Can an S Corp Purchase Real Estate?

An S corporation can legally purchase and hold real estate. While permissible, this decision carries financial consequences that differ from other forms of ownership. The S corporation structure introduces unique rules and limitations that affect the investment from the initial purchase to its eventual sale.

Understanding these implications is important for avoiding unexpected and costly tax outcomes. The perceived simplicity can obscure complex tax traps and limitations that may not become apparent until years after the initial transaction.

The Property Acquisition Process

When an S corporation buys real estate, the property must be titled in the corporation’s exact legal name. The purchase is recorded on the company’s books, establishing the property’s initial tax basis. This basis is the purchase price plus certain acquisition costs like legal fees and title insurance.

Securing financing for the purchase often involves more than just the corporation’s creditworthiness. Lenders frequently require the S corporation’s shareholders to provide personal guarantees for the mortgage. This means that if the corporation defaults on the loan, the lender can pursue the personal assets of the shareholders to satisfy the debt.

The requirement for personal guarantees highlights a distinction between corporate and personal financing. While the S corporation is the legal borrower, the financial risk does not stop at the corporate level. Shareholders must be prepared for their personal credit to be scrutinized and leveraged during the underwriting process.

Tax Consequences During Ownership

Once the S corporation owns the property, all income and expenses are passed through to the shareholders. Rental income and operating expenses like property taxes, insurance, and maintenance are reported on each shareholder’s personal tax return. This information is conveyed annually on a Schedule K-1.

A tax benefit during ownership is depreciation. The corporation can claim a depreciation expense, a non-cash deduction that accounts for the wear and tear on the building over time. This expense also passes through to the shareholders via the Schedule K-1, reducing their taxable income from the property without an actual cash outlay.

A shareholder’s ability to deduct pass-through losses is limited to their basis in the corporation. Basis consists of the shareholder’s direct investment in the stock plus any loans made directly to the corporation. An S corporation shareholder does not get to include their share of the corporation’s mortgage debt in their basis. This often restricts the ability to deduct losses generated by depreciation, as a shareholder’s basis may be insufficient to absorb them.

For some S corporations, another tax consideration is the passive investment income tax. This tax applies to S corporations that were previously C corporations and still hold earnings from their C corp years. If more than 25% of the corporation’s gross receipts come from passive sources like rent, a corporate-level tax could be triggered.

Selling or Distributing the Property

When an S corporation sells its real estate to an outside party, the corporation calculates the gain or loss by subtracting the property’s adjusted basis from the sale price. This gain or loss is then passed through to the shareholders on their Schedule K-1s and reported on their personal tax returns. The character of the gain is often a Section 1231 gain, which can be treated as a long-term capital gain.

A potential complication in a sale is the Built-In Gains (BIG) tax. This tax applies if the S corporation converted from a C corporation and sells an asset that had appreciated in value during its time as a C corporation. The tax is levied at the corporate level on this gain and applies to sales occurring within a five-year recognition period.

A significant tax trap arises when an S corporation distributes the property to a shareholder instead of selling it. Under Internal Revenue Code Section 311, the distribution is treated as a “deemed sale,” meaning the corporation must act as if it sold the property to the shareholder for its current fair market value. This triggers recognition of the full gain at the corporate level, which then flows through to all shareholders.

This deemed sale creates a taxable event for the shareholders, who must pay tax on their share of the phantom gain. The distribution itself is a separate event that is measured against the shareholder’s stock basis. If the fair market value of the distributed property exceeds the shareholder’s basis, the shareholder may have to recognize a second, separate gain.