02/11/2026
“You can check out any time you like - but you can never leave” – Eagles, Hotel California
Have you ever tried to fit a square peg into a round hole? With enough force, you might get it in there, but you’ll likely splinter the wood and ruin the peg.
In the world of tax planning, putting appreciating real estate inside an S Corporation is that square peg. On paper, it looks like a business asset, so why not? In reality, it is one of the most expensive rookie mistakes a high-income earner or small business owner can make.
While the S Corp is a fantastic vehicle for saving on self-employment taxes for your active business income, it is a legal and financial cage for your passive real estate assets.
The good news? There is a better way.
The biggest danger of putting real estate in an S Corp is that while it is easy to get the property in, it is incredibly expensive to get it out.
Imagine you bought a commercial building for $500,000 inside your S Corp. Ten years later, it is worth $1 million. You decide you want to move that property into a different entity or perhaps hold it personally.
Under IRS rules, distributing appreciated property from an S Corp to a shareholder is treated as a deemed sale. The IRS views this as if the corporation sold the property to you at its current fair market value.
One of the greatest wealth-building tools in the tax code is the Step-Up in Basis. Usually, when an individual passes away owning real estate, the heirs receive the property at its value on the date of death. This effectively wipes out the capital gains tax on all the appreciation that happened during the decedent's life.
However, when an S Corp owns the property, the IRS sees two distinct layers of value that do not talk to each other:
When a shareholder passes away, the outside basis (the stock) gets a step-up to fair market value. That is great for the stock, but it does absolutely nothing for the inside basis (the building). The building remains trapped inside the corporation at its old, original cost.
If your heirs decide to sell that building, the corporation realizes a massive gain because the building's inside basis never changed. While there are complex accounting maneuvers to try to offset this by liquidating the corporation in the same year, the margin for error is razor-thin. If the timing is off, your heirs could end up paying taxes on a legacy that should have been tax-free.
As a real estate investor, one of your most powerful moves is the Cash-Out Refinance. You take out a loan against the equity of the building and use that tax-free cash to buy more property or fund your lifestyle.
However, in an S Corp, your ability to take that cash out of the company without paying taxes is limited by your basis. Debt inside an S Corp does not increase your basis (unlike in a partnership). If you pull out more cash than you have basis in your shares, those tax-free loan proceeds could actually result in a taxable distribution. You end up paying taxes on borrowed money.
Most business owners choose an S Corp to save on Self-Employment (SE) taxes. You pay yourself a reasonable salary and take the rest of the profit as a distribution that isn't hit by the 15.3% SE tax.
However, rental income is already exempt from SE tax. By putting real estate inside an S Corp, you gain zero additional payroll tax savings, but you add layers of complexity, administrative costs, and the risk of the deemed sale mentioned above. You are effectively using a complex tool to achieve a result that the tax code already gives you for free in a simpler LLC structure.
Instead of the S Corp owning the building, the most effective strategy for small business owners is a self-rental setup:
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Greg Tobias, Enrolled Agent
Admitted to practice before the Internal Revenue Service