Residence owned by S-Corp

[SunTaxMan]

New client. Attorney drew up business purchase documents several years ago. The Shareholders' (husband and wife) live in a residence that is on the same property as, and included in, the deed of the real estate where the business is located. Real Estate is held by an LLC, reporting on Schedule C, separate from the business operation, reporting on 1120S.

For several years they have done nothing about the residence aspect of this situation. I am thinking there is a problem in simply ignoring this. It would seem that they should either be paying rent to the LLC (owner of the real estate) or have "personal use" added to the W-2.

To complicate things, there is no "mortgage" on the property. Real Estate and business purchase is included in a single "commercial loan" with payments being made by the S-Corp.

Or am I fretting unecessarily?

By the way, Happy Thanksgiving! We look forward to dinner with 3 of our 5 children and a number of grandchildren, cousins, etc., I hope your day is as wonderful as we anticipate ours to be.....

[OldJack]

As I see it you are the only one that thinks there is a problem. The property is owned by an LLC that is ignored for purposes of the real estate and income taxes. I don't understand the Sch-C filing as you have not mentioned any source of income from a real estate activity that would need to file a Sch-C. There is no requirement that the owners of personal real estate charge rent to a related company or unrelated company. Rent is usually only a problem when too much is being paid.

The commercial loan appears to just have personal assets for security. That is a common requirement for most S-corp loans.

I think you are just over analyzing the situation.

[jainen]

>>The commercial loan appears to just have personal assets for security<<

I don't completely understand how the purchase was set up, but the bottom line is that the cost of personal housing is being paid with corporate funds. The corporation does not own the property, so some kind of accounting is needed for the payment. Depending on the details, the two ideas in original post (rent or W-2) are probably the most reasonable choices. If treated as rent from the corporate employer, expenses would not be allowed.

Throwing an LLC into the mix is the current favorite scheme to hide the fact that personal expenses are being deducted from business income. When you remember that the IRS disregards the LLC, what this taxpayer (and his lawyer) are trying to pull off becomes clearer.

Speaking of lawyers, won't a plaintiff's attorney have fun with this, should a liability claim arise?

[OldJack]

>>To complicate things, there is no "mortgage" on the property<<

>>but the bottom line is that the cost of personal housing is being paid with corporate funds.<<

I disagree that the cost of housing is being paid by the corporation. There is no evidence that the corp loan is a substitute for a mortgage. It is common that a small business loan has to have security of personal assets.

[kcjenkins]

Well, let me just ask another question. What sort of business are we talking about here? If there is a legitimate business reason for them to live on the property then it is neither income to them nor an issue for the corp. I've seen this in situations where an auto repair business owned the house next to the business, where the owner lived, and took all the late night wrecker calls, for example. Dairy owners who live on the farm are, of course, the classic example. It's always a 'facts & circumstances' determination. There is no single answer that fits all cases.

[OldJack]

Of course further facts could have a bearing on the situation. However, as the question was posted it appears that, for tax purposes, the "individuals" own the real estate as a qualified residence. I operate a business from my personal residence and do not charge the business rent. Having the real estate in a LLC for liability protection associated with the business operating on or near the premise does not mean there is tax cheating going on. This is just cheap insurance. We should not take the position of the IRS and automatically assume there is something wrong in this case.

[jainen]

>>There is no single answer that fits all cases<<

No, but there is an extremely common answer, which is that homes owned or paid through a business entity are taxable compensation. This answer fits a very wide spectrum of business activity, but especially pass-throughs and LLCs. Even with the most generous terms of clergy rules, you can't automatically assume that the fringe benefit is non-taxable.

Maybe the property was held free and clear in the name of the sole proprietor LLC, and just added as security to a business loan since the business was going to be relocated onto that property. That's not how I read the original post, but it's as good a guess as any.

[SunTaxMan]

Old Jack,

You said, "I don't understand the Sch-C filing" -- my mistake, Schedule E.

You said, "The commercial loan appears to just have personal assets for security." Security for the Commercial Loan is Real Estate (land and buildings, including the house/residence), inventory at time of purchase, personal property for business functioning (shelving, office, storefront particulars).

You said, "I think you are just over analyzing the situation." Not an unusual reaction for me. I had a friend tell me once, "TR, you are the only person I know who, if I ask for the time, you will tell me how to build a clock!"

[SunTaxMan]

KC,

You said, "If there is a legitimate business reason for them to live on the property then it is neither income to them nor an issue for the corp." I don't see any "legitimate business reason" - they COULD live miles away and still operate the business.

[kcjenkins]

Now I'm confused. Didn't you tell us there was no mortgage involved? Now you say that the land and buildings are security for the loan?

[SunTaxMan]

KC,

You are correct. Thus the reason for both "confusion" and my uncertainty as to how to handle the situation.

There is NO "Mortgage" - no 1098 being issued.

The "loan" is a "Commercial Loan" with land, buildings, business (goodwill) and contents (at purchase date) -- all specified in the purchase agreement -- serving as collateral for the loan.

Payments (principal and interest) are being paid by the S-Corp. RE Taxes are being paid by the S-Corp. Utilities, insurance, etc, etc., are being paid by the S-Corp.

Welcome to my world.

Hope you had a great Thanksgiving.

[jainen]

>>The "loan" is a "Commercial Loan" with land, buildings, business (goodwill) and contents (at purchase date) -- all specified in the purchase<<

Please clarify whether the real estate was acquired with the proceeds of the commercial loan at the same time as the business, or was previously owned and just used as additional collateral.

[OldJack]

The "loan" is a "Commercial Loan" with land, buildings, business (goodwill) and contents (at purchase date) -- all specified in the purchase agreement -- serving as collateral for the loan.

The fact that the real estate is "titled" in the name of the LLC indicates that it is "owned" by the individuals and would imply to me that the S-corp should not be paying the real estate taxes and possible other expense items. If the S-corp is paying personal items, such expenses should be charged as distributions to the shareholders and not an expense to the business.

If the LLC did not actually purchase (pay for) the property but received a deed for the same, then there is a legal problem that the stupid attorney needs to correct or the LLC should sue him for malpractice on the real estate closing.

[SunTaxMan]

OldJack

You said, "If the LLC did not actually purchase (pay for) the property but received a deed for the same, then there is a legal problem that the stupid attorney needs to correct or the LLC should sue him for malpractice on the real estate closing."

Are you speaking with the authority of an Attorney, or just retaliatory rhetoric?

[jainen]

>>Are you speaking with the authority of an Attorney, or just retaliatory rhetoric? <<

I would guess it's rhetoric, STMan. He's trying to dramatize the implications of the question you keep avoiding. Obviously he is not rendering a legal opinion because he doesn't have the necessary facts to do so. That's the whole point.

What do you expect us to make of your original post, which says "Residence owned by S-Corp" in the heading but says "the LLC (owner of the real estate)" in the text? Then you say there's no mortgage but the loan is secured just like a mortgage.

You ask us how to handle it -- well, I suggest you start by clarifying whether your new client is the corporation or the shareholders. Or both, if you can resolve the conflict of interest. Anyway, the best way to handle it depends on which side you are on.

And the second thing I suggest is that you explain to us why the previous tax preparer quit. And that ain't just rhetoric.

[OldJack]

Are you speaking with the authority of an Attorney, or just retaliatory rhetoric?

Well... I am certainly not an attorney. I am sometimes pretty stupid but not that stupid.

I would say if you want us to discuss this situation further you should post us a list of exactly what the facts of the case are. Who owns what and how did they get it. Who is using what and how much of it.

[SunTaxMan]

Old Jack

I appreciate the caution regarding legal advice and don't consider user group posting as "law." But I do appreciate the advice and the counsel of those wiser than I am in such matters.

After seeing this thread develop, I am convinced I need to examine the purchase and loan agreements much more closely that I have so far - to determine exactly who DOES own what and WHO is in HOCK for the loan.

So far, I suspect that not separating the residence from the business real estate at the outset is the crux of the problem.

Taxpayer has said the Preparer they were using, both at the time of purchase and in the unsuing 4 years, has not questioned the purchase agreement, loan agreement or the "spreadsheet" information taxpayer submitted for return preparation. I suspect the absence of "appropriate questions of investigation" in the return preparation has "complicated" the taxpayer's situation. Taxpayer has said their CPA has said, "I don't know how to handle your situation, so am simply not addressing the issue. I take what information you provide and do the returns." Doesn't sound like good "Tax Practice" to me.

[OldJack]

Taxpayer has said their CPA has said, "I don't know how to handle your situation, so am simply not addressing the issue. I take what information you provide and do the returns."

That does not sound like what a CPA would say. It sound more like what the CPA's client would say about his non-CPA accountant. It might be an unlicensed accountant working for a CPA.

In fact, it is hard to believe that a CPA would prepare a S-corp tax return from just a spreadsheet provided by the client. It is common for a CPA to make adjustments to the business numbers as they are seldom, if ever, correct. Correcting them usually requires details from examination of the business records.