For those of you who think that C Corporations are a blast from the past, think again. There are a significant number of taxpayers out there, whether by action or inaction, stealth or sloth, that remain C Corporations.
The maximum rate of tax that applies to both the ordinary income and the capital gain of a C corporation is 35 percent. Furthermore, characterization of a corporation’s gain as capital gain may be important because a corporation may deduct capital losses only to the extent that the corporation has capital gains for the year. A corporation’s net capital losses may be carried back three years and forward five years.
Converting capital gains to ordinary expiring Net Operating Loss (NOL). In the case of Corporations that sell depreciable assets, 20% of the gain that could have been capital gain is converted to ordinary income. Furthermore, in the case of Corporations that sell depreciable assets to related parties, the gain that could have been capital gain is also converted to ordinary income. This may be valuable where the Corporation has significant expiring NOLs.
Transferring appreciated assets out of a C Corporation with Section 1031 exchanges to avoid gain. In the case of a C Corporation with recognized built-in gain assets that elects to be treated as an S Corporation, the sale of appreciated assets during the 10-year period after the conversion from C Corporation to an S Corporation are taxed at C Corporation rates of 35% rather than at the lower flow-through rates.
The Section 1374 taint will continue to apply to property received by the S corporation in a Section 1031 exchange. For eample:
Corporation X files an S election that takes effect on January 1, 2000. On that date, X owns a parcel of land with a basis of $10 and a value of $50. Thus, the land has a built-in gain of $40.
In 2002, X exchanges the land for a building in a tax-free exchange under Section 1031. Section 1374does not tax X on the exchange because X has no recognized gain. However, the building has a built-in gain of $40 in the hands of X. If X disposes of the building before 2010 and recognizes gain, Section 1374can apply to, at most, $40 of gain.
By deferring the taxable gain in a Section 1031 exchange during the 10-year built-in gain period, the taxpayer can take advantage of the lower flow-through individual tax rates after the expiration of the 10-year period.
Section 1031 exchanges can also be used to restructure appreciated real estate owned by a Corporation owned by its shareholders to avoid gain on the distribution of appreciated assets under Section 311(b).
For more information about 1031 exchanges, contact the tax attorneys at All States 1031 Exchange Facilitator at 877-395-1031.