If you’re a real estate investor, developer, or landlord who has (or is considering) placing rental properties, commercial buildings, or land into an S corp, this is for you.
Many business owners elect S corp status for the tax savings on active income. So, it’s tempting to assume it’s also the right vehicle for real estate holdings. But in most cases, an S corporation is the wrong structure for investment real estate.
The two biggest landmines? Shareholder basis limitations that cripple your ability to deduct losses, and property transfer rules that can trigger immediate taxes when you move assets in or out. These problems often stay hidden until you refinance, distribute cash, sell, or pass the property to heirs.
Here’s why real estate and S corps don’t mix well, and what to do instead.
1. Basis Limitations: Third-Party Debt Doesn’t Count In an S corp, your deductible losses (including vital depreciation) are limited to your stock basis plus any direct loans you personally make to the corporation (IRC §1366(d)).
Third-party debt — mortgages, bank loans, or lines of credit in the corporation’s name — does not increase your basis, even if you personally guarantee the loan.
Compare that to an LLC taxed as a partnership: Partners receive basis for their share of all entity-level liabilities, including nonrecourse mortgages (IRC §752). This “phantom basis” lets you deduct depreciation and losses far beyond your cash invested.
Real-world example: A $500k property with $100k down and a $400k mortgage inside an S corp gives you only ~$100k of basis. Depreciation quickly suspends excess losses. You lose the powerful tax shelter that makes leveraged real estate attractive.
2. Property Transfer Rules: Getting It Out Is a Tax Trap Contributing property into an S corp is usually tax-free under IRC §351 (with some exceptions if debt exceeds basis under §357(c)).
But distributing appreciated real estate out of the S corp (or liquidating) is painful. Under IRC §311(b), the corporation must recognize gain as if it sold the property at fair market value. That gain passes through to all shareholders on their K-1s.
Example: Building with $200k tax basis now worth $800k? Pulling it out triggers $600k of taxable gain immediately — even with no cash changing hands.
LLCs taxed as partnerships generally allow tax-free property distributions with carryover basis under IRC §731.
Bottom Line For rental or investment real estate, an LLC taxed as a partnership almost always wins:
• Full basis from entity debt for immediate depreciation deductions
• Tax-free distributions of appreciated property
• Flexibility for special allocations and 1031 exchanges
S corps can still work well for active operating businesses (like property management companies with W-2 payroll), but they are rarely the right home for the real estate assets themselves.
Are you a real estate investor, or developer with additional accounting needs? visit keepyourbooks.com/contact to schedule a consultation with us!