Never Buy Real Estate In an S Corp
Buying real estate inside an S corporation is usually discouraged by tax professionals because it creates tax inefficiencies, financing limitations, and major exit problems. For most investors, an LLC taxed as a partnership or disregarded entity is far more flexible. Let’s walk you through a few key reasons why this is often the case.
1. Loss of Step-Up in Basis at Death
When real estate is owned personally or in a partnership/LLC, heirs receive a step-up in basis to fair market value at death.
Example:
Purchase property: $300,000
Value at death: $900,000
With direct ownership or an LLC:
Basis steps up to $900,000
Heirs can sell with little or no capital gains tax
With an S-corp:
The stock basis may step up, but the property inside the corporation does NOT.
If the property is sold, the gain is still recognized at the corporate level.
This can create huge taxable gains for heirs.
2. Hard to Take Property Out of the S-Corp
If you later decide to move the property out of the S-corp, it’s treated as if the corporation sold the property at fair market value.
Example:
Property inside S-corp worth $1M
Basis $400k
Moving it out triggers a $600k taxable gain.
This is often called the “trapped real estate problem.”
3. No Special Allocation of Income or Loss
An S-corp must allocate income strictly pro-rata based on ownership.
Unlike partnerships or LLCs, you cannot:
Allocate depreciation differently
Allocate losses strategically
Structure preferred returns
Real estate investors often rely on this flexibility.
4. Problems with Debt Basis
Real estate investors rely heavily on debt to increase basis and deduct losses.
In partnerships/LLCs:
Property debt increases basis, allowing loss deductions.
In an S-corp:
Corporate debt generally does NOT increase shareholder basis unless the shareholder personally loans money to the corporation. This can limit loss deductions from depreciation.
5. Financing Is Harder
Many lenders dislike lending to S-corps for real estate because:
They prefer individual or LLC ownership
Mortgages often require title to be held by an individual or LLC
Some loans prohibit corporate ownership
6. Payroll Requirement Issues
S-corps are designed for active businesses, not passive assets.
If an S-corp has income:
The IRS expects a reasonable salary to owners.
Rental real estate is typically passive, so an S-corp structure often adds unnecessary payroll complexity.
7. Loss of Flexibility for Investors
Real estate investors often need flexibility for:
Bringing in partners
Changing ownership
Profit waterfalls
Preferred returns
S-corps allow only:
One class of stock
Limited types of shareholders
This severely restricts deal structures.
What Most Real Estate Investors Use Instead
Typical structures:
Single Owner → Property → Single-member LLC (disregarded entity)
Multiple Owners → Property → LLC taxed as partnership
Operating business + real estate: Business → S-corp then Real Estate → Separate LLC that leases to the S-corp
Common structure example that many of our small business owners clients follow:
Operating Business
│
▼
S-Corp
│
Pays rent
│
▼
Real Estate LLC (owned personally)
Benefits:
-
Liability separation
-
Rent becomes a business deduction
-
Real estate gets depreciation
-
Easier future sale
Simple rule to remember: S-corps are great for operating businesses,while LLCs are better for holding appreciating assets like real estate.
