Losses on property distributions can never be claimed on IRS Form 1120-S
S Corporations are usually closely held with only a few shareholders. Property often passes from the S Corporation to the shareholders. Technically cash is property, but let’s make it interesting with a IRS Form 1120 S / NC CD 401S example utilizing land. As in all our examples, we’ll use Wilmington NC Widgets, our demo S Corporation. The tax implications of Form 1120S are stressed below and we assume the transaction makes sense for both Wilmington NC Widgets, Inc. and the shareholder.
Basic Scenario
One of the shareholders, Smith, wants a piece of land owned by Wilmington NC Widgets. WNW bought 5 acres of land years ago, as an investment, for $300,000.
Land Worth $250,000 - $50,000 Loss
Generally, distributions of loss property should be avoided in S Corporations, at least from the tax perspective. Here’s why. WNW doesn’t ever get to take the $50,000 loss on the IRS Form 1120S. It can only take a loss if the land is sold. But Smith’s basis in the land would have been the $250,000 FMV.
Land Worth $350,000 FMV - $50,000 Gain
Essentially the IRS treats this transfer like a sale of the land to the shareholder at FMV. The tax consequences for the land are the same if Wilmington NC Widgets sells the land to Smith and he/she disposes of it, or WNW sells it and distributes the cash to Smith. Assuming it can be sold. At the time of transfer, the S Corporation recognizes a gain of $50,000. The CPA allocates this gain to shareholder’s basis, through Form 1120S’ Schedule K, according to the percentage of Wilmington NC Widgets, Inc. they own. Simultaneously, the shareholder’s basis is reduced by the entire $350,000, but not below $0.
“Documenting Fair Market Value (FMV) at the time of transfer is crucial if the S Corporation or shareholder is ever audited by the IRS.”
Gary Bode
Wilmington NC CPA and Tax Accountant
Moral of the Story
In S Corporations, the tax consequences of non standard transactions on Form-1120S and NC CD401S deserve proactive consideration with your Wilmington NC CPA.
If you’d like a free initial consult with a CPA who prepares S Corporation returns, please call us at (910) 399-2705.
