Tax consequences of liquidating an annuity
While claimed over a 10-year period, compliance with the statutory criteria must be met over a 15-year “compliance period” (Sec. The LIHC is subject to recapture if any interest in the building (including stock owned in an S corporation that owns the building) is disposed of during the compliance period. Alternatively, the shareholders can pledge Treasury securities in lieu of a surety bond (Rev. The liquidation of an S corporation that has passed through the LIHC to its shareholders, and the distribution of the low-income housing property (or proceeds from its sale) to the shareholders, appear to result in recapture. For example, the low-income housing credit (LIHC) authorized by Sec. A reduction in stock ownership triggers recapture when the shareholder’s interest falls below two-thirds, and then one-third, of what it was in the year the S corporation placed the investment credit property in service (Sec. 42 is a business tax credit for residential rental property that qualifies as low-income housing under detailed statutory criteria. 302 if the distribution is pursuant to a plan and occurs within the tax year the plan is adopted or the following tax year and the “safe harbor” of Sec. Under the safe harbor, the assets, or proceeds from the sale of the assets, of a trade or business conducted by the S corporation during the previous five-year period must be distributed to the terminating shareholder, and the S corporation must continue conducting a trade or business that it conducted during the same prior five-year period.A distribution in partial liquidation that does not qualify for sale or exchange treatment will be governed by the usual S corporation distribution rules of Sec. In certain cases, this treatment is preferable to sale or exchange treatment. 1368 treatment, the sale or exchange rules can be easily avoided, for example, by failing to adopt a plan of liquidation or delaying the distribution until two years after the tax year the plan is adopted.In a complete liquidation, pass-through losses suspended because of basis limitations that remain after the basis of the redeemed stock has been reduced to zero do not reduce gain or increase loss resulting from the liquidation. 1.1366-2(a)(5).) While there is no authority on point, it appears that the shareholder is not entitled to restore basis after the liquidation has been completed in a manner similar to the post-termination transition period rules of Sec. Losses limited by the at-risk rules are also eligible for indefinite carryover (Sec. Unlike the basis limitation rules, at-risk basis is increased by gain recognized from disposition of the stock. While a taxpayer who disposes of his or her entire interest in a passive activity can deduct suspended passive losses (and any loss from the disposition) against current passive and nonpassive income, an exception to this rule postpones the deduction if the passive activity is transferred to a related party (Secs. While a corporation and a 50%-or-more shareholder are related for this purpose, it seems that this exception would not prevent a less-than-50% shareholder from recognizing suspended passive losses due to the liquidation of the corporation. However, a “mere change in the form of conducting the business” will not cause investment credit recapture if certain conditions are met (Sec. Since suspended passthrough losses are lost, the shareholder should consider creating additional basis before the final distribution through additional capital contributions or loans. Accordingly, it appears that suspended losses arising from the at-risk rules can be claimed by the shareholder to the extent of gain recognized. General business credits can be subject to recapture as the result of the liquidation of an S corporation. Recapture is reduced 20% for each year the property is held, so recapture is zero once the S stock has been held for five years.
If the sale and distribution do not occur in the same tax year, a shareholder may report capital gain from the sale of the asset but report a capital loss (which cannot be carried back) in a later year when the sale proceeds are distributed. In a complete liquidation, the shareholder’s basis in the distributed property will be its FMV (rather than by reference to the transferor’s basis).
The liquidation process itself does not terminate the company’s S election.
Therefore, passthrough items in the year of liquidation are allocated under the normal per-share, per-day rule of Sec. However, a bunching of income can occur in the year of liquidation of a fiscal-tax-year S corporation if the final liquidating distribution occurs on a date other than the last day of the fiscal year.
This may in turn make it difficult to accurately determine the AAA available for ordinary distributions and makes inadvertent dividend distributions from AE&P more likely to occur.
If the S corporation has AE&P, the shareholders may want to forgo distributions prior to commencement of the liquidating distributions, because once the AAA is exhausted, preliquidation distributions are treated as dividend income to the extent of AE&P.