New Business

[barzillai]

Client A runs a recycling business. It is going very well, so he invites Client B to join him in the business. They are setting up an LLC and want to be taxed as an S-Corp. Client A will contribute equipment with a basis of $50,000 to the business. Client B will contribute $30,000 cash. Client A then wants to withdraw $20,000 out so their bases will be equal.
Is this transaction taxable to client A? And if it is, is there another way to do this so it isn't?

Thanks

[Snaggletooth]

Avoid the Train Wreck

Godzilla, if A is allowed to contribute a non-cash item, the proper computations for this will be a train wreck for years. Here are just a few of the twists:

The equipment will need to be booked at its FMV on the books of the corporation, and not its basis to "A". The difference between FMV and basis will need to be tracked, and amortized over the depreciable life of the equipment. The effect on basis will be different for each shareholder will be different, as the tax depreciation will be allocable to "B" and not to "A." This is often misunderstood, as "A" is the partner who contributed the equipment, but "B" gets allocated for the depreciation on it. (The guiding thought on this apparent mismatch is that "B" is regarded as actually buying it, thus is entitled to the depreciation).

Your question asks if there is a better way:

Absolutely. Your clients should do this:

1. Let "B" contribute his $30,000 for his share in the corporation.
2. Let "A" sell the equipment to the corporation for $50,000 cash. "A" thus no longer owns the equipment, and reports the sale on his personal return at zero gain.
3. Let "A" keep $20,000 proceeds and contribute the remaining $30,000 for his share in the corporation.

If you do this, ALL of your objectives will be met, without the horrendous eternal bookkeeping described above.

Good luck - Snag

[barzillai]

Thank You for the help. Your suggestion makes alot more sense. One other question. Client "A" owns the property the business is going to run out of. He was also going to put it into the LLC. I suggested he keep the property and rent it to the business. Then the business deducts the rent while he can deduct the loan interest, depreciation, prop taxes and insurance against the rent paid to him. Am I correct in giving this advice?

[Snaggletooth]

Correct

Real estate for a small corporation should hardly EVER be owned by the
corporation. Putting the property in the corporation would a non-cash contribution
which would bring in the train wreck described in the post above. PLUS it leads
to other complications, especially if sold.

The corporation should lease the property at an agreed-upon fair rental value. If the parties desire, it could even be written such that the corporation incurs operating expenses such as property taxes and repairs. I think deductions such as depreciation and interest would be deductible only by its owner, however.

You told your client exactly right.

[Davc]

Snagg, I think you're using partnership rules rather that S-Corp rules. S-corps don't allow special allocations. For the original poster, if a distribution is made to only one shareholder, you lose S status.

But Snag's better way will work.