How Do You Convert Property into an S-Corporation?

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Shareholders contribute money, equipment, property, and services to a corporation when they want to start this type of business entity. These assets are the business's starting capital and they are said to have been “converted” into the corporation’s ownership. Everything that’s donated into the corporation becomes the corporation's capital assets.

A shareholder receives a capital account in their name in exchange for donating time, money and property. The account shows their share of the capital assets in the new business. A shareholder can sell their share of an S-Corp so any gain or loss on small business stock is calculated like capital gains on stocks or mutual funds. The shareholder has to know their tax basis in the investment in order to calculate the gain or loss. 

Key Takeaways

  • Converting property involves transferring it into the ownership of the corporation.
  • Property that you convert becomes your capital contribution to the S-Corp, which would form your basis for a capital loss or gain if you later sell your interest.
  • The value of the property becomes the corporation’s basis in it.
  • Property is valued at the lesser of its adjusted basis or its fair market value when it’s donated or converted.

The Value of the Property Becomes the Corporation’s Basis

The value of the property becomes the corporation's basis in it when it is donated, transferred, or converted to an S-Corp. The value is also added to the capital account of the shareholder who donated it.

Let's say you donate a relatively new computer to your newly-formed S-corporation. The "adjusted basis" of the computer is $1,500. You also contribute $10,000 in cash. Here's how your capital account would look:

  • Owner's equity (as it will appear on the company's balance sheet)
  • William's capital account
  • Cash $10,000
  • Equipment $1,500
  • Total Capital $11,500

Your total capital contribution to the S-Corp is $11,500.

Note

You would calculate your capital gain or loss based on the contribution amount if you later sell your stake in the company.

How To Account for the Contributions

The company's basis in the donated property is the smaller amount of either its fair market value (FMV) or the shareholder's adjusted basis, according to the IRS. Adjusted basis is the original cost of the property plus any improvements, plus any purchase costs, plus any selling costs, minus any depreciation.

You must calculate two numbers to figure out the value of your capital contribution and to calculate the company's basis for depreciation: the fair market value of the computer you donated and the computer's adjusted basis. 

An Example of Property Conversion

The computer in this scenario was your personal property. You never used it as business property and you never claimed any depreciation on it. You purchased the computer for $2,000, which included costs for shipping and tax. Your adjusted basis in the computer would be:

$2,000 original cost plus $0 improvements plus $0 purchase costs (because shipping and tax were already included in the purchase price) plus $0 selling costs minus $0 depreciation equals a $2,000 adjusted basis.

You must next figure out the fair market value of the computer. Check various websites such as eBay and craigslist. You might find out that your computer model is selling for around $1,500 in good condition. You could expect to get about $1,500 for it if you were to sell it in this condition, so this is the FMV of the computer.

Note

Your property is valued at the lesser of its adjusted basis or its fair market value when you donate or convert it to your S-Corp. 

The value of the computer is therefore $1,500 because that’s the lesser of these two figures. Therefore, Your capital account is increased by $1,500 and the corporation can use $1,500 as its basis for depreciating the computer.

If the Computer Was Business Property 

You most likely depreciated the computer’s cost on IRS Schedule C if you used it as an independent contractor. You bought it for $2,000, which included shipping and tax. You bought the computer in June 2021 and took Section 179 depreciation on your 2021 Schedule C, opting to claim its full cost in the first year. Your adjusted basis in the computer would be:

$2,000 original cost plus $0 improvements plus $0 purchase costs (because shipping and tax were included) plus $0 selling costs minus $2,000 Section 179 depreciation taken in 2021, equaling $0 adjusted basis.

Just as in the example above, the fair market value of the computer is $1,500. The lesser of these two figures is $0, so your computer is unfortunately valued at $0. Your capital account is increased by $0. The corporation cannot depreciate the computer because the corporation's basis in the computer is also $0.

Note

Your adjusted basis in the property is zero if you’ve expensed the full cost of your business property using Section 179. The S-Corp inherits your adjusted basis, which is still zero, when you convert your business property into the corporation.

Frequently Asked Questions (FAQs)

How long does a bank require you to live in a home before converting it to investment property?

The general rule is that lenders will require you to live in a property for 12 months before you can treat it as an investment property but this isn’t a legal requirement. Lenders sometimes make exceptions. 

What happens to liabilities and assets when you convert a disregarded LLC to an S corporation?

Not all states will allow you to convert an LLC to an S-Corp, and you will most likely have to change the structure and ownership of your LLC even if your state allows it. You can then do a statutory conversion to transfer all liabilities and assets. 

Updated by
Beverly Bird
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Beverly Bird has been a writer and editor for 30+ years, covering tax breaks, tax preparation, and tax law. She also worked as a paralegal in the areas of tax law, bankruptcy, and family law from 1996 to 2010. Beverly has written and edited hundreds of articles for finance and legal sites like GOBankingRates, PocketSense, LegalZoom, and more.
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  1.  Cornell Law School Legal Information Institute. “Capital Account.”

  2. Internal Revenue Service. “Instructions for Form 7203 - S Corporation Shareholder Stock and Debt Basis Limitations.”

  3. Internal Revenue Service. "Frequently Asked Questions/Property (Basis, Sale of Home, Etc.)"

  4. Internal Revenue Service. “Publication 551 (12/2018), Basis of Assets - Adjusted Basis.”

  5. Internal Revenue Service. “Publication 551 (12/2018), Basis of Assets - Fair market Value.”

  6. Internal Revenue Service. “IRS issues guidance on Section 179 expenses and Section 168(g) depreciation under Tax Cuts and Jobs Act.”

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