when it involved LLC X, tax return, LLC Y tax return, and his personal tax return.
I do not think he could file a Tax Free Exchange for LLC X since he is going to seize it to exist. So, the gain will be pass through to his personal return based on the Current Market Value to the Cost Basis when the properties were first purchased under LLC X.
There is nothing for LLC Y to file until the newly transfered properties are sold. Or, can LLC Y file a loss based on the new Cost Basis of the properties, which LLC Y acquired from LLC X. The loss will than pass through to his personal tax return and create a wash between the profit from LLC X, and Loss on LLC Y.
Or, should he file a Tax Free Exchange on his personal return, since both the purchases and sales will eventually pass through back to his personal returns.
Please provide the detail instructions to how to file the Tax Free Exchange to deferred these hypothetical Capital Gains since in reality, there is no Cash changing hand, but the appreciation or depreciation on the properties LLC X owned to begin with.
Thank you.
Answers
.
Hi Sean, I am so sorry that I missed out the Important piece of information. He actually been filling the 1120S for LLC X for a few years now. 2009 would be the the first year he is filing 1120S for LLC Y. He owns the property out right, so there is no Mortgage Company, Lien holder to worry about.
Expert
Just to let you know up front: Here I am making the assumption that your buddy is a sole proprietor who has his LLCs set-up as “disregarded entities.” This means that no Form 1120 (C Corp.) or 1120S (S Corp.) is filed. Property distributed to the owner is distributed at basis. This means the accounting for the property is transferred from one entity to the other, and looks like a property distribution to the owner from one LLC, and a contribution of property to the other LLC. Accumulated Depreciation and cost basis transfers to the new LLC. Since a sale has not occurred, a Section 1031 qualified intermediary is not required. The Section 1031 exchange only needs to occur to defer the gain on a property sold. No loss or gain is recognized on a sole proprietor's property transfer among LLCs.
Example: a $250,000 house (and its land) is transferred in this down market to the 2nd LLC. The accumulated depreciation is $50,000, so current basis is $200,000. If the property is now only worth $150,000, no loss is realized (experienced) or recognized (claimed as a loss), because no sale occurred. The property is placed on the new LLC’s books at its cost basis, which is original purchase of $250,000, listed as an asset (debit), and $50,000 accumulated depreciation, a contra asset (credit), plus any mortgage is listed on the new LLC’s books, too.
And, just to clear things up a little: When you are mentioning a personal residence, Section 121 is the one rule the IRS uses to allow you to experience tax-free gains, from $250,000 in appreciation for a single person, and $500,000 for a couple, but only for your “qualified primary personal residence” that has been such for any 2 of the last 5 years. This is the only way to truly make tax-free money. Section 1031 exchanges are not allowed for personal residences, but there are ways around this, as well, such as turning personal residences into rental property.
Back to the LLC property transfer issue: The only problem that arises is when an S Corp. or C Corp tries to transfer property, and a gain is recognized, because tax on built-in gains has to be paid, a unique tax on the appreciation of property inside a corporate structure.
Technically, if the above assumptions fit the scenario, the LLCs are not individual companies as far as the IRS is concerned. If the building/property is used for business, Schedule C of Form 1040 is used, if it is a rental property, Schedule E is used. Now, forgetting about the IRS, transfer of title can be problematic. The mortgage company can call the loan if the property transfers and their contract states they can do so upon the event of an unapproved transfer. Also, the title insurance policy might not be transferrable. If the title policy is the only issue, often the title company will charge title policy transfer and "doc" fees and possibly recording fees.
In some states, such as California, according to Section 17942 of State Code, fees are paid on each LLC. $800 annually per entity and possibly a tax based on the LLCs income.
Please let me know if there is anything more I can be of assistance with.
Sean M. Williford, EA
About the Expert
I am an IRS Enrolled Agent and have 9 years tax, retirement and financial planning experience. I am always working for my clients' best interest, and search for ways to benefit you, even if that means spending additional time planning and explaining. I am most concerned with understanding and planning for the whole financial experience of the individual, business or family. View Profile
Unfortunately, the dissolution of one S Corp creates a sale of the property. This is a taxable event. The property at that point could be transferred at basis to another corporation or entity. However, since the property was transferred to another S Corp, now the property inside of that corporation is going to be taxable upon sale or dissolution. A Section 1031 exchange can only occur inside of the same corporation, since the corporation, not the sole proprietor or partners own it. It might be a good idea to get the property out of the second S Corp, and into an LLC, since the appreciation is probably pretty low if any. In this down economy, the appreciation subject to tax might be less than if these transactions occurred in a healthier real estate market. Remember that property is transferred at fair market value from the S Corporation. Let me know if you need more info - I'm keeping this answer shorter and more to the point so as to make the point really clear concerning properties held inside corporations being taxable at sale or dissolution.
Please login or register to rate this answer!