Discussion:CAPITAL GAIN IN C CORP

What I find most often in my travels is folks with C-corp captured real estate who want to get out *now*. And, if not now, then certainly in less than ten years. Roofs don't last for ever. An extra ten years of repairs and maintenance on a commercial building is real money. The folks I consult for often don't want to be stuck replacing a roof while waiting out an S election. If the buildings are in good shape, ten years is a walk in the park. If the buildings are already more than 20 years old (as they almost have to be if the owner has them in a c-corp), that walk in the park is at night and in a bad area of town with busted-out street lamps.

Then there is situation of an unknowable future unrelated to the property itself. I know an older couple who had $17m tied up in a real estate portfolio and who were six years into the S election window when the wife was diagnosed with Really Bad<tm> cancer. He wanted to cash-out, get her the best medical treatment, be by her side the entire time and, since the clock was ticking, take that round-the-world cruise they had been promising themselves since they got married in 1963. Because they sold quickly, they didn't get the best price. They also paid a brutal corporate tax on liquidation. The only reason they didn't sell six years earlier when they retired and move into something more liquid was they didn't have a solution to the c-corp tax problem other than the S election. (*)

For folks who want out more quickly than an S election, I'd recommend a stock sale. (Of course, I'd recommend it a little less spamily than some other people have. {grin}) There are buyers out there hungry for c-corp owned real estate or c-corps after the real estate has been sold. (Key ingredient: the stock sale must happen in the same fiscal year as the asset sale.) Those buyers are savvy and are better able to mediate the tax liability than someone who has only faced the situation once. Heck, there are a lot of corporate CPAs with 20 years experience who have never had to shutter a c-corp, let alone a c-corp with real estate. The advantage to the seller is obvious: more money net at the end of the day. And, by 'end of the by day', I mean 45 to 90 days instead of ten years.

Capital gains rates will rise in 2010 as the law stands. That is a fact. Even if Congress throws on the breaks and backs-out the rise, I can't see capital gains rates less than where they are now. If c-corp owners want to put money back in their pocket, the next two or three years is the time. They would be foolish to wait.

(Same thing with folks who are hot on 1031 exchanges... What are they smoking and can I get some? Why are they delaying paying taxes now when they know they will be higher later? When I hear people pushing 1031 exchanges, I really try to probe them as to if they think capital gains rates will be lower down the road. A few deny that rates will rise in 2010. Fine. Maybe that train will fall off the tracks. I still haven't heard one tell me they will be lower.)

JR1: Non-competes are a good solution is some situations but a hard sell if the primary asset is real estate. How are you going to compete against a specific building in a specific location? Real estate is location driven. Also, is the non-compete long enough to be meaningful?

I had one person try to sell me on the idea of a three-year non-compete on a office building transaction. There were no comparable office buildings in a five-mile area that the seller could have bought into. There was raw land close enough to count but it wasn't zoned appropriately and was slightly smaller. Fast-track rezoning would have taken six months to a year. Construction would have taken 18 months to two years. The non-compete would not have stood up because it had no meaningful effect given its three-year window -- it would have been *impossible* for the seller to compete. There was no economic substance to the payout. For a non-compete to be defensible, it must have an demonstrable economic effect to the party signing the agreement and receiving the buyer's check.

Don't get me wrong, there are some situations were a non-compete is a great way to take monies out. Real estate, however, is not generally one of those situations.

(* Two years later, she went itno remission and they have taken their dream cruise on the QE2. In comparison to cancer, the $5.6M tax bill doesn't seem so bad. Still, had they sold their stock instead of liquidating, they would have netted $2.75m more. With a couple extra million, they could have taken the grandchildren on the cruise with them.)

(Wow. I'm really verbose today. Must be that new brand of coffee we have in the office.)

The other issue is that real estate tends to be a big ticket item. If you want to bonus out the last $80,000 when you sell your plumbing supply business, that amount may fly below the radar. That is aggressive but not, in my opinion, reckless.

On the other hand, if you sold a building that was triple-net leased and for which you did no real property management (depositing the check is not considered active management), I doubt you'll be able to take out the last $800,000 or $1,200,000 as a bonus without raising serious red flags.