S Corperations

S-Corporations and Built-in Gains

Although S corporations are passthrough entities and as such are not subject to tax at the corporate level, a corporation that converts from a C corporation to an S corporation is subject to a corporate level tax on the disposition of any assets held on the date of conversion to the extent that there were "built-in gains" on the conversion date. That is, to the extent that any assets with built-in gains on the date of conversion are disposed if by the S corporation within 10 years following the date of conversion, the S corporation is subject to a capital gains tax at the highest corporate rate on the built-in gain. The shareholders of the S Corporation also must include the gain on their individual returns, although a credit is provided for taxes paid at the corporate level. Section 1374.

One method of deferring the built-in gains tax is by entering into a like-kind exchange under Section 1031. Rather than disposing of an asset with substantial built-in gain, thereby triggering the built-in gains tax, the S Corporation can enter into a like-kind exchange and defer the recognition of the tax. Note, however, that the property received in the exchange will retain the built-in gain that the relinquished property had at the time the C corporation converted to an S corporation. section 1374(d)(6).