Discussion:Selling a C-Corp or Asset

We have a C-Corporation with 4 shareholders. Shareholder 1 is a 52% partner, while 2-4 are 16% each. We are trying to sell our hotel which is currently under contract as an asset sale. We then realized just how much taxes we would be paying if we kept it like this. We were informed that we could significantly reduce the taxes by selling the corporation rather than the hotel itself.

A few complications come up in this situation. The first, a few years ago, we refinanced the property and came out with about 900K. We loaned that money to myself from the corporation and put it into our investment firm (smith barney). Currently, that loan stands at around 500k. What do we have to do about that loan before we close this sale?

Another complication is that the buyer is worried about being liable if somebody happened to sue us. We are willing to sign the necessary papers to indemnify the buyer, but he has raised a concern about us not having the financial means to pay for these possible liabilities.

The last thing is the buyer is concerned about his cost basis for the hotel if he purchases the corporation. Our original purchase price was 1.2 million. He will be purchasing for 2.25 million. If he were to sell the property, say in 4 years, would he be working from the 1.2 million basis or the 2.25 million basis. I also ready about an IRC Section 338 that may or may not apply here to allow the buyer to use the increased basis. Will that section 338 be harmful to me, the seller?

Thank you for any input. If you need more information, ask me and i'll tell you everything I can. We are under the gun here as the buyer is trying to close.

Hindsight is always better than foresight. Who advised you to put RE inside a C corp? About your only recourse to avoid the double taxation is to make an S election and wait 10 years for the Built-In Gains tax to go away. Even that may not work if there is no business in the corporation other than the building, because the S corp could be subject to the tax on Excessive Net Passive Income. Take heart, dividends are currently taxed at 15%. If you sell on installment basis better collect everything prior to 2009 as the 15% tax on dividends may be gone after the 2008 elections.

You mention the basis is $1.2m but you also say that you paid $1.2m for the property. You also mention 'a few years ago' in relation to a loan. Have you depreciated the property? If so, your effective basis is going to be less. Which, in turn, makes your tax bill even higher on an asset sale. Has your CPA told you what he thinks your tax bill will be? How long have you owned the property?

Since you have already ruled-out a 1031 exchange and don't want to sit on the property for ten years while waiting on an S election, a stock sale (instead of an asset sale) may be your best bet. It would certainly net the shareholders the most amount of money at the end of the transaction. By selling the stock instead of the asset, the shareholders will pay a single capital gains tax rate instead of being taxed twice.

Even if the real estate is sold in an asset transaction, you may still be able to sell the company's stock in a second, unrelated transaction. This, too, will allow the shareholders to net more than that would otherwise.

(If you need help finding a stock buyer or wish a detailed analysis of your situation, email me: corptaxhelp@gmail.com. No charge for that, by the way. I'm not selling anything.)

I was reading about the structure of asset sales and came across people with large values put on such things as goodwill and no compete clauses. If we were to restructure our current contract this way, would this help me out in any way?

In Martin Ice Cream, the IRS acknowledged that personal goodwill does exist. That's the good news. The bad news is, goodwill is hard to apply, difficult to appraise and, on audit, darn near impossible to defend.

In this case, you are not selling a business where you might be able to scrape together some goodwill. You are selling real estate -- a building. I imagine you had the property appraised and the value came back at around $2.25M. The delta between the appraisal or fair market value and the selling price could be fudged into goodwill if you were really aggressive. Is that delta $125,000? Are you prepared to defend the use of goodwill for such a minimal tax savings?

If the appraisal came back at $2.125M and the selling price was $2.25M, some would tell you to rewrite the contract so that $1.25M is the real estate and $1M is personal goodwill. The IRS is going to be the first to ask 'gee, if the property was appraised at $2.125M, why did you sell it for a million dollars less than fair market value?'.

A non-compete clause in this case of real estate is just as aggressive. I'd want to know from what competition the new owners are protecting themselves. How long is the non-compete? Is it reasonable to believe that you will take your profits and open a hotel right across the street or close enough to be viable competition?

I'd be worried if my advisor was pitching personal goodwill as a viable exit strategy. I'm less down on non-competes, having used them in the past. I can't see how you might work a non-compete into this transaction.

You mentioned Martin Ice Cream. In you opinion, how aggressive is the IRS in pursuing cases in which Martin was claimed. You would think that you could look at two different companies in the same market and make a comparison on whether personal goodwill could be claimed. Consider a service company such as a carpet cleaner. In a vacuum (excuse the pun) all company should react similarly, given a like product, market, pricing, etc. Wouldn't it be fair to say that the success of a company is based primarily on the efforts of the materially active shareholder. What arguments are used by the IRS to dispute this claim.

Personal goodwill is a viable tool for service companies whose shareholders are actively involved in the business. In your example, it could be a good option. Still, I find goodwill difficult to appraise. The more value assigned to personal goodwill, the more uncomfortable I become with a transaction. Proving an abstract to the IRS is an uphill battle. The greater the value assigned to personal goodwill, the longer and steeper the hill.

When you move away from a service company and into a business where there are more tangible components, it is more difficult to claim personal goodwill.

In Mrr's situation, the primary corporate asset is real estate -- the apitome of tangible. Real estate is one of those things that is easily valued. If ten appraisers look at a specific established hotel property, their numbers are not going to be more than 5% divergent. In my experience, it is often less than 5%. I don't see where you can fit much personal goodwill into the transaction. Unless Mrr's last name is Hilton or Motelsix, from where would the personal goodwill come?