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Wednesday, June 20, 2018

C Corporation Acquisitions and the TCJA


Investing in real estate oftentimes means holding the property in diverse types of corporations or partnerships. If you’re looking to purchase property and it’s held by a C corporation, you need to know the IRS rules for this type of entity, which were affected by the Tax Cuts and Jobs Act.

Double taxation and the TCJA

Generally, owners of C corporations that hold real estate may prefer to sell the corporation’s stock rather than incur the “double taxation” that the IRS imposes if the real estate is sold and the proceeds distributed to the stockholders. To facilitate a quick transaction, the owners might, therefore, reduce the price if purchasers take on their corporate structure.

However, a lower purchase price isn’t the end of the deal. For many years, double taxation has been one of the primary disadvantages of a C corporation. That is, the IRS first taxes the corporation’s profits at the corporate level. Then, if the corporation pays out some of its profits as dividends, the IRS also taxes dividend recipients.

The TCJA did soften the bite of this double taxation. Previously, a C corporation’s tax rate was one of several different brackets, up to a maximum of 35%. Add to that the 20% tax on the dividends when paid out to shareholders. Under the TCJA, there’s now a flat corporate tax of 21%, plus the same tax on dividends.

Transfer taxes and the deal

The cost of the deal could be affected by transfer taxes that commonly range from 0.1% to 5.0% of the real estate’s value, depending on the property’s location. Some states and numerous municipalities impose a transfer tax on indirect transfers of ownership in real estate. They don’t require the recording of a deed, change of name or bill of sale.

In such jurisdictions, the mere transfer of a “controlling interest” in a legal entity is considered a taxable transfer of real property. A controlling interest is usually defined as more than 50% of the ownership interests in the entity, although the percentage varies depending on the state.

Two general approaches are taken for determining whether a transaction triggers the transfer tax. First, under the broad approach, the jurisdiction taxes any transfer of a controlling interest in an entity that owns real estate in the jurisdiction.

Under the more narrow approach, the jurisdiction taxes transfers of controlling interests only if the entity being transferred was primarily in the business of owning real estate (often determined by comparing its real estate activity with its total activity). It’s the law of the jurisdiction where the real estate is located that applies, not the law of the jurisdiction of the C corporation’s incorporation or of the purchaser.

But transfer taxes aren’t the only thing you should be concerned about. For example, you’ll need to keep in mind that the apparent value of the real estate could be undermined by pre-existing legal liabilities, such as tax delinquencies.

A few more considerations

Another possible downside: Ongoing tax losses—which are common with real estate activities—can’t be used to offset a shareholder’s other income, because the losses are inside the corporation.

Generally, it isn’t advantageous to convert a C corporation to S corporation status, because of the taxes owners would face on built-in gains. And under the TCJA changes, the effective tax rate for S corporations is now typically higher than the 21% tax rate for C corporations. Converting to a limited liability company may also have substantial negative tax consequences, because the IRS will treat it as a liquidation.

When you buy C corporation stock, your tax basis in its real estate holdings isn’t impacted, as it would be if you had purchased the assets. While you, as the new owner, have tax basis in your stock equal to your purchase price, the depreciable assets inside the corporation simply continue to be depreciated as they were before.

Get the right information

While the TCJA made positive changes to the tax implications of C corporations, there’s more to the story. Be sure to consult with your tax advisor to make sure you have the most up-to-date information about a possible acquisition of a C corporation. Better safe than sorry.

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