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Why Owning Real Estate in a Corporation's Name is Not a Good Idea
Owning real estate in a corporation's name is not a good idea from both a tax and liability standpoint.
Double Taxation
A regular C corporation is not a pass-through entity. Corporations pay taxes at the entity level. When a corporation distributes its earnings to its shareholders as a dividend, they must include those dividends in their taxable income, which results in double taxation of those earnings; once at the entity level and a second time at the individual level.
Appreciating Assets
If an asset that appreciates in value is held inside a corporation and the asset is subsequently sold by the corporation at the higher value, the gain will be taxed at the corporate level. If the corporation subsequently distributes the gain to its shareholders, the gain will be subject to taxes on their individual income tax returns, resulting in double taxation.
Example:
You own property in your C corporation. The C corporation sells the property and realizes a gain of $10,000. The corporation's income tax rate is 15 percent. The corporation's income tax is $1,500 (15 percent x $10,000).
The corporation pays you a dividend of $8,500 (the gain of $10,000 minus the $1,500 in taxes). Your personal income tax rate is 15 percent. Your tax on the dividend is $1,275 (15 percent x $8,500). Total tax paid is $2,775 (corpooration: $1,500 + you: $1,275). That's almost 28 percent of the $10,000 gain ($2,775/$10,000)
Now assume the same facts, except, you're organized as an LLC (a pass-through entity):
Assume your tax rate is 15 percent. Your tax is $1,500 (15 percent x $10,000 gain). The LLC entity is not subject to tax since it is pass-through entity. In this case, you save $1,275 by being organized as an LLC rather than a C corporation.
If the corporation was in a higher tax bracket than 15%, it would have paid taxes at its higher marginal tax rate. For individuals, however, dividends received from domestic corporations are taxed at the lower capital gain rates. By being organized as an LLC (a pass-through entity) if your tax bracket was higher than 15% the dividend would have been taxed at the lower capital gain rate.
Corporate Liability
If you own real estate inside a corporation and the corporation is sued, property owned by the corporation could be lost. For example, if you own an office building and someone slips on the lobby floor as a result maintenance failure (i.e. water spilled on the floor), the corporation could be sued.
If the corporation does not carry sufficient insurance to pay the claim and the uninsured amount if sufficient enough, the claimant may end up owning the corporate stock. If this were to happen, and the claimant ends with owning 51%, putting the building up for sale could be on the table. For example, if the claim is $1.5 million and your insurance covers only $1 million and the fair market value of your corporate-owned building $500,000, the building could end up being sold to satisfy the remaining portion of the claim. While your personal assets would be protected since the lawsuit was against the corporation, you'd lose the building.
Charging Order
What if you're a member of a multi-member LLC and one of the members gets sued personally and ends up with a judgment against him (a debtor-LLC member). Are the non-debtor LLC members insulated from the judgment-creditor? Are the LLC's assets at risk?
The idea behind a charging order is to protect non-debtor LLC members in multi-member LLCs from claims against a debtor-member and to protect the assets of the business entity so it may continue to operate unimpeded.
In other words, the Charging Order limits the collection efforts of a judgment creditor. A charging order only gives a judgment creditor the right to attach a debtor LLC member's interest in LLC distributions and not the LLCs assets.
This means the business's assets remain out of the reach of the creditor, allowing the business to continue operating without disruption and with its assets in tact. A judgment creditor may not vote his charging interest or participate in the management of the business either. These restrictions preclude a judgment creditor from voting for an LLC distribution, which would allow the creditor to get his hands on some of the businesses money.
Partnership statutes and limited liability company statutes in most jurisdictions provide for charging orders.
Historical Note
The advent of the charging order dates back to around 1914 in the United States. It was designed to protect non-debtor partners from claims against a debtor partner. At that time, a creditor was able to obtain a writ of execution from the court directly against the partnership's assets. This led to the seizure of business's assets by the sheriff. This was possible because at that time the partnership itself was not treated as a juridical person, but simply as an aggregate of its partners.
The seizure of partnership assets was usually carried out by the sheriff, who would go to the partnership's place of business and shut it down, causing a major disruption of business and financial loss to the non-debtor partners.