sell home to your corp or LLC to become a rental and claim $500k exemption?


D

Dick Adams

Alan said:
inky dink wrote:
There is an AICPA Case Study that supports this theory because
Sec. 121 does not have any language that prohibits it when the
sale is to a related party. It is based on a private letter ruling
relating to the old Section 1034 deferral of capital gain on the
sale of your main home if you reinvest the proceeds in a new
home within two years. That section did not have any language
that prohibited the deferral of gain when the sale was to a related
party where it would be depreciable property.

You can read it here:
http://www.aicpa.org/pubs/taxadv/jul2008/casestudy.html
For the purpose of argument's sake, let's presume you can do this.
Now tell me who is going to give your S-Corp a mortgage so you
can have the proceeds from the sale? Is there a State other than
California where mortgages do not have a "due on sale" clause?

If you want a workable legal exploitation of the tax code, consider
this. A Dentist buys a lot zoned commercial, gives a 20 year lease
of the land to a Professional Corporation which in turns builds a
house to be used as its office and as offices leased to others, the
PC pays the mortgage from the rents and depreciates the building.
After 20 years or more, the Dentist terminates the lease, removes
the tenants, sells her/his primary residence taking the $250K/$500K
exemption, lives in the house for two years, and then sells it taking
the exemption again.

The difference between this scenario and the OP's scenario is:
1) Economic Substance;
2) The ability to get a mortgage; and
3) Triple dipping (two exemption and 20+ years of depreciation).

This can also be done by someone in the rental housing business
who converts rental units into their primary residence every 2+
years.

The tax code favors people who engage in tax planning.

Dick
 
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S

Stuart Bronstein

For the purpose of argument's sake, let's presume you can do this.
Now tell me who is going to give your S-Corp a mortgage so you
can have the proceeds from the sale? Is there a State other than
California where mortgages do not have a "due on sale" clause?
Due on sale clauses are now permitted with respect to all loans made
by federally chartered or insured banks, due to federal regulations
promulgated a few years ago.

California had, by court decision, outlawed them as unreasonable
restraints on alienation as contrary to public policy. But since
such a large percentage of loans now do properly contain these
clauses, it would be hard to continue to argue that they're contrary
to public policy.

As a practical matter lenders will generally allow transfer to a
borrower's wholly owned corporation, since the legal liability
doesn't change much if at all - at least not in California.
If you want a workable legal exploitation of the tax code,
consider this. A Dentist buys a lot zoned commercial, gives a 20
year lease of the land to a Professional Corporation which in
turns builds a house to be used as its office and as offices
leased to others, the PC pays the mortgage from the rents and
depreciates the building. After 20 years or more, the Dentist
terminates the lease, removes the tenants, sells her/his primary
residence taking the $250K/$500K exemption, lives in the house for
two years, and then sells it taking the exemption again.
If he's the only owner of the corporation, receiving the property in
his own name might constitute a taxable redemption to the extent its
market value exceeds his basis in the corporation.

If you're talking about an S-corp that conclusion would be different.
The difference between this scenario and the OP's scenario is:
1) Economic Substance;
2) The ability to get a mortgage; and
3) Triple dipping (two exemption and 20+ years of depreciation).

This can also be done by someone in the rental housing business
who converts rental units into their primary residence every 2+
years.

The tax code favors people who engage in tax planning.
As one prominent federal judge famously said many years ago, it's ok
to avoid taxes, just not to evade them.

Stu
 
A

Alan

Dick said:
For the purpose of argument's sake, let's presume you can do this.
Now tell me who is going to give your S-Corp a mortgage so you
can have the proceeds from the sale? Is there a State other than
California where mortgages do not have a "due on sale" clause?

If you want a workable legal exploitation of the tax code, consider
this. A Dentist buys a lot zoned commercial, gives a 20 year lease
of the land to a Professional Corporation which in turns builds a
house to be used as its office and as offices leased to others, the
PC pays the mortgage from the rents and depreciates the building.
After 20 years or more, the Dentist terminates the lease, removes
the tenants, sells her/his primary residence taking the $250K/$500K
exemption, lives in the house for two years, and then sells it taking
the exemption again.

The difference between this scenario and the OP's scenario is:
1) Economic Substance;
2) The ability to get a mortgage; and
3) Triple dipping (two exemption and 20+ years of depreciation).

This can also be done by someone in the rental housing business
who converts rental units into their primary residence every 2+
years.

The tax code favors people who engage in tax planning.

Dick
I'm going to assume that your two questions are rhetorical and
you are not looking for an answer.

For the record, I don't advocate entering into such a transaction
without getting a PLR.

P.S. Re California. I believe there is a federal law that makes
due on sale clauses on loans from federal banks enforceable in
all states. In addition, CA Civil Code 2924.6 appears only to bar
enforcement in limited situations.

2924.6. (a) An obligee may not accelerate the maturity date of
the principal and accrued interest on any loan secured by a
mortgage or deed of trust on residential real property solely by
reason of any one or more of the following transfers in the title
to the real property:
(1) A transfer resulting from the death of an obligor where
the transfer is to the spouse who is also an obligor.
(2) A transfer by an obligor where the spouse becomes a
coowner of the property.
(3) A transfer resulting from a decree of dissolution of the
marriage or legal separation or from a property settlement
agreement incidental to such a decree which requires the obligor
to continue to make the loan payments by which a spouse who is an
obligor becomes the sole owner of the property.
(4) A transfer by an obligor or obligors into an inter vivos
trust in which the obligor or obligors are beneficiaries.
(5) Such real property or any portion thereof is made subject
to a junior encumbrance or lien.
(b) Any waiver of the provisions of this section by an
obligor is void and unenforceable and is contrary to public policy.
(c) For the purposes of this section, "residential real
property" means any real property which contains at least one but
not more than four housing units.
(d) This act applies only to loans executed or refinanced on
or after January 1, 1976.
 
I

inky dink

Dick Adams said:
For the purpose of argument's sake, let's presume you can do this.
Now tell me who is going to give your S-Corp a mortgage so you
can have the proceeds from the sale? Is there a State other than
California where mortgages do not have a "due on sale" clause?

If you want a workable legal exploitation of the tax code, consider
this. A Dentist buys a lot zoned commercial, gives a 20 year lease
of the land to a Professional Corporation which in turns builds a
house to be used as its office and as offices leased to others, the
PC pays the mortgage from the rents and depreciates the building.
After 20 years or more, the Dentist terminates the lease, removes
the tenants, sells her/his primary residence taking the $250K/$500K
exemption, lives in the house for two years, and then sells it taking
the exemption again.

The difference between this scenario and the OP's scenario is:
1) Economic Substance;
2) The ability to get a mortgage; and
3) Triple dipping (two exemption and 20+ years of depreciation).

This can also be done by someone in the rental housing business
who converts rental units into their primary residence every 2+
years.

well, I am not a dentist and I do not play one on TV . . .

my question: will the depreciation need to be recaptured, or will the
$250k/$500k exemption cover this? in other words, might he have a lot of
depreciation recapture and not much gain that could be subject to the
exemption?

Also, I think a good case could be made for economic substance for the
original question, i.e. wanting to limit liability, etc.
 
S

Stuart Bronstein

inky dink said:
my question: will the depreciation need to be recaptured, or will
the $250k/$500k exemption cover this? in other words, might he
have a lot of depreciation recapture and not much gain that could
be subject to the exemption?
Do you mean after it's owned by the corporation? Remember that the
corporation will be the legal owner, and isn't entitled to the
exemption. In addition, you only get the exemption to the extent
it's used as a residence. So the answer is no.

On the other hand if, when it's fully depreciated, you dissolve the
corporation, take the house back and use it as a residence again, you
will be eligible for the exemption again after another two years.
However upon taking the house back you will then be required to claim
a capital gain to the extent the value of the property exceeds your
basis in the corporation.
Also, I think a good case could be made for economic substance for
the original question, i.e. wanting to limit liability, etc.
You can transfer the property to a corporation without tax
consequences. There is no economic need to sell it. So I think the
economic substance argument could well fall flat.

Stu
 
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B

Bill Brown

One final comment with regard to corporations.

IRC Section 351 is not an election.
 
S

Stuart Bronstein

Bill Brown said:
One final comment with regard to corporations.
IRC Section 351 is not an election.
Right. If you fit within its ambit, there's no tax effect on a
transfer to a corporation.

The suggested scenario is not the typical §351 situation, so it's not
obvious that it would apply. But I can certainly imagine the IRS
arguing it, and a court being convinced by it.

Stu
 
I

inky dink

Alan said:
There is an AICPA Case Study that supports this theory because Sec. 121
does not have any language that prohibits it when the sale is to a related
party. It is based on a private letter ruling relating to the old Section
1034 deferral of capital gain on the sale of your main home if you
reinvest the proceeds in a new home within two years. That section did not
have any language that prohibited the deferral of gain when the sale was
to a related party where it would be depreciable property.

You can read it here:
http://www.aicpa.org/pubs/taxadv/jul2008/casestudy.html

The letter ruling is 8350084.

given what has transpired in this thread, what do people think of the AICPA?
do they publish specious stuff? Is this an anomaly? Might they be on to
something?
 
D

Dick Adams

Do you mean after it's owned by the corporation? Remember
that the corporation will be the legal owner, and isn't
entitled to the exemption.
No, the Dentist owns the land and leases it to the corporation.
On the other hand if, when it's fully depreciated, you
dissolve the corporation, take the house back and use it
as a residence again,
The corporation does not need to be dissolved because it
never owned anything except the lease.

Let me spell it out again.
1. Dentist buys land and leases the land to a corporation
owned by Dentist and other shareholders. Lease should
be 20-25 years.
2. Corporation can be a PC, an LLC or an S-Corp or whatever.
3. Corporation gets financing and builds house to be as
offices by Dentist and other shareholders as a leasehold
improvement.
4. Dentist, other shareholders, and other tenants pay rent.
5. Corporation uses rents to maintain property and pay off
mortgage. Corporation depreciates house per term of
lease and distributes profits to shareholders.
6. Lease ends and corporation has no assets other than common
furniture which it can sell and distribute cash received
to shareholders.
7. All tenants relocate.
8. Dentist receives leasehold improvements, rehabs into
personal residence, lives there for at least two years
sells land and house, and takes $250/500K exemption.
9. During this time, Dentist goes to church every week and
that Congress does not modify tax exemption against
Dentist's self-interest.

Please note that this is not a D-I-Y project. <g>

The original question was selling your primary residence
to an S-Corp you own so you can start depreciating it at
FMV instead of basis. That transaction has no economic
substance beyond taxation. The transaction outlined above
"should" work because there is economic substance and there
are multiple shareholders at risk for both the financing
and the lease.

Dick
 
S

Stuart Bronstein

No, the Dentist owns the land and leases it to the corporation.
Thanks for the clarification. That makes a lot more sense.
Let me spell it out again.
1. Dentist buys land and leases the land to a corporation
owned by Dentist and other shareholders. Lease should
be 20-25 years.
2. Corporation can be a PC, an LLC or an S-Corp or whatever.
3. Corporation gets financing and builds house to be as
offices by Dentist and other shareholders as a leasehold
improvement.
4. Dentist, other shareholders, and other tenants pay rent.
5. Corporation uses rents to maintain property and pay off
mortgage. Corporation depreciates house per term of
lease and distributes profits to shareholders.
6. Lease ends and corporation has no assets other than common
furniture which it can sell and distribute cash received
to shareholders.
7. All tenants relocate.
8. Dentist receives leasehold improvements, rehabs into
personal residence, lives there for at least two years
sells land and house, and takes $250/500K exemption.
9. During this time, Dentist goes to church every week and
that Congress does not modify tax exemption against
Dentist's self-interest.
That's brilliant!!! As I recall leasehold improvements by the tenant
are not considered taxable income to the landlord. There's no
depreciation on the raw land, so there's nothing to recapture.

Stu
 
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D

Dick Adams

Stuart Bronstein said:
(e-mail address removed) (Dick Adams) wrote:

That's brilliant!!! As I recall leasehold improvements by
the tenant are not considered taxable income to the landlord.
There's no depreciation on the raw land, so there's nothing
to recapture.
Thank you, but unfortunately I can't take credit for it as
I read the idea 35 to 40 years ago.

Dick
 
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D

Dick Adams

Alan said:
There is an AICPA Case Study that supports this theory
because Sec. 121 does not have any language that prohibits
it when the sale is to a related party. It is based on a
private letter ruling relating to the old Section 1034
deferral of capital gain on the sale of your main home if
you reinvest the proceeds in a new home within two years.
That section did not have any language that prohibited the
deferral of gain when the sale was to a related party
where it would be depreciable property.

You can read it here:
http://www.aicpa.org/pubs/taxadv/jul2008/casestudy.html

The letter ruling is 8350084.
First of all, this is NOT an AICPA Case Study, but rather it
is a Case Study written by a Tax Attorney who adapted it from
PPC's "Guide to Tax Planning for High Income Individuals" and
published in the July 2008 issue of "The Tax Adviser". There
is no indication that the Case Study was subjected to rigorous
peer review.

Second, this Case Study is based on a PLR that appears to have
been issued in 1983 under the pre-1986 Tax Act rules for tax
deferment on the sale of primary residences. IMRHO a 25 year
old PLR is of questionable reliability. Also I am under the
impression that PLR's are only relevant for the person who
requested the PLR.

Third, today someone wrote in another thread "depreciation
recapture and the homeowners exemption" that the "Housing
and Recovery Act of 2008" has changed the rules for
Depreciation Recapture of rental property to primary
residence conversions effective 1 January 2009. If that
is correct, the tax benefits of such conversions have been
greatly diminished.

Finally, an Auditor can disallow anything for any reason
shifting the burden of proof to the taxpayer. I read it
in a book, a newsletter, or on the Internet has never been
an acceptable defense.

If I was still a University Professor, I would assign this
Case Study as a research project in a Graduate course in
either Taxation or Auditing and would be impressed by a
paper that was able to defend it.

Dick
 

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