S-Corp Taxes on Upside-Down Property
Dear Tax Talk,
My brother and I set up an S corporation to buy and sell real property. When the market collapsed, we were stuck with a home that cost us $500,000 with a $400,000 mortgage and $300,000 value. My brother couldn't keep up with the payments and gave his stock to me. Can I terminate the corporation and recognize the $200,000 loss? How do I figure S-corp taxes?
- Remaining Bro
Dear Remaining Bro,
The general rule is that a liquidating corporation recognizes a gain or loss on the difference between its basis in the property ($500,000) and the value of the property distributed ($300,000). This would mean the corporation would have a $200,000 loss on liquidation, which would flow through to you as a shareholder. However, when the property is subject to a liability, the value cannot be considered to be less than the amount owed. Since the mortgage is $400,000 and the value is $300,000, the mortgage balance becomes the value for liquidation purposes. Hence the corporation is limited to recognizing a loss of $100,000 upon liquidation.
If the property was used as rental property, the loss would be a Section 1231 loss or treated as an ordinary loss to you on your Schedule K-1. Otherwise, it might be considered capital loss. Your basis in the asset becomes $400,000. If you later sell it for less than $400,000, you would recognize that additional loss.
There are certain other limitations, which don't seem to be present here. However, I advise you seek the assistance of a qualified CPA in preparing your taxes to be certain you don't run afoul of any rules.
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