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Christopher Phelps
Christopher Phelps, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 2710
Experience:  CPA, CFP, PFS, Tax Practitioner 21 Years, Member AICPA/CSCPA Tax/Financial Planning Committee Member
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IRC 351 question

Resolved Question:

We are in the process of selling a piece of property that is not our primary residence. The selling price is 190k and we live in California. We have decided not to seek a 1031 exchange. We are also presently setting up a corporation. Will we be able to take advantage of the IRC 351 exemption for corporations with such a new corporation? The corporation would be in place before the close of escrow.
Submitted: 11 years ago.
Category: Tax
Expert:  Christopher Phelps replied 11 years ago.

IRC Section 351 prevents the recognition of gain (or loss) on the transfer of property to a corporation in exchange for stock that is substantially owned by the same persons who owned the property.

When the corporation sells the property, the gains will be subject to taxation at the corporate level (at the corporate marginal tax rate since there is no corporate capital gains rate like the 15% available to individuals). Any gains you pull out of the corporation would then be subject to another layer of taxation as either dividends received by you, capital gains or as salary depending on how you structure the payout. Transferring real estate to a corporation would be unwise unless you have a specific corporate use for it. Even then I would recommend yu hold the property in at least a wholly owned sub-LLC of the corporation.

Since a 1031 exhange is not viable and there is no other exclusion available (i.e. IRC Sec. 121), your best bet to reduce the tax hit is to make sure you calculate the gain properly.

The difference between your net sales price and your cost basis (adjusted for improvements and depreciation) is your capital gain.

Your net sales price is the contract selling price less any selling costs (i.e. broker commissions and other transaction costs as well as fix-up expenses for the real property is involved).

Your cost basis is determined by taking your original purchase price (plus any non-recurring closing costs) and adding the cost of any improvements made during ownership and then subtracting any allowable depreciation (whether claimed or not). If you inherited the property you would claim as your acquisition cost the value for the asset claimed in the decedents estate tax return. If no estate tax return was filed then you use the fair market value of the asset (supported by an appraisal if not readily determinable) as of the date of death.

If you own the property for more then one year, then the gain will be treated as a long-term gain and will be taxed up to a maximum capital gain rate of 15% (5% if the gain would otherwise be taxable in the 10% and 15% brackets). Otherwise the gain is treated as a short-term capital gain and to the extent not offset by other capital losses will be considered as ordinary income the same as wages and interest subject to whatever your marginal tax rate is.

Don't forget state taxes. If the property was located in a state other then in your state of residence, you will likely need to file a return in that state as well. Your resident state will likely give you credit for any taxes paid to the other state on your resident state income tax return (if any).

Because it is impossible for me to identify and consider ALL the relevant facts, this advice is not intended or written to be used for the purpose of avoiding penalties, and cannot be used for that purpose.

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