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Be Tax Savvy: Don’t Own Your Real Estate in an S-Corp

Tue, 18 Aug 2026 17:30:53 GMT

If your Accountant or someone else tells you to take title to Real Estate in an S-Corporation, don’t listen. Run the other way!

There are many adverse tax consequences if you own Real Estate in an S-Corporation. Many are detailed in the tables below.

Two of these adverse income tax consequences is that live or die, it’s a great gift to the IRS.

If you die owning Real Estate in an S-Corp, your heirs will inherit your unrealized capital gain when they sell the Real Estate.
When you own Real Estate in an S-Corp you forfeit the “step up in basis” that your heirs would enjoy if you had owned the Real Estate outright, or in a partnership, or an LLC.
“Step up in basis” is the Federal Income Tax Benefit that excuses your heirs from the obligation to pay tax on the unrealized appreciation of property they inherit.
If you sell the Real Estate in the S-Corp while you are alive,
you incur capital gains tax within the S-Corp, and then
are taxed again when you distribute the sales proceeds out of the S-Corp.
Yes, here’s a situation where your pay “double tax” even though you were told that the S-Corp is a “flow through entity”.

On the other hand, neither of these adverse income tax consequences arises if you own the Real Estate outright, in a partnership, or in an LLC (taxed as a disregarded entity or partnership).

The tables below give you more details about the comparison of owning Real Estate in an S-Corp compared with an LLC.

Real Estate: S-Corp v LLC 2025-10-30

Notes about S-Corps:

Under state law, there is no such thing as an “S-Corp” or a “C-Corp”. An S-Corp is the same as a regular corporation.
S-Corps and C-Corps are creatures of US Federal Income Tax Law. They are defined by US Federal Income Tax Law rules.
When forming, buying, selling, or merging an S-Corp or a C-Corp you must comply with both State Law and US Federal Income Tax Law.

Loss on Small Business Corporation Stock

Tue, 18 Aug 2026 17:17:42 GMT

Conclusions

Pursuant to Section 1244 of the Internal Revenue Code of 1986, as amended, up to $100,000 of the loss on the sale of stock (which includes the stock becoming worthless) of a Small Business Corporation in any one tax year can be treated as an Ordinary Loss and deducted in full against Ordinary Income. If the loss exceeds the Section 1244 limit, the excess will be a Capital Loss.

To report a loss on the sale or exchange of Section 1244 Stock,

Report the ordinary loss portion on IRS Form 4797, Part II
Report the balance of the loss that exceeds the 1244 loss maximum (capital loss portion) on IRS Form 8949

Discussion – Applies to Stock issued after November 6, 1978

Loss Treated as Ordinary Loss; not Capital Loss (1244(a)). For an individual, a loss on section 1244 stock issued to such individual or to a partnership which but for this section would be treated as a loss from the sale or exchange of a capital asset shall be treated as an ordinary loss subject to the limitations specified in Section 1244 of the Internal Revenue Code of 1986, as amended.
Treasury Regulations Section 1.1244(a)-1 . To claim a Section 1244 loss, the individual or partnership must have held the stock continuously from date of issuance by the corporation to the date of the loss. Stock acquired from anyone other than the corporation issuer cannot be Section 1244 Stock.
Small Business Corporation (1244(c)(3)). A corporation is a “Small Business Corporation” if at the time the subject stock was issued, the corporation had not received (in the aggregate) more than $1million in exchange for issuance of its stock. The value received for stock issued in exchange for property other than money shall be the adjusted basis of the property received by the corporation at the time of the exchange.
Section 1244 Stock (1244 (c)(1)). 1244 stock means stock in a domestic corporation that was issued directly to the shareholder out of authorized but unissued stock, if at the time the subject stock was issued to the individual or partnership,
the issuer was a Small Business Corporation,
the stock was issued in exchange for money or other property (but not stock or securities), and
if during the five most recent tax years ending before the date the loss was incurred, the corporation derived more than 50% of its aggregate gross income from sources other than royalties, rents, dividends, interest, annuities, and sales or exchanges from stocks or securities.
There are special rules for corporations that were not in existence for at least 5 years and for stock issued before November 6, 1978.
Treasury Regulation 1.1244(c)-1(b) . Only common stock can be Section 1244 Stock.
Treasury Regulation 1.1244(a)-1 . The stock becoming worthless or subject to liquidation of the corporation is treated as a sale or exchange for claiming a Section 1244 loss. Transfer to a bankruptcy trustee is not a sale or exchange for purposes of Section 1244.
S-Corp Observation . An S-Corp may qualify as a Small Business Corporation, however, it is unlikely that Section 1244 will be of much value to the S-Corp shareholder because operating losses passed through to the shareholder will likely have already reduced his basis to or near zero.
Treasury Regulations Section 1244(d)-3 . Stock received in a sale or exchange of 1244 Stock in a transaction that qualifies as a tax-free reorganization pursuant to the Internal Revenue Code of 1986, as amended, under Section 368(a)(1)(E), recapitalization, or under Section 368(a)(1)(F), a mere change in identity, form, or place of organization will retain its character as Section 1244 Stock.

This Blog is not legal advice. It may be Lawyer Advertising.

Past results are no guarantee of future outcomes .

Want to Learn More? Go to Arthur’s BLOG on the same topic

Starting Your Business: Choice of Legal Entity

Tue, 18 Aug 2026 17:14:41 GMT

Business Entities , Corporations , Income Tax , Limited Liability Companies , Partnerships , S-Corps

When you start a new business there is a wide array of available legal entities from which to choose, including without limitation:

Sole Proprietorship
Partnership (general or limited)
Limited Liability Company (LLC)
Corporation (“C” or “S” Corp)

So, How to Choose?

It’s not a “one-size fits all” situation.

Anyone can log on to “Legal Zoom” or similar website or even the website of the Secretary of State and form a Corporation or a Limited Liability Company. If you’re going to be the sole owner, then you don’t even need to file anything to get started, you can be a Sole Proprietorship and report the business on a Schedule “C” on your personal income tax return.

But that’s where the real trouble can start. Choosing the right form of entity for your business depends on a thorough understanding of the facts and circumstances, plans and expectations for your business.

This is one of the most important times to get knowledgeable professional advice – the time before the business starts.

What Facts and Circumstances, What Plans and Expectations Need to be Considered?

What kind of business will this be?
Personal Service
Professional Service
Distribution
Manufacturing
What is the sales model?
“Bricks and Mortar”
Local, One State
Multi-State
Multi-State
Telemarketing
Internet
Will there be more than one owner – will you have a partner?
What kind of risks and potential liabilities will the business face?
Company Debts
Professional Service Liability
Liability for Acts or Negligence of Others (partners, employees)
Product Liability
Will there be employees?
Do you think the business will lose money in the first year or two?
Do you have enough working capital to cover the start-up losses and your own living expenses until the business is profitable?
Will you bring in investors to contribute working capital to keep the business going during the loss period?

Liability Protection

Flexible Ownership Structure

Observation: The General Partnership and the Limited Liability Company offer the most flexibility both in type of ownership interests and special income tax allocations. There is, however, a big and highly significant difference between the two, namely:

The Limited Liability Company protects the business owner from many kinds of liability; and is a “pass-through entity”.
The General Partnership does NOT protect the business owner from liability; but is a “pass-through entity”. (see Income Tax Structure, below)

Income Tax Structure

Is the business income taxable to the business entity?

Do the owners pay income tax again when they receive distributions (money or Property) from the business entity?

Taxable Entity – Double Taxation: When business income is taxable to the business entity and then the owners are taxed again when they receive distributions from the entity.

Pass-Through Entity: When the business income is not taxable to the business entity; instead the business income is taxable directly to the owners. The owners are not taxed when they receive distributions from the entity.

Special Income Tax Allocations

What’s a Special Income Tax Allocation?

When is it important?

Most people don’t think about income tax allocations. In most cases, we assume, and such is that case, that if a business owner, partner of investor owns 20% of the business, that person will also be allocated 20% of the taxable income and tax losses of the business. Yes, that’s true in most cases; but it doesn’t have to be the case for some business entities.

A special allocation occurs when the tax losses are allocated to the owners in a different proportion than their ownership of the business.

Why would you want to make a special allocation?

Here’s a simple example : Let’s say you are the founder and actively running the business. You are operating the business; your partner is an investor who contributed $100,000 for the working capital needed to run the business. The business is owned 50-50 between the two of you.

Now let’s say the business lost $50,000 in the first year of operations. Here’s what happens with each type of two owner business:

“C” Corporation:
it’s a taxable entity – double taxation –
the full $50,000 of losses are “trapped” in the business.
“S” Corporation:
it’s a pass-through entity;
no special allocations;
You have no “tax basis” in your stock;
your partner has $100,000 of “tax basis” in her stock.
Your partner can write off 50% of the loss – $25,000; but the other $25,000 is yours; since you have no tax basis in your stock, the other $25,000 of loss is “suspended” until you get enough tax basis in your stock to write-off the loss.
Partnership:
It’s a flow-through entity;
Let’s say by special allocation the losses are allocated first to those who contributed money to the business.
By special allocation, the full $50,000 loss is allocated to your partner – so she can write-off the full $50,000 loss.
That’s good for her taxes; but remember
If it’s a general partnership, then neither you nor your partner have liability protection; and
If it’s a limited partnership and she is the limited partner and you are the general partner; she has liability protection; but you don’t.
Limited Liability Company:
Same facts and tax allocation as with the Partnership in 3, above; however,
Both you and your partner have liability protection because it’s a multi-member LLC (doesn’t matter in which state it’s organized).

Now, it should be apparent to you why this special income tax allocation is important. It provides an important tax benefit to the investor. It cushions the investor’s investment risk because she gets the early benefit of the income tax deduction without any reduction in her ownership interest in the company.

A special allocation of losses may be a strong incentive to investors in a start-up business.

Decision Tree

What Characteristics are Important to You?

Consider the Possibilities

Covenants Not to Compete Are Subject to State Law; not Federal Law

Tue, 18 Aug 2026 16:51:59 GMT

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The Federal Trade Commission Rule effective September 4, 2024, attempting to strike down most covenants not to compete has been invalidated by the Courts.
However, noncompete clauses are still subject to restrictions under State laws. Laws governing Covenants Not to Compete vary between States, however, here are typical State Law requirements:
First, the covenant must either be included in a legally enforceable contract, such as an employment agreement or agreement for sale of a business, or be a legally enforceable contract itself.
Second, the covenant must comply with specific restrictions under applicable state law.
A covenant not to compete is a restraint on trade. Most courts are reluctant to enforce restraints on trade – including Covenants Not to Compete.
Many states have specific laws defining what restrictions are valid in an enforceable Covenant Not To Compete.
Typically:
The party seeking to enforce the covenant must prove a legitimate business interest that is worth protecting.
The duration of the restricted period must be reasonable; not too long.
The territory and scope of the restriction must be reasonable; not overbroad.
A Covenant Not To Compete that limits an individual’s freedom to engage in his or her profession or usual line of work will likely not be enforceable if the duration is more than a year – often even less than a year.
A Covenant Not To Compete entered into in connection with the sale of a business will generally be enforceable for a longer time – sometimes as much as 3 to 5 years – to protect the goodwill value of the purchased business.