Property Contributed to S Corp

[DaveinTexas]

I think my brain is melting. I either have alzheimer's or I have studied so much over the past 6 months that my brain has official imploded.

Here's the situation:

Dentist is sole shareholder/owner of S corp. Dentist buys property, he thinks, in the S Corp name---meaning he thinks the S Corp is responsible for the note. However, he finds out later that the property is in his name---he is responsible for the note.

In order to deduct the interest on the property on his 1120S, can he contribute the property, subject to a mortgage to the S Corp without a taxable event occurring? If he cannot deduct the interest on his 1120S, what other options does he have? Could the interest be reported on Sch. E, part II as "business interest"?

His original cost of property--land for a future professional building: $460,000
Mortgage on land: $415,000

I know that if you contribute property subject to a liability to a partnership, the assumption of the liability is considered a distribution to the partner. I am thinking that in this case, there should be no taxable event until the property is sold or distributed back to the shareholder.

Am I correct in my assumptions or do I need to be measured for a straight jacket?

TIA

[Brad Imsdahl]

Contributing property to a corporation in exchange for stock is a tax free event IF after the transfer, all shareholders involved in the transfer own at least 80% of the stock (Section 351). Since in your case, there is only one shareholder, the 80% requirement is met.

If liabilities exceed the contributor’s adjusted basis in the property contributed, then the excess is treated as a taxable gain to the one contributing the property.

TTB, page 18-5 and 18-6 discusses all of this.

[DaveinTexas]

So, according to Seggerman,

since the shareholder of the S Corp, the dentist, is still personally liable for the debt on the land; is it safe to assume that the S Corp assumed his liability and can now deduct the interest on the 1120S?

Or is interest deductible only as investment interest limited to investment income on the 1120S? The purpose of the land purchase was to eventually construct a building to house his practice on the land.

TIA.

[Brad Imsdahl]

I wouldn’t contribute the land to the S corporation. I don’t think it is a good idea to contribute appreciated property to a corporation. I would keep it out and have the dentist rent the land to the S corp after the S corp starts using it for business. Deduct the interest from the liability as investment interest.

[JoshinNC]

I agree with Brad

He beat me to the point. I advise my professional clients (docs, attorneys, etc.) to form an LLC to hold the property and then rent it back to the Corp. They can move the property in and out of the LLC with no tax event (provided they don't sell the property).

Plus, down the road they normally buy other rentals, and can put them in the LLC too.