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.
Ask the adviser
To ask a question on Tax Talk, go to the "Ask the Experts" page and select "Taxes" as the topic. Read more Tax Talk columns.
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.
Bankrate's content, including the guidance of its advice-and-expert columns and this website, is intended only to assist you with financial decisions. The content is broad in scope and does not consider your personal financial situation. Bankrate recommends that you seek the advice of advisers who are fully aware of your individual circumstances before making any final decisions or implementing any financial strategy. Please remember that your use of this website is governed by Bankrate's Terms of Use.