Liquidation of S corp by estate, and stepped up basis

I have not encountered this situation before........I would appreciate comments.

An S corp owns several separate pieces of high value real estate.

Sole shareholder has several beneficiaries for his estate.

The objective is to separate the parcels, so that each beneficiary receives property instead of an interest in the whole group, so that each beneficiary can sell/keep their portion as they choose, as compared to the group having to agree to sell..........and having the added complication of having to sell all of the properties in the same tax year, accompanied by a liquidation of the corp in order to get the application of the stepped up basis against the sales proceeds.

I am told that the estate can liquidate the corp, and apply the stepped up basis of the corporate stock to the assets.........and then distribute the assets to beneficiaries.

I have never seen that...........merely because I have never seen that.

Would this be as straight-forward as it appears--------or are there some hookers I am not seeing?

An S corp owns several separate pieces of high value real estate. Assuming that high value resulted from appreciation over basis, having the real estate in a corp. was a bad move.

... each beneficiary can sell/keep their portion as they choose .... Does that mean they will each get an undivided interest in each property, or rather they will each get a property that approximates the value of their share?

I am told that the estate can liquidate the corp, and apply the stepped up basis of the corporate stock to the assets.........and then distribute the assets to beneficiaries.. Yes, but at the cost of a gain upon liquidation, inside the S corp., as though the properties had been sold at FMV. To be offset by a loss when/if they sell at the same value. That's the shorthand version. It's a bit more involved.

Without digging in too deeply, tho', assuming we're talking about a death here, which isn't clear even tho' we're speaking of an estate....if the real estate is the only underlying asset, arguably the corp steps up in value at date of death, washing out those built in gains......

arguably the corp steps up in value at date of death, washing out those built in gains......

Correct JR1. But you know the timing is so tough, especially with multiple properties.

arguably the corp steps up in value at date of death, washing out those built in gains......

Correct JR1. But you know the timing is so tough, especially with multiple properties.

I don't quite understand why anyone would feel the "timing is tough". These properties don't have to be sold to a third party. In the wake of the death of the shareholder, the properties could be distributed to an LLC with ownership mirroring the s-corp (could even still be the estate) and the liquidation of the s-corp would be in the same year. This allows stock losses to offset the property gains (plus some, most likely). Once in the LLC, the properties themselves could be distributed to heirs or the interest to the LLC distributed and they would get the benefit of higher depreciation deductions and rental income. Win-win!

Did this with a client a few years ago. Worked like a charm. The family still owns all but one property, which they only sold because one of the kids DEMANDED a cash out when mom passed.

I agree. The key is that the current shareholder needs to dispose of the stock in the same tax year that the corporation becomes no longer the owner of the real estate. Otherwise, you'll have a large capital gain in Year 1 (corporation recognizes a gain on Sch. K-1, shareholder pays a lot of tax) followed by a large capital loss in Year 2 (shareholder disposes of stock, loss deduction is limited).

Doesn't 1250 enter the picture (unrecaptured gain tax rate) and maybe 1245?

Great point. So the character of the gain on the K-1 may not be the same as the character of the capital loss on the disposal of the S corp.

However, I figure that in most situations the unrecaptured Sec. 1250 gain won't be a problem, because the capital loss will offset it (if it's in the same year) and you won't actually have anything taxed at 25%. Because unrecaptured Sec. 1250 gains are still capital gains. (It could turn out different, though, if the shareholder had other stuff going on on their personal Sch. D.)

It would be the recapture ordinary income from Sec. 1245 (and from accelerated depreciation with Sec. 1250) that would be a problem. Or if there's carryforward Sec. 1231 loss issues.

Clarifications:

Properties are farms........consisting of only land. Placed in S corp in order to avoid the SE tax on ag rents from commonly-owned C corps......section 1402. No 1250 problems......or nominal at best. Savings in SE taxes can exceed 15K x 20years = 300,000, plus interest effects. Personal return effects can be controlled thru the salaries from the related C corp. (C corps used for operations in order to maximize employee benefits, and to level out the economic swings related to ag industry.)

At the death of the sole shareholder, his estate would acquire the S corp stock. That stock would be valued at market, equal to market of owned land.

Estate would liquidate the s corp..........triggering the gain upon liquidation. The resulting increase in basis would be applied against the income from passing out the land......no taxable income.

Estate would then pass out the land to the beneficiaries, and that land would have the basis to the estate.

This accomplishes the objective of splitting up the corporation into its component land parcels, and getting selected parcels to selected beneficiaries.

Due to my lack of knowledge in estate taxation-------- I am ignorant as to whether this process is legal/workable.

Resultantly------the question for you.

Let's prove it with a simple example. Assume date of death land basis of 500, land value 2,000, which is also the value of the S stock. Assume the shareholder's basis in the S stock before he died was -0-. (or use another value if you wish).

Corp has gain on land upon liquidation of 1500. The gain flows thru to the estate (shareholder) income tax return and increases its basis in the stock it "exchanges" in liquidation by 1500, making its total basis 3500, for which it received land with a value of 2000, and thus a loss of (1500) to offset its S corp flow thru gain. Thus, a wash in taxable income, and a remaining basis of 2000. Isn't that what we're saying?

Yes.........is that for sure the way things would go within the estate's returns?