Renting or Selling Property to a Closely Held Business

As a business owner, you're doubtlessly looking for ways to cut taxes on your earnings from the business' operations.  If you operate your business as a C corporation, there are two levels of tax to worry about.  This double taxation shows up in two ways: (1) the annual corporate income tax on the business' taxable income, followed by the personal income tax on any dividends you take out and (2) the double tax cost of getting property out of the business and back into your hands.

Since real estate rents and receipts for the use of royalty-type assets are exempt from FICA and self-employment tax, it often makes sense for a business owner to personally hold title to those assets.  This allows the business to make tax-deductible payments to the owner for the use of these assets without a FICA or SE tax cost while maintaining individual ownership of some business assets.  These techniques can also provide a source of retirement cash flow to you and facilitate the eventual transition of business ownership to the younger generation.  Deductible rental and royalty payments can be made in addition to reasonable compensation for services rendered.

If the business is a C corporation, rental and royalty agreements also solve the problem of having appreciated assets "trapped" in a C corporation due to the prohibitive double tax cost of distributing them to the owners.  Care must be taken when using rental and royalty arrangements to charge a market rate for the assets' use, since the IRS routinely scrutinizes those transactions.  Care must also be taken when personal property is leased, due to the less favorable self-employment tax rules for those assets.  I can help you determine what a fair rental or royalty rate is, and guide you through the applicable tax rules.

Alternatively, C corporation cash can be withdrawn without double taxation by selling shareholder assets to the corporation.  However, the sales price must be reasonable to avoid an IRS assertion that a constructive dividend has been paid.

Another technique for withdrawing corporate wealth is a split-interest purchase, in which a shareholder and the corporation simultaneously acquire separate interests in the same asset.  To avoid trapping an asset in a corporation, and to provide a means of extracting corporate cash from current operations, the corporation would typically acquire a term interest in the asset and the shareholder would acquire a remainder interest.  Further, a corporate tax deduction may be available for a term interest in otherwise nondeductible assets such as land.

Because these transactions involve related parties, they must be carefully analyzed.  Among other things, the related-party rules may deny the benefit of capital gain treatment on asset sales, deny installment sale benefits, disallow losses from asset sales, deny the benefits of like-kind exchanges, or delay certain deductions from related-party transactions.  However, with planning, it is often possible to avoid these traps.

If any of these strategies sound like a way you might want to save taxes, please let me know.


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