Jump to content
ATX Community

1031 Exchange, S-Corp Owned Land


G2R

Recommended Posts

Client is a 75% owner in an S-Corp.  The S-corp owns property that is about to sell for big bucks.  Client wanted to do a 1031 exchange but wants to be 100% owner of the new properties.  I explained that usually the same owners must sell and buy the exchanging properties in a 1031 exchange. 

If the S-corp buys out the 25% owner shares, then my client becomes 100% owner of the S-corp and can proceed with the 1031 exchange under the S-corp umbrella.   What do you think?

Is there any advantage or disadvantage to 1031 occurring BEFORE the 25% shareholder is bought out? 

Link to comment
Share on other sites

1 hour ago, G2R said:

So the 25% SH needs to be out BEFORE the 1031 happens or the entire gain will be recognize.  

That's my impression subject to the following:

"There are some scenarios where shareholders of an S corp can complete a 1031 exchange on legacy assets, but that requires owning and operating the asset as an active business investment -- likely the exact opposite scenario when dissolution of the corporation is the main objective or when shareholders are at loggerheads due to competing financial interest"

  • Like 1
Link to comment
Share on other sites

3 hours ago, G2R said:

So the 25% SH needs to be out BEFORE the 1031 happens or the entire gain will be recognize. 

 I don't see why.  As long as the property remains in the s-corp after the 1031 there is no gain recognized.  Your client can buy out 25% shareholder either  before or after, but replacement property must remain in the corp.

Link to comment
Share on other sites

4 hours ago, G2R said:

rules for shareholder buyout and 1031 timing.  

There are not any specific rules for that.  You just follow code 1031 and apply it to the entity level which is the corporation.  Then you follow the rules for shareholders.  Your client has the advantage of owning 75%, so that puts him in the drivers seat.

 

Link to comment
Share on other sites

1 hour ago, DANRVAN said:

There are not any specific rules for that.  You just follow code 1031 and apply it to the entity level which is the corporation.  Then you follow the rules for shareholders.  Your client has the advantage of owning 75%, so that puts him in the drivers seat.

 

Ok, between your article @DANRVAN and the one @cbslee linked, I think this is how it goes. 

Cbslee's article discussed one shareholder wanting 1031 & the other wanting to cash out.  What I thought they were saying was that it's all or nothing.  If any cash is taken by a SH, then the entire 1031 exchange is taxable.  But actually, reading it a second time, what it's saying is, the portion not reinvested is recognizable proportionate to the SH ownership. (Typical 1031 stuff.)

Say they sell property for $100. Shareholder A wants to 1031 his portion, the company reinvests $75 into a like-kind property and no gain recognition will occur on that.  But SH B wants their portion for themselves, so if they distribute $25 to themselves, that triggers gain recognition to the shareholders based on ownership. (25% of the sale's proceeds aren't reinvested, so SH A would have to recognizes 75% of that 25%'s gain!)   That's unfair to SH A, but that's how it would play out.  

So, I'm not seeing a way around 50% of of the gain being recognized by the SHs without financing the stock buyout. 

  • 25% would be recognized by SH B when he sells his stock in the company. 
  • 25% of the $100 would be recognized when it's not reinvesting in like-kind property & instead used to buy SH B's stock. (Unless he gets a loan from a bank and finances the stock buyout.)

The timing of the SH buyout is irrelevant. 

Then I found this article: https://legal1031.com/1031-exchange-resources/1031-exchanges-s-corporations/

In the article, they give a potential solution, but I'm struggling to understand OPTION 3's execution.  

Link to comment
Share on other sites

6 hours ago, G2R said:

That's unfair to SH A, but that's how it would play out.

If shareholder A is 75% and wishes to "own" 100% of the property as sole shareholder he will have to pay a price one way or another.   So his choices are basically to buy out the shares of B or pay tax on his share of the gain if proceeds from the sale are not fully invested in replacement property.

 

6 hours ago, G2R said:

Say they sell property for $100. Shareholder A wants to 1031 his portion, the company reinvests $75 into a like-kind property and no gain recognition will occur on that.

Gain is recognized at that point and allocated to the shareholders since less than 100% of the proceeds were reinvested.  Then the cash from the sale is used to redeem the stock of B and A becomes 100% shareholder.

 

6 hours ago, G2R said:

struggling to understand OPTION 3's execution.  

That would involve a corporate reorganization coordinated with the 1031 where each shareholder ends up with a separate company; which in turn hold their separate replacement properties.  Does not sound like the direction your client wants to go.

  • Like 2
Link to comment
Share on other sites

15 hours ago, G2R said:

 That's unfair to SH A, but that's how it would play out.

You might be surprised on how that would work out.

Say for example the only asset of the corp was bare land in a prime location, basis of 100,000 and fmv of 200,000, clear title.

So B's stock value of 25% = 50,000.

First option is  for A to buy B's stock for 50,000 out right if he has the cash, either before or after 1031 transaction with zero boot received.

If he does not have the cash,  the property can be sold through a partial 1031 and 50,000 of cash received, which is used to redeem B's stock. 

Then a gain of $50,00 is recognized.  A's 75% share of the gain is 37,500.  Assume the gain is taxed at 15% federal and 10% state for a total of $9,375.

So now instead of spending 50,000 to become 100% owner of corp worth $200,000, he has paid $9,375 in taxes to to become 100% owner of a corp worth $150,000.

A third option is to complete the 1031 in whole, then borrow 50,000 against the replacement property at the corporate level.  The $50,00 is then used to redeem the 25% stock owned by B.  In that scenario A has not spent any money personally to become 100% owner in a corp worth $150,000, including a note payable of $50,000.  Also, "A" does not incur a tax bill under that option.

Hope I am not overlooking anything here, but if you run the numbers for your client he or she will have some solid footing to make a decision.

 

  • Like 1
Link to comment
Share on other sites

Thank you @DANRVAN for all your insight on this.  It's good to hear another professionals advice on the matter.  You're 2nd option for the buyout if they don't have cash is what I was trying to explain in my post above (obviously not well).  I've referenced my thoughts in Red below.  If you see something drastically different than you analysis, please let me know.  I want to learn.

16 hours ago, G2R said:

Say they sell property for $100. Shareholder A wants to 1031 his portion, the company reinvests $75 into a like-kind property and no gain recognition will occur on that (partial 1031).  But SH B wants their portion for themselves, so if they distribute $25 to themselves that triggers gain recognition to the shareholders based on ownership. (25% of the sale's proceeds aren't reinvested, so SH A would have to recognizes 75% of that 25%'s gain!)   That's unfair to SH A, but that's how it would play out.  (Meaning, he'd pay tax on the 25% not reinvested, though he doesn't get the money distributed to him if SH B takes it.  That's why it's a crap idea for SH A.)

So, I'm not seeing a way around 50% of of the gain being recognized by the SHs without financing the stock buyout.  (Meaning between the two SH, 50% of the realized gain would be recognized)

  • 25% would be recognized by SH B when he sells his stock in the company. 
  • 25% of the $100 would be recognized when it's not reinvesting in like-kind property & instead used to buy SH B's stock. (Unless he gets a loan from a bank and finances the stock buyout.) (see below)

 

43 minutes ago, DANRVAN said:

A third option is to complete the 1031 in whole, then borrow 50,000 against the replacement property at the corporate level.  The $50,00 is then used to redeem the 25% stock owned by B.  In that scenario A has not spent any money personally to become 100% owner in a corp worth $150,000, including a note payable of $50,000.  Also, "A" does not incur a tax bill under that option.

This is what I meant by the 2nd bullet point above. "25% of the $100 would be recognized when it's not reinvesting in like-kind property & instead used to buy SH B's stock. (Unless he gets a loan from a bank and finances the stock buyout.)  

Only problem is I asked the SH if he thought the bank would give me the loan with the recently acquired property as collateral, he said he didn't think so.  Seems odd though considering the loan would be for 25% of the property's value.  

I probably should have noted that BOTH SHs are my clients so the tax ramifications to both are important. 

Link to comment
Share on other sites

5 minutes ago, G2R said:

(Meaning, he'd pay tax on the 25% not reinvested, though he doesn't get the money distributed to him if SH B takes it.  That's why it's a crap idea for SH A.)

Would that be an actual distribution of cash, or would it be a redemption of B's stock so A becomes 100% shareholder?

 

9 minutes ago, G2R said:

.  Seems odd though considering the loan would be for 25% of the property's value.  

There could be a cash flow concern with making the payments.

The shares of B could also be sold to A on an installment. 

It is not clear here what the objectives are.  Is the idea to get shareholder B out?

Link to comment
Share on other sites

49 minutes ago, DANRVAN said:

Would that be an actual distribution of cash, or would it be a redemption of B's stock so A becomes 100% shareholder?

Redemption of B's stock so A become 100%.

50 minutes ago, DANRVAN said:

It is not clear here what the objectives are.  Is the idea to get shareholder B out?

The two SHs do not want to own the replacement property together.   Since the property is tied up in the S-corp, it seems getting B out offers the lowest tax cost overall.  A becomes 100% owner of the S-corp and can choose the property he wants inside the corp & B, with the SH buyout proceeds, can purchase whatever property he wants individually.    Does that sounds accurate? 

Link to comment
Share on other sites

18 hours ago, G2R said:

B, with the SH buyout proceeds, can purchase whatever property he wants individually.   

So B also wants property,  then they need to look at a 1031 followed by a corp split.   The exchange is completed before the split and two separate replacement properties are picked out by the respective shareholders.  The replacement properties are valued in proportion to each shareholders interest.  After the split each shareholder owns 100% of their respective company which holds their property.

That is a simplified explanation, you will need to do more research to determine if that is right path for your clients.

Link to comment
Share on other sites

Join the conversation

You can post now and register later. If you have an account, sign in now to post with your account.

Guest
Reply to this topic...

×   Pasted as rich text.   Restore formatting

  Only 75 emoji are allowed.

×   Your link has been automatically embedded.   Display as a link instead

×   Your previous content has been restored.   Clear editor

×   You cannot paste images directly. Upload or insert images from URL.

Loading...
  • Recently Browsing   0 members

    • No registered users viewing this page.
×
×
  • Create New...