Florida real estate investors often create limited liability companies to separate properties, organize ownership, and manage liability exposure. At some point, an investor's accountant or adviser may suggest making an S corporation election for an LLC to pursue potential payroll or self-employment tax advantages.
That election may be appropriate for an active operating business. For an LLC holding appreciating rental or investment real estate, however, the long-term tax consequences require careful review. One often overlooked concern is what happens to the property's tax basis when the owner dies.
An LLC and an S Corporation Are Not the Same Thing
An LLC is a legal entity formed under state law. An S corporation is a federal tax classification. A Florida LLC can therefore remain an LLC under Florida law while electing to be taxed as an S corporation for federal income-tax purposes.
The election does not merely change how the owner files a return. It places the LLC within the corporate tax framework. That distinction can become especially significant when the LLC owns real estate that has appreciated substantially.
Florida's tax law also distinguishes between LLCs classified as partnerships and entities taxed as corporations. Florida law states that an LLC classified as a partnership for federal income-tax purposes generally is not subject to Florida corporate income tax, illustrating why the federal classification matters.
Understanding Inside Basis and Outside Basis
Florida property owners reviewing how an LLC’s S corporation election may affect their real estate and heirs.
To understand the estate-planning concern, investors should distinguish between two assets:
- The owner's interest in the entity, often called the outside basis
- The real estate owned by the entity, often called the inside basis
Suppose an S corporation owns a rental property purchased for $300,000. After depreciation and years of appreciation, the property is worth $900,000, but its adjusted tax basis is only $180,000.
When the shareholder dies, the inherited S corporation shares may receive a new basis based on their date-of-death value if the requirements of federal tax law are satisfied. The corporation's basis in the rental property, however, generally remains $180,000. A court addressing a comparable corporate-trust structure concluded that the death and inheritance of the ownership shares did not give the entity a new basis in its underlying property.
This is the critical issue. The heirs may receive a basis adjustment in the S corporation stock, but not a corresponding adjustment in the real estate held inside the corporation.
Why the Missing Inside Step-Up Matters
If the S corporation later sells the property for $900,000, the entity generally calculates gain using its existing adjusted basis. In this example, that could mean approximately $720,000 of taxable gain before accounting for transaction costs, depreciation recapture, passive-loss rules, and other adjustments.
The gain generally passes through to the shareholders. A higher basis in the inherited shares may provide a separate tax benefit in certain transactions, such as a later sale or liquidation of the entity, but it ordinarily does not erase the gain recognized when the S corporation sells the property.
This can create a disappointing result for a family that believed the property itself would receive the same basis adjustment that directly inherited real estate might receive. It is more precise to say the S corporation election may prevent a basis adjustment at the property level, not that the heirs receive no basis adjustment at all.
Moving Property Out May Also Be Taxable
Investors should not assume the problem can be solved by deeding an appreciated property from the S corporation to the shareholder or the shareholder's revocable trust.
A corporate distribution of appreciated property may be treated as though the entity sold the property at fair market value. As a result, moving the property out of the S corporation can potentially trigger taxable gain even when no cash changes hands. As a general federal tax principle, a corporation recognizes gain when it sells, exchanges, or otherwise disposes of appreciated property.
Prior C corporation history, debt in excess of basis, depreciation recapture, suspended losses, and the timing of the S election can create additional complications.
Consider the Entire Ownership and Estate Plan
An S corporation election is not automatically wrong. The concern is using it without evaluating the type of income, expected appreciation, holding period, succession plan, and anticipated exit strategy.
Depending on the circumstances, investors may consider an LLC taxed as a disregarded entity or partnership, direct ownership coordinated with a revocable trust, or another structure developed with legal and tax advisers. No structure is appropriate for every portfolio.
Before electing S corporation treatment or transferring Florida real estate into an entity already taxed as an S corporation, review the plan with an estate-planning attorney and qualified tax professional. Correct planning at the beginning may be far easier than attempting to remove appreciated property later.
Practical Client-Focused Takeaways
- An S corporation election is a tax election, not a different form of Florida LLC.
- At death, the inherited shares may obtain a basis adjustment, while the entity's real estate generally does not.
- The distinction between stock basis and property basis can produce substantial taxable gain on a later property sale.
- Distributing appreciated real estate from an S corporation may itself trigger gain.
- Review the entity, deed, financing, depreciation history, and estate plan before making the election.
- Coordinate advice among the investor's estate-planning attorney, CPA, and tax counsel.
At Gold Legacy Law, PLLC we do not have tax returns but can recommend an experiences CPA if you have questions regarding this blog.
Disclaimer: This article is provided for informational purposes only and does not constitute legal advice. Reading this content does not create an attorney-client relationship between you and Gold Legacy Law. For legal advice regarding your personal situation, please contact our office to schedule a consultation.
