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PDtax
PDtax, CPA firm owner
Category: Tax
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Experience:  32 years tax experience, including four years at a Big 4 firm.
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This is for PD Tax. Can you supply specifics regarding the

Customer Question

This is for PD Tax.

Can you supply specifics regarding the following:

S corp shareholders can only deduct losses up to their basis or at risk limitation, which generally does not include mortgage indebtedness. Partners can deduct more, since they are personally liable. (Can you explain what you mean by more? Can you explain why?)

Long term real estate holding is the greatest wealth builder I know of. As a property grows in value, it can be refinanced, and the value distributed to its owners. S corp shareholders are taxed on distributions in excess of their basis as capital gains. Partners do not feel this pain. (Why not?)

Also, can you explain the difference as to how the built-in gain or loss on contributed property is handled by the partnership and the S corporation?
Submitted: 1 year ago.
Category: Tax
Expert:  PDtax replied 1 year ago.

PDtax :

Thanks again, here's some follow up to our original question/answer session.

Expert:  PDtax replied 1 year ago.
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Expert:  PDtax replied 1 year ago.
Can you supply specifics regarding the following:

S corp shareholders can only deduct losses up to their basis or at risk limitation, which generally does not include mortgage indebtedness. Partners can deduct more, since they are personally liable. (Can you explain what you mean by more? Can you explain why?) Partners can 'go negative' in their equity account, and often the losses are not suspended. S corp shareholder losses are limited to the basis and at risk limitations (essentially what I call the 'skin in the game'). Partners can obtain basis from the entity debt, while S corp shareholders have a much harder time doing so.


Long term real estate holding is the greatest wealth builder I know of. As a property grows in value, it can be refinanced, and the value distributed to its owners. S corp shareholders are taxed on distributions in excess of their basis as capital gains. Partners do not feel this pain. (Why not?) Another limit to S corp capital. Once your S corp capital is exhausted, and you don't have at risk to fall back on, distributions to you of any kind are capital gains. This could even be proceeds from a mortgage refinance. Partners do not have that trigger.

Also, can you explain the difference as to how the built-in gain or loss on contributed property is handled by the partnership and the S corporation?

Built in gain property for a partnership first:

704(c) built in property gain (property contributed by a partner with built in gains) will, when sold, be allocable to the partner who originally contributed it. Treas. Reg. § 1.704-3(b) outlines the post-gain allocation methods, but the partnership agreement is looked to first for allocation.

Built-in gain property with nonrecourse debt that is also transferred further complicates the math. In the case of a partnership, when such property is contributed only that portion of the liability of which the contributing owner is considered relieved creates a potential tax problem. The relieved liability constitutes a deemed cash distribution to that contributing partner, and taxes are charged on relief in excess of the partner’s outside basis under IRC sections 752 and 731.

Also, depreciation of built in gain property in the partnership are set up so that the contributing partner does not get to benefit from the larger depreciation amount generated from transfer. This makes sense, if you think about it. Why should a partner be allowed to contribute his property and get increased depreciation?

Disguised sales, subsequent sales of contributed property, distributions of other property as part of the contribution, and basis adjustments at a partner's passing, all have additional rules to eliminate the benefit of the gain to the contributing partner.

S corp property contributions require shareholder control immediately after transfer under 351. Assumption of affiliated debt happens frequently for S corp transfers as well.

In the case of a contribution of appreciated property to an S corporation in order to obtain tax deferral, IRC section 351(a) requires that the transferor shareholder, along with all other shareholders making contemporaneous contributions of property, control the corporation immediately after such transfer, and IRC section 368(c) requires that the transferring shareholders control 80% or more of the stock.

In the case of an S corporation, there is no special allocation of any precontribution gain or loss when the property is sold.

When encumbered property is contributed to an S corporation, and the entity assumes the underlying liability, realized gain is recognized under IRC section 357(c) by the shareholder to the extent that the assumed liability exceeds the tax basis of all her contributed property.

We have been asked not to copy and paste other authors' work for our answers here. As you know, tax law analysis is very specific, but I have tried to adhere to that instruction from the site management. The analysis is rewritten for you, but the sources listed must be credited.

More detail can be provided at the following web addresses: http://www.nysscpa.org/cpajournal/2002/1002/features/f104002.htm, http://tax.ncbar.org/newsletters/oct2010taxassessments/appreciatedproperty.

Thanks again for asking at Just Answer. I'm PDtax.

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