When property is added to a business, depending on the entity type, there will be varying tax implications. Here, we’ll talk about what happens when the property is either sold or distributed to the owners.
Entity Choice: C-Corporations and S-Corporations
Put a building in a C corporation, and it is not coming back out without triggering two levels of tax (within the corporation itself and to the shareholder). Contribute the property to an S corporation instead, and the property can’t come back out without triggering corporate-level gain that will be passed to the member.
Entity Choice: Partnerships
But, place appreciable real estate into a partnership, and when it is distributed back to the partner, the partner will take a basis in the property equal to the lesser of the partnership’s basis or the partner’s basis in the partnership. Thus, gains will not be recognized until the property is sold.
While appreciated property can be put into a corporation free from tax, it cannot come out without some gain being recognized. Partnership law, however, provides tax-deferral options. Sections 731 and 732 of the code combine to say that when a partnership distributes property to a partner in a current distribution, generally, no gain or loss is recognized by either the partnership or the partner.
Instead, the partner takes a basis in the distributed property equal to the lesser of the partnership’s basis in the distributed property or the partner’s outside basis in the partnership interest.
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