Land owned by a c-corp
Any thoughts on the following problem would be greatly appreciated.....
My father owns a small business, which is incorporated as a c-corp. The business consists of a small operating company and the land that the company is located on. The corporation also generates rental income from a few other independant companies. The land is worth considerably more than the operating company. As he nears retirement age, my father is probably going to close down/liquidate the operating company. He would also like to potentially sell off the land. Unfortunately, as I understand it, selling the land would result in the corporate capital gains tax of ~40% (the land has a very low basis) plus individual income tax on any cash dividends (I'm not holding my breath for the Bush dividend tax cut to go through). Total tax burden on a sale would be in excess of 60% if my math is correct.
Obviously the corporation should have been structured as two seperate entities - a c-corp for the operating company and some tax efficient vehicle like an LLC for the real estate. Then one could easily (relatively speaking) sell the equity of the LLC to another real estate investor and only pay the 20% long term capital gains rate on the sale. But that's not the hand we've been dealt, and those structuring decisions were made decades ago.
Anyone have any creative ideas on how to reduce tax burdens upon sale of the real estate??? I doubt we'd be able to do anything to get the 20% capital gains rate, but 60% seems outlandish. I've spoken to some CPAs and lawyers, but haven't heard any real decent options. Not looking to violate any tax laws, obviously.
Much thanks!
Has your Father consider refinancing the land, pulling as much cash out before selling the property. It would reduce his gain on the property sell off, make sure he finances the buy out of prepayment penalty. The monthly interest can also help reduce his tax burden as well. Just one way to consider doing it, check out the numbers see how they fall on both sides.
Sorry vincenth, refinancing won't work like that. Business income from the sale of company property goes off of the tax basis, not the amount owed.
That said, there may be a way around this. First, I'm not an expert, and you need to run this by one before trying.
I don't have any numbers to work with, but he could sale you the property at the tax basis or below. By showing no gain or loss, that would prevent him from being taxed at all.
If you want to keep the land yourself, you could then borrow against the property to actually pay your father what he wants for the property. This is the tricky part of the process. You will need a legitimate reason for giving your father the money. As an added benefit, your father's company could lease the property from you, thereby creating a tax deductible business expense.
If you don't wish to keep the property, the you could resell it, splitting the funds with your father when it does sell. As the new owner, your tax basis will be much higher and the capital gains will be lower.
Roger
Quote:I don't have any numbers to work with, but he could sale you the property at the tax basis or below. By showing no gain or loss, that would prevent him from being taxed at all.
If you don't wish to keep the property, the you could resell it, splitting the funds with your father when it does sell. As the new owner, your tax basis will be much higher and the capital gains will be lower.
rajwarrior (Roger),
You will have to explain this one to me. How will the tax basis upon resale be higher than the actual purchase price?
If I understand your question correctly, the advice is to sell the real estate for its tax basis and therefore since the sale price = tax basis, there would be no gain. Nice try, but you forgot one very important detail. It is called gift taxes.
If you sell the property to a related person for less than the FMV, if the IRS audits the transaction, they will likely consider the difference to be a gift. Unless your father is willing to use part of his unified credit to exclude the amount "gifted" to you from gift taxes, the tax rate to your father would be even higher. The IRS will likely deem the corporation to have distributed the real estate to your father (therefore triggering the corporate level tax and a dividend tax to your father) and then a gift by your father to you. When you add all the taxes together, I bet you find out the effective tax rate is around 85%!
The simplest thing you can do to reduce the gain is to have your father convert the C corporation to an S corporation by making an S election on IRS Form 2553. Then wait 10 years until selling the real estate. If the real estate is sold after the 10 year period, then the gain will be taxed only at 20% since the S corporation does not pay a tax.
Alternatively, (or in addition to the above) you could have your father structure a "freeze partnership" or "freeze corporation" to freeze the future appreciation from the double taxation effect. This is more complicated and is beyond the scope (and length) of this post. Have your father talk with his estate planning attorney about this technique.
Taxjunkie