Tax considerations for New York real estate businesses.

Buying, selling, and managing real estate in New York involves a number of complex tax issues. Following is a brief introduction to several important tax considerations for those in the business to consider.

Which Entity Should Yon Choose?

Choosing an entity involves several tax and non-tax considerations. For most real estate businesses, however, a traditional C corporation is not the best choice. C corporations are subject to double taxation for both federal and state purposes--first at the corporate level and again at the shareholder level when dividends are distributed. In addition, C corporations must pay New York City (NYC) corporate income tax on income allocable to NYC (such as gain on the sale of NYC property). NYC resident shareholders are also subject to NYC personal income taxes on dividend income.

"Pass-through" entities--such as partnerships, LLCs, and S corporations--generally avoid entity-level taxes and are therefore more desirable structures than C corporations. All income, losses, and other tax attributes flow through to the individual partners, members, or shareholders. In NYC, however, S corporations are subject to the city's corporate income tax. Partnerships and LLCs are subject to the city's Unincorporated Business Tax (UBT), but there's an exception for certain real estate businesses. As with corporations, nonresident partners and LLC members are exempt from NYC personal income tax.

Are You a Real Estate Professional?

One of the advantages of a passthrough entity is that you can deduct your share of business losses (subject to certain limitations). And real estate professionals have an advantage over other taxpayers: They can use qualifying rental real estate losses to fully offset other types of income, such as salaries, commissions, interest, and dividends. Generally, to qualify as a real estate professional, you must spend at least 750 hours a year on real estate activities in which you "materially participate."

If you're involved in several real estate businesses, you may need to file an aggregation election so you can count them as a single activity in order to meet the material participation requirement.

What Basis Do You Have?

Even if you qualify as a real estate professional, your loss deductions are limited to your at-risk basis in the entity. If you're an S corporation shareholder, your at-risk basis is generally equal to the amount you've invested in the stock plus any loans you've made to the corporation. If you're a partner or LLC member, your at-risk basis is generally equal to your capital account plus your share of any recourse and qualified nonrecourse liabilities, such as mortgages.

The ability to deduct losses is an important consideration in choosing the fight entity for your business. Also, if you don't have enough basis at risk to offset losses, there may be opportunities to increase your basis to take advantage of those deductions.

Can You Exchange It?

Real estate sales can trigger substantial capital gains taxes at the federal, state, and even local levels. Before you, make a sale, consider whether there's an opportunity to defer the taxes through a Section 1031 "like-kind" exchange.

You need not trade properties simultaneously. By using a qualified intermediary to sell a property and hold the proceeds, you can avoid current taxes so long as you identify like-kind replacement property within 45 days and reinvest the proceeds in qualified property within 180 days.

Keep in mind that while virtually any type of real estate held for business or investment purposes qualifies as like-kind property, an exchange that involves cash or non-like-kind personal property may trigger current taxes.

Are Yon a Dealer?

Being treated as a real estate "dealer" rather than an investor can have several negative tax consequences. Your profits will be taxed as ordinary income instead of capital gains and you'll be disqualified from deferring the tax through a See. 1031 exchange. In addition, you'll lose your UBT exemption in New York City.

The IRS considers you a dealer if your business is buying and selling real estate rather than holding it for investment. To make this determination, the Service looks at several factors, including the duration of ownership, the extent of improvements, and the continuity of your sales activities over time.

If you complete a condo conversion, for example, you will likely be considered a dealer. There may be ways to structure your investment, however, to obtain capital gain treatment on a portion of your profits.

Get the Big Picture

There are many other issues--both tax and nontax--that New York real estate businesses should consider. Your advisors can help you determine the right structure for your business in light of your overall financial picture.

By Marc Wieder, CPA 

Anchin, Block & Anchin LLP