Seacoast Law & Title

Depending on the nature of the real estate and the what legal form the title is held in, federal tax treatment of real estate transfers can widely vary from transaction to transaction and result in a significant difference in one’s tax liability. The first basic tax goal of a buyer of real estate is to maximize future tax benefits. In doing so, an important consideration is the form of entity chosen through which the property will be acquired, and subsequently transferred. With the goal of maximizing both their tax and non-tax business interests, a buyer should choose an entity that complements their current legal and/or corporate structure. 
A seller’s goal is the minimization and deferral of any gains resulting from the transfer of the property. The characterization of gain that a seller realizes is significantly impacted by the purchase price allocation. Proper tax planning is critical to mitigating any future risk and necessitates a comprehensive analysis of gains and losses, adjusted basis, and depreciation considerations. The resulting tax consequences that can arise from the sale of property can be significantly impacted by the form of legal entity. 
While direct ownership of the property can maximize favorable tax benefits, there is no liability protection under this scheme as the individual is directly liable. 
Under federal statute, any business entity with two or more members may elect to be treated as a partnership, which establishes the benefits of federal income tax treatment while providing the same liability protection as LLCs and LLPs. Partnership benefits include a favorable characterization of gains and losses, and a pass-through of income, credits and deductions to the members. There is also more flexibility in terms of allocations and provide an ability to distribute to the shareholders appreciated property without the recognition of gain or loss. 
Another form of entity to purchase and hold real property is the C-Corporation. C-Corporations are the least favorable form and provide little advantage to the title holder. One of the reasons is that the shareholder in a C-Corporation is taxed on two separate levels. First, it is taxed as a corporation from the sale and second, as an individual on the distribution of net proceeds arising from the sale.
Under state law, Subschapter S-Corporations provide the same liability protection as C-Corporations and are only taxed at the shareholder level and so provide a more favorable tax rate than the C-Corporation does. However, like C-Corporations, S-Corporations face problems with the distribution of appreciated property as it cannot avoid the recognition of gain.

Many individuals and businesses chose to acquire and hold real estate in the form of a LLC, or Limited Liability Corporation. Limited liability corporations provide both tax benefit and liability protection. Limited liability corporations are the first new form of business entity in widespread use in the United States since 1917. In a revenue ruling in 1988, the Internal Revenue Service held that LLCs organized under a Wyoming statute were to be classified as partnerships for federal income tax purposes. The LLC could combine the advantages of limited liability like a corporation and taxation like a partnership. LLCs became a popular form of business organization for operating businesses, investment partnerships, and family entities.

On January 1, 1997, the issuance of the so-called "check-the-box regulations," further promoted the popularity of LLCs by replacing a set of historic regulations that determined whether an unincorporated business entity would be classified as an association taxed as a corporation for federal income tax purposes or a partnership based on the number of corporate attributes possessed by the entity. The check-the-box regulations allowed all multi-member LLCs to be taxed as partnerships unless they elected to be taxed as corporations.

Due to the widespread use of LLCs for favorable tax benefits, many families have chosen this vehicle for the transfers of family vacation homes and camps from one generation to the next. Past practice involved transferring fractional interests which resulted in the need for numerous deeds which in turn often resulted in problems with title as well as mortgaging the property. Choosing to transfer the family property to a corporation or partnership facilitated the transfer of interests in the property. The Internal Revenue Code under §6012 requires that any corporation or partnership possessing assets annually file income tax returns. Properly structured, incorporations can facilitate the transfer of family real estate, but still come with tax obligations and compliance.

For individuals and businesses alike, acquiring real property should be coupled with a serious consideration of entity formation. In doing so, seeking the advice on professionals, whether it be legal or financial, should be the first step in this venture.

This article is not intended as legal advice and individuals should seek their own legal counsel.

Mary-Anne E. Martell, Esq., is the president and owner of Seacoast Law & Title. The firm is located in Westbrook and offers professional services in a variety of legal areas including real estate, residential and commercial title services, business organization, family law, estate planning, and bankruptcy. This is the second of a six-part real estate series. Mary-Anne welcomes comments and suggestions @ This e-mail address is being protected from spambots. You need JavaScript enabled to view it or (207) 591-7880