The answer to this question really depends on the type of legal entity your business is operated through. Businesses may be operated as any of the following legal entities:
- Traditional "C" Corporation
- S Corporation
- Single-Member Limited Liability Company which is taxed as a sole proprietorship
- Limited Liability Company with multiple owners, which is taxed as a corporation or partnership
- General Partnership
- Sole Proprietorship
Each legal entity has unique tax advantages and disadvantages, depending upon the nature of the business. Let's answer this question, legal entity by legal entity.
There would be no long-term capital gains tax on the sale, but there would be regular corporate income tax on the sale if there were a gain realized on the sale. The reason for this is that C corporations do not have any preferential capital gains tax rates available to them. Generally, all of the income recognized by a business operating through a traditional C corporation is taxed at the corporate income tax rates that range from 15% up to 35%, depending upon the level of taxable income. Any asset sale by a corporation to a shareholder would be taxed if there were a gain on the sale, this includes a house. Furthermore, the sales price must represent what is called an arm's length price. Arm's length means it represents what an independent third party would pay for the home. If the sales price of the home was determined to be not at arm's length by the IRS, then there are a host of distribution-related issues that could apply, and which are beyond the scope of this article.
The sale of a house by an S corporation to one of its shareholders would be treated as a long-term capital gain (if the corporation owned the house for more than one year). This gain would be passed through to the respective shareholders and taxed on their individual income tax returns. An S corporation generally does not pay any income tax. All items of income and loss are passed through to the individual shareholders who must report these income or loss items on their individual income tax returns. There are other issues, such as depreciation recapture if the house were used for a business purpose, but that is beyond the scope of this article.
Single-Member Limited Liability Company ("LLC") and Sole Proprietorship
Single-member LLCs and sole proprietorships are taxed the same way at the federal level. If the house were used for business purposes and was owned by an LLC (title was in the name of the LLC) then the gain on the sale would have to be reported by the owner of the LLC on his or her individual income tax return. If the house were owned more than one year by the LLC then the owner would treat the gain as a long-term capital gain. With respect to a sole proprietorship, the house can only be titled in the name of the individual who operated the sole proprietorship. Since title does not change, there is no sale and no capital gains issue until the individual sells the house to an independent third party. Depreciation recapture rules would apply if the house were used by the business whether an LLC or sole proprietorship, but that is beyond the scope of this article.
Limited Liability Company with Multiple Owners, Taxed as a Corporation
The rules that apply to a corporation would be identical in this scenario, meaning any long-term capital gain would be taxed only within the LLC.
Limited Liability Company with Multiple Owners, Taxed as a Partnership and General Partnership
Partnerships are similar to S corporations in that the individual items of income and loss are not taxed within the partnership, but are passed through to the individual partners and taxed on their individual income tax returns. Thus, any sale of a house by the partnership would be taxable to the individual partners not the partnership. If the partnership owned the house for more than one year then the gain would be eligible for the long-term capital gains tax rate, which is currently 15%.
The Bottom Line
The real troublesome issue with respect to a house owned by a business is the loss of the home sale exclusion. The home sale exclusion allows individuals who own a home as their primary residence to exclude up to $500,000 of the gain from taxation ($250,000 for individuals whose filing status is single). When the house is owned by a business this home sale exclusion is lost, which is a significant tax consideration. As in any tax transaction, it goes without saying that individuals need to seek the advice of a CPA or Attorney.
SEE: Should You Incorporate Your Business?
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