S-Corp set up for rental properties, but properties still in owner's personal name

[DawnDay7]

TP was advised to set up a corp with S-election with another shareholder for 2 rental properties (each owned one property), one contributed a property deeded in S-corp name, the other encountered difficulties and was unable to change deed from his personal name.  Payroll was done for both shareholders.  Should only the correctly deeded property income and expense be reported on 1120-S?  For property still deeded to shareholder's personal name:  Should 50% of property income and expense be reported on each shareholder's 1040 Sch E, or 100% reported on the 1040 Sch E of the shareholder to which the property is deeded?

[BobKamman]

Far too few facts here for any attempt to answer, but IRS will generally follow "substance over form."  Was there a problem preparing and executing the deed, or only with recording it?  Deeds don't have to be recorded to be effective.  

[DawnDay7]

TP claimed that refi is required to change deed.  He feels that bank is not likely to approve in S-Corp name and doesn't want to forfeit the low interest rate he already has.  

[JRC]

Interesting..

[qbteachmt]

"TP was advised to set up a corp with S-election"

Let's start with the issue of the advice in the first place, which is extremely misguided. You can search the web for why not to hold Real Estate in an S Corp. I would never take the advice of that person again.

"Should 50% of property income and expense be reported on each shareholder's 1040 Sch E, or 100% reported on the 1040 Sch E of the shareholder to which the property is deeded?"

Neither. No, you cannot just split the income and expenses for an S Corp and the deeded owner. That's because an S Corp is its own entity. Everything gets reported on the 1120-S and not the 1040 Sched E. Then, the shareholders are issued a K-1. You describe more how a partnership would work, but you have a corporation to deal with. The corporation is not a co-owner.

Yes, a ReFi often is required, because the lender needs the owner to be on the hook, and the owner would be the Corporation, as its own entity separate from the humans. That's the point of creating a corporation. That's part of why this was bad advice.

You did not state when this started. If 2021 was the first year, then you can deal with this a couple of ways. One is to execute a management agreement, where the S Corp is not the owner of the undeeded property, but will collect rental income and able to shoulder operating costs on behalf of the owner. That also means issuing a 1099-Misc Box 1 to the real owner for some amount as rental/lease income paid to him (bypassing payroll and the K-1 process as it would be part of expenses to the corporation). The real owner then has some costs and asset and depreciation and entries on the Sched E 1040 as the only owner.

And there should be some sort of legal framework, such as quitclaim deed or wrap around mortgage or something that is legal and common in their State for selling the property to the S Corp (which still is a bad idea).

Obviously, this is very late to be dealing with 2021. There have been a lot of errors and this is already mid-2022. You might want to get mentoring from a tax attorney to help deal with this, since it involves deeded/titled, and debt secured real estate.

[DawnDay7]

Thanks for responding.  

Agree, have read all the disadvantage to holding RE in an S.  Yes, this was started in 2021.   Is there an option other than management agreement?   Should S-Corp be marked as final, reporting only the payroll; with income and expense of rentals reported on TP's Sch Es?

[qbteachmt]

"Is there an option other than management agreement?"

Of course.

"Should S-Corp be marked as final,"

If they are going to unwind all of this for 2022, sure.

"reporting only the payroll; with income and expense of rentals reported on TP's Sch Es?"

No. You already have one property owned by the S Corp, so you honor what that entails.

You have to deal with Asset, Debt, insurance, tenant agreements, income, expense, depreciation, etc, accordingly, and straighten that out going forward.

Here is how it would more typical be advised:

You and I each have multiple suite business or resort buildings. We want to co-manage and perhaps, one or the other of us wants to be able to be gone now and then. We form an S corp to be our property manager firm. That S Corp employs us and a few other parties to run the properties we own personally and the S Corp pays us (and other owners we can get under management contract) some sort of Net Rent. We each then have income from net rent to help pay our own mortgages and ownership costs (as opposed to operating costs). And we have wage compensation for purposes of FICA, retirement, health, etc, as long as we also do some of the work. And there might hopefully be K-1 income as operational profit from operating the S corp well. And we have staff, so we no longer need to cover the midnight flood, the leaking roof, the irate phone calls, the deadbeat rent collection, and the evictions. This is very typical in my area, where we have Resort property and multiple unit buildings in ski/lake communities. It's a Rental Pool operation.

[DawnDay7]

Thanks so much for the additional details.  Very different scenario here - 2 small rentals in OH, very little property management and no staff required.  Hoping TP can reverse bad decision.

[qbteachmt]

"Hoping TP can reverse bad decision."

This is so strange; I wonder what problem they thought this would solve? And now you have to doubt the S Corp shares are even correct (which impacts K-1 allocation), since they likely were based on value of property being contributed (how many shares, which value used, etc) and that would be something to address. There are the tax considerations for the contribution and/or the disposition, in that the shareholder had a basis, the property had a value, and the change of ownership of the property can trigger tax consequences.

[BobKamman]

"TP claimed that refi is required to change deed."

Was that advice coming from the same source as putting it into an S Corp in the first place?  When things start sounding this flaky, I would tell the potential client that life is too short to mess with such problems. Especially if they don't show up until after April 15.   They were doing payroll?  But no employees, so withdrawing the profits that way?  You're in Ohio, is there a problem there with doing an LLC?  Usually the mess that people get into is going to a seminar where they are told that for "protection" they need an LLC, but maybe they thought a corporation would be easier, and then to avoid double taxation they elected S status.  

Is this a new client?  I would find out who sent them to you, and order 6 pizzas to be delivered to their address, C.O.D.