10 Reasons Not to Put Real Estate in Your S Corporation

Real estate inside an S corporation often looks simple at the start. Over time it creates tax costs and planning limits that are hard to unwind. Here are ten practical reasons to keep operating businesses and real estate separate.

1) Removing the Property Later Creates Tax

A distribution of appreciated real estate from an S corporation is treated like a sale. The company recognizes gain and that gain flows to shareholders.

2) No Inside Basis Step-Up at Death

When a shareholder dies, heirs receive a step-up in stock basis. The building inside the S corporation does not step up. Partnerships can elect an inside step-up that matches the new owners. S corporations cannot.

3) Debt Rarely Boosts Shareholder Basis

Shareholders get basis for direct loans they make to the S corporation. They generally do not get basis for third-party debt taken by the entity. Lower basis limits loss deductions and can make otherwise routine distributions taxable.

4) Cash-Out Refinance Proceeds Can Be Taxable to Owners

If the S corporation refinances the building and distributes cash, shareholders need enough stock or debt basis. If basis is short, the distribution can be taxable. Partnerships usually increase partner basis for entity debt, which supports tax-free cash distributions within limits.

5) 1031 Exchanges Are Harder to Customize

Real estate owners often want different exchange paths. Inside an S corporation, the property is owned at the entity level, so separate owner exchanges are difficult. 

6) Asset Protection Is Cleaner with Separation

Placing the building in the same entity that runs payroll, vendors, and field risk exposes the real estate. A separate LLC that holds the property and leases it to the S corporation keeps liability silos clearer.

7) Self-Rental Rules Affect Loss Planning

Rent received from leasing a building to a trade or business in which the owner materially participates is generally nonpassive. Suspended passive losses from other activities usually do not offset that income.

8) No Special Allocations Inside an S Corporation

S corporations allocate items pro rata per share on a daily basis. There are no targeted allocations and no section 704(c) style layers. You cannot send extra depreciation to the owner who needs it most.

9) Owner Buyouts and Exits Are Costly

When owners split up, moving bricks and mortar to match the deal terms is difficult. Non pro rata property distributions and redemptions can trigger gain on appreciated assets.

10) Built-In Gains Tax Exposure for Prior C Corporations

If the company used to be a C corporation and elected S status, a sale of appreciated property during the recognition period can create a corporate-level built-in gains tax. That is on top of the pass-through income.

Better Alternatives for Real Estate Ownership

For most business owners, keeping real estate separate from operating entities offers more flexibility and tax advantages. Consider these alternatives:

• Separate LLC: Hold the property in a separate LLC and lease it to your S corporation
• Partnership: For multiple owners, a partnership entity provides more flexible allocation options
• Individual Ownership: In some cases, direct ownership and a triple net lease to your business may be optimal

Every situation is unique, and the right structure depends on your specific circumstances, growth plans, and exit strategy.