Q: I just formed an S Corporation and I would like to raise some capital. Can I buy a house with my corporation at a good deal then sell it back to myself with a profit?
A: Your question is an interesting one but we are puzzled by it.
First, an S corporation is simply an ordinary corporation that has made a special election with the IRS for federal income tax purposes. An S corporation usually does not pay federal income taxes. The S Corporation may file a return with the IRS but the corporation’s income or losses are divided amongst and passed through to its owners, known as shareholders. The shareholders would then report the income or loss on their own individual income tax returns.
So, if the S Corporation buys the property and then sells it to you, it would appear that you are selling the home to yourself.
The problem, when it comes to real estate transactions, is that this sort of insider transaction might be considered a scam.
Let’s say you buy a property for $100,000 and sell it back to yourself at $150,000. It looks like you have a $50,000 profit. But since you paid the original amount, it’s as though you’re trying to get a loan for an extra $50,000. If you personally apply for a mortgage for $150,000, the lender is going to do an appraisal and figure out that the S Corporation just bought the property for $100,000. The comparable pricing will show that the true value is only $100,000, and you’ll be denied approval for your loan. But if the lender finds out that you actually own the S Corporation – and the lender will – it will look like mortgage fraud, which is against the law.
As part of any loan application, the lender will require copies of your tax returns and in the case of a person owning an S Corporation, the lender will probably require copies of those financial documents as well.
The risk is extremely high that you would be caught and might be accused of mortgage fraud. It’s just not worth it. There’s no benefit we can see to buying real estate inside with a corporation for the sole purpose of selling it to yourself at an inflated price.
But we do think it’s a great idea to buy real estate at today’s reduced prices. For as long as these reduced prices last, and as long as interest rates are at historic lows, this will be a wonderful time to buy and hold investment property.