When a C-corporation sells commercial real estate (CRE), its profit is hit with a 21% flat federal capital gains tax. The core problem stems from the Internal Revenue Code itself, which treats the C-corporation as a completely separate taxpayer from its owners. This creates a brutal “double taxation” conflict, where the profit is taxed once at the corporate level, and then the exact same profit is taxed a second time when the remaining cash is given to the shareholders. Over 90 percent of private company sales are structured as asset sales, the very transaction type that triggers this punishing two-level tax, potentially consuming over half of the total gain.
Here is what you are about to learn:
- 💰 Uncover the Hidden Second Tax: You will understand exactly how double taxation works and why the IRS gets two separate payments from a single property sale.
- ⚖️ Master the Key Calculation: Learn how to calculate your property’s “adjusted basis,” the single most important number that determines the size of your taxable gain.
- ❌ Dodge Critical Tax Blunders: Discover the most common and costly mistakes C-corp owners make and the specific, negative consequences of each one.
- 🆚 Compare Your Options: See a clear, head-to-head comparison of selling property from a C-corp versus an S-corp or an LLC, showing the dramatic difference in your take-home cash.
- 🗺️ Navigate Strategic Exits: Explore the three most common sale scenarios and learn how strategies like using past business losses can completely change your financial outcome.
The Two Tax Bills Hiding in Your C-Corp Sale
To understand the tax hit, you must first see the three key players involved in the sale: the C-corporation, its shareholders (the owners), and the Internal Revenue Service (IRS). The C-corporation is a legal entity, like a separate person in the eyes of the law, that owns the real estate. The shareholders are the actual people who own the C-corporation by holding its stock.
The relationship between them is what creates the tax problem. The C-corporation sells the building and, as its own legal “person,” must file a tax return and pay a 21% tax on the profit to the IRS. After the corporation pays its tax, the leftover cash belongs to the corporation, not the owners.
To get that cash to the owners, the corporation must pay them a dividend. When the shareholders receive that dividend check, the IRS views it as personal investment income. The shareholders must then report that dividend on their own personal tax returns and pay a second tax on it.
Why the IRS Takes Two Bites: Understanding the Double Taxation Trap
This process is called double taxation, and it is the single biggest disadvantage of holding real estate in a C-corporation. The “why” is simple: the law recognizes the corporation and its owner as two distinct, taxable entities. Each entity has its own obligation to pay tax on the income it receives.
The first tax is straightforward. The C-corporation sells an asset, recognizes a gain, and pays corporate income tax at a flat 21% federal rate. Many states also charge a corporate income tax, which is paid on top of the federal tax, increasing this first bite.
The second tax happens upon distribution. The after-tax profits, when paid out to shareholders, are typically classified as “qualified dividends.” These dividends are taxed on the shareholder’s personal return at federal rates of 0%, 15%, or 20%, depending on their income level. High-income shareholders also face an additional 3.8% Net Investment Income Tax (NIIT), pushing their maximum federal rate on that dividend to 23.8%.
The direct consequence is a massive loss of wealth. A $1 million profit can easily shrink to less than $500,000 in the owner’s pocket after both layers of federal and state taxes are paid. This tax inefficiency is why most advisors strongly caution against using a C-corporation for buy-and-hold real estate investing.
Your Starting Point: How to Calculate the “Adjusted Basis” That Determines Your Taxable Profit
The amount of profit, or “gain,” you pay tax on is not simply the sale price. It is the sale price minus your property’s adjusted basis. The basis is your investment in the property for tax purposes, and getting this number right is critical.
Your starting point is the cost basis. This is the original purchase price plus most of the initial acquisition costs. You can include expenses like legal fees for preparing the contract, recording fees, survey costs, and title insurance in your cost basis.
Over the years, this basis changes, creating the “adjusted” basis. You increase your basis for the cost of any capital improvements, which are things that add value or prolong the life of the property, like a new roof or an HVAC system replacement. You decrease your basis for things like depreciation deductions or any insurance payouts you received for casualty losses.
Imagine your C-corp bought a warehouse for $800,000 and paid $20,000 in closing costs, making the initial cost basis $820,000. Five years later, you spent $100,000 to repave the entire parking lot. Your basis increases to $920,000.
The Phantom Profit: How Depreciation Increases Your Tax Bill at Sale Time
Depreciation is an annual tax deduction the IRS allows you to take for the wear and tear on a commercial property. While these deductions are valuable because they lower your corporation’s taxable income each year, they come with a significant catch at the time of sale.
Every dollar of depreciation you claim reduces your property’s adjusted basis. A lower basis means a larger gap between your basis and the sale price. This creates a bigger taxable gain, which is why it is often called a “phantom profit” because you have to pay tax on the benefits you already received.
This process is known as depreciation recapture. For individual taxpayers, the portion of the gain caused by depreciation is taxed at a special rate of up to 25%. For a C-corporation, however, the rules are simpler and harsher: the entire gain, including the portion from depreciation recapture, is all lumped together and taxed at the same flat 21% corporate rate.
If your C-corp bought a building for $1 million and claimed $300,000 in depreciation over the years, your adjusted basis is now only $700,000. If you sell it for the same $1 million you paid, you still have a $300,000 taxable gain that your corporation must pay $63,000 in federal tax on ($300,000 x 21%).
Three Roads, Three Tax Outcomes: Common C-Corp Sale Scenarios
The structure of your sale dramatically changes the tax outcome. While there are many variations, nearly all transactions fall into one of three main scenarios. Understanding them is key to anticipating your tax bill and negotiating with a buyer.
Scenario 1: The Default Path – A Straightforward Asset Sale
This is the most common transaction for a private company and the one that triggers the full force of double taxation. Here, your C-corporation sells the physical property directly to the buyer. The buyer loves this because they get to record the property on their books at the new, higher purchase price, which means bigger depreciation deductions for them in the future.
| Financial Step | Tax Consequence |
| C-Corp Sells Building for $2M | The C-Corp calculates its gain. Let’s say the adjusted basis was $500,000, so the gain is $1.5M. |
| C-Corp Pays Tax | The corporation pays a 21% federal tax on the $1.5M gain, which is $315,000. |
| Cash Remaining in C-Corp | The C-Corp now has $1,685,000 in cash ($2M sale price – $315,000 tax). |
| C-Corp Distributes Cash to Owner | The $1,685,000 is paid to the shareholder as a dividend. |
| Shareholder Pays Tax | The shareholder pays a 23.8% tax (20% dividend rate + 3.8% NIIT) on the dividend, which is $400,930. |
| Owner’s Final Take-Home Cash | The owner is left with $1,284,070. The total tax paid was $715,930, an effective tax rate of 47.7% on the original gain. |
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Scenario 2: The Seller’s Dream – A Stock Sale
To avoid the corporate-level tax, shareholders can sell their ownership—their stock—in the C-corporation instead of having the corporation sell the asset. In this case, the gain is only taxed once at the shareholder level, at the lower long-term capital gains rates. This is almost always the seller’s preferred structure.
However, buyers strongly resist this. The C-corporation still owns the building with its old, low basis. The buyer, now owning the corporation, does not get the “step-up” in basis and loses out on massive future tax deductions.
| Seller’s Action | Buyer’s Reality |
| Shareholder sells stock for $2M. | The shareholder pays a single capital gains tax (e.g., 23.8% on their gain), avoiding the 21% corporate tax completely. |
| Buyer acquires the C-Corp. | The buyer now owns the corporation, which still owns the building with its original low basis of $500,000. |
| Buyer wants to depreciate the asset. | The buyer can only continue depreciating the property based on the old, low $500,000 basis, not the $2M they just paid. |
| Buyer inherits hidden risks. | The buyer is now responsible for any and all past liabilities of the C-corporation, known or unknown, including old tax problems or lawsuits.[23] |
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Scenario 3: The Strategic Play – Using Net Operating Losses (NOLs)
A C-corporation with a history of business losses may have a powerful tool called a Net Operating Loss (NOL) carryforward. These NOLs can be used to offset, or “soak up,” the taxable income from the real estate sale, potentially eliminating the first layer of corporate tax entirely.
This completely changes the negotiation. If the seller can use NOLs to avoid the corporate tax, they can agree to the buyer’s preferred asset sale structure. This gives the buyer the step-up in basis they want, and in return, the seller can demand a higher purchase price, effectively sharing the tax savings.
| Strategic Move | Financial Outcome |
| C-Corp has $1.5M in NOLs. | The corporation has a history of losses from its main business operations that it can use in future profitable years. |
| C-Corp sells the building for a $1.5M gain. | The corporation applies its $1.5M of NOLs against the $1.5M gain, resulting in $0 of corporate taxable income. |
| The corporate-level tax is eliminated. | The first layer of tax is completely avoided. The full $2M in sale proceeds can be distributed to the shareholder. |
| Shareholder pays dividend tax. | The shareholder still pays the second layer of tax on the $2M dividend, but the devastating first tax hit is gone. |
| Seller negotiates a higher price. | Knowing the buyer gets a full step-up in basis with no corporate tax cost, the seller can argue for a purchase price higher than in a normal asset sale. |
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Tax Landmines: 5 Critical Mistakes That Inflate Your C-Corp Tax Bill
Navigating a C-corporation real estate sale is filled with potential missteps that can have severe financial consequences. Avoiding these common errors is just as important as implementing advanced strategies.
- Forgetting About State Taxes. The 21% federal corporate tax is only part of the first tax bite. Most states levy their own corporate income tax, which can add another 5% to 9% or more to the bill. Forgetting to factor this in will lead to a nasty surprise and a significantly lower amount of cash to distribute.
- Sloppy Record-Keeping on Basis. Many owners fail to keep detailed records of capital improvements made over decades of ownership. Without receipts and documentation, you cannot prove these additions to your basis. The consequence is a lower adjusted basis, a higher taxable gain, and a needlessly inflated tax payment.
- Distributing the Property Directly. Some owners think they can avoid a sale by simply deeding the property from the corporation to themselves as a dividend. The IRS considers this a “deemed sale” at fair market value. This single action triggers the exact same double taxation as a cash sale, creating a massive tax bill for the owner without providing any cash to pay it.
- Ignoring the Asset Sale vs. Stock Sale Conflict. Sellers often dream of a simple stock sale, only to find at the last minute that the buyer will only agree to an asset sale. Because the buyer’s tax benefits from an asset sale are so large, they will significantly reduce their offer price for a stock sale. Failing to model and negotiate this point early can cost you hundreds of thousands of dollars at the closing table.
- A Last-Minute S-Corp Conversion. Converting to a tax-friendly S-corporation seems like an easy fix, but there’s a trap. If you sell the real estate within five years of converting, the IRS imposes a “Built-In Gains” (BIG) tax on the appreciation that existed at the time of the conversion. The BIG tax is calculated at the highest corporate rate, completely defeating the purpose of the conversion and leading to a tax outcome similar to a C-corp sale.
C-Corp vs. The Alternatives: A Head-to-Head Tax Showdown
The tax inefficiency of a C-corporation is most obvious when compared directly to “pass-through” entities like an S-corporation or a Limited Liability Company (LLC). In these structures, there is no corporate-level tax; the profit from the sale “passes through” to be taxed only once on the owner’s personal return.
| Feature | C-Corporation | S-Corporation | LLC (Taxed as Partnership) |
| Tax on Sale (Entity Level) | Yes. A flat 21% federal tax plus state corporate tax is paid by the corporation first. | No. The entity pays no federal income tax. The gain passes directly to the shareholders. | No. The entity pays no federal income tax. The gain passes directly to the members. |
| Tax on Distribution (Owner Level) | Yes. After-tax profits are taxed again as dividends to shareholders, up to 23.8% federally. | Yes. The gain is taxed once on the shareholder’s personal return at capital gains rates (up to 23.8%). | Yes. The gain is taxed once on the member’s personal return at capital gains rates (up to 23.8%). |
| Total Effective Tax Rate | Extremely High. Often 40% to 50%+ when federal and state taxes are combined.[6, 4] | Moderate. Limited to the single layer of personal capital gains tax (e.g., 23.8% + state tax). | Moderate. Limited to the single layer of personal capital gains tax (e.g., 23.8% + state tax). |
| Asset Protection Nuances | Good liability protection for the business, but a creditor can seize your personal shares of stock, gaining control of the company and its assets.[12] | Same liability protection and vulnerability as a C-corp. The corporate “veil” must be maintained. | Often stronger. Many states offer “charging order” protection, which prevents a creditor from seizing the asset and only gives them rights to distributions. |
| Flexibility on Exit | Very Rigid. Locked into the asset sale vs. stock sale conflict, which creates major tax friction. | More Flexible. Can distribute property out to shareholders without a corporate-level tax, though it may trigger shareholder-level tax. | Most Flexible. Can often distribute property out to members and divide assets with no immediate tax consequences. |
The Key Players in Your Transaction: Who They Are and What They Want
Every real estate sale involves parties with competing interests. In a C-corporation transaction, these interests are magnified by the complex tax rules.
- The C-Corporation: This is the legal entity that holds title to the real estate. It doesn’t have “goals” in a human sense, but its legal existence requires it to follow corporate formalities like board resolutions to authorize the sale and to file its own tax return (Form 1120) reporting the gain.
- The Shareholders: These are the true owners. Their primary goal is simple: to maximize their after-tax cash proceeds from the sale. The double taxation structure of the C-corp is their single biggest obstacle.
- The Buyer: The person or entity acquiring the property. The buyer has two main goals: 1) to receive a “step-up” in basis to the full purchase price, which allows for larger depreciation deductions and lower taxes for them in the future, and 2) to avoid inheriting any of the C-corporation’s hidden liabilities from the past. This is why they will almost always demand an asset sale.
- The Internal Revenue Service (IRS): The federal tax-collecting agency. The IRS’s role is to enforce the tax code as written. In this context, it ensures that tax is collected at the corporate level on the gain from the asset sale and again at the individual level on the subsequent dividend distribution.
- The Qualified Intermediary (QI): This is a specialized, independent party that is legally required if you want to attempt a tax-deferral strategy like a Section 1031 exchange. The QI holds the sale proceeds so the seller never has “constructive receipt” of the funds, which is a strict IRS requirement for the exchange to be valid.
The C-Corp Real Estate Playbook: Do’s and Don’ts for a Smarter Sale
Successfully navigating the sale requires careful planning and avoiding common pitfalls. Following a clear set of guidelines can help preserve your capital.
Do’s
- Do Plan Years in Advance. The most powerful strategies, like converting to an S-corp to avoid the built-in gains tax, require a five-year waiting period. Strategic planning should begin long before a sale is even contemplated.
- Do Get a Professional Valuation. When negotiating an asset sale, the purchase price must be allocated among different assets (land, building, equipment, goodwill). A credible, third-party appraisal is essential for defending these allocations if the IRS questions them.
- Do Model the After-Tax Outcomes. Before negotiating, have your accountant run the numbers for both an asset sale and a stock sale. Knowing the exact financial impact of each structure gives you the data you need to negotiate price adjustments effectively.
- Do Investigate Your Tax Attributes. Dig into your corporate records to see if you have any Net Operating Losses (NOLs) or other tax credits. These can be valuable assets in a negotiation and may make an asset sale far more palatable.
- Do Engage Professionals Early. The tax and legal complexities of a C-corp sale are immense. Bringing in experienced tax advisors and corporate attorneys at the very beginning of the process is the single best investment you can make.
Don’ts
- Don’t Assume Liability Protection is Absolute. If you fail to maintain corporate formalities, like holding annual meetings or keeping corporate funds separate from personal funds, a court could “pierce the corporate veil,” making your personal assets vulnerable.
- Don’t Co-Mingle Funds. Never pay personal bills directly from the corporate bank account or deposit rental income into your personal account. This is a primary reason for a court to pierce the corporate veil and can create an accounting nightmare.
- Don’t Forget the 3.8% NIIT. When calculating your personal tax on dividends, remember to add the 3.8% Net Investment Income Tax if you are a high-income earner. Forgetting this tax will result in an unexpected bill from the IRS.
- Don’t Wait Until You Have an Offer. The moment you receive an offer, you have lost most of your planning time and leverage. The best time to structure your entity and plan your exit is when you have no pressure from a buyer.
- Don’t Hold Appreciating Real Estate in a C-Corp. If you are just starting out, avoid this structure for buy-and-hold real estate at all costs. The tax consequences upon sale are simply too severe compared to the benefits of an LLC or S-corp.
Is a C-Corp Ever a Good Idea for Real Estate? Pros and Cons
While generally discouraged for holding appreciating assets, the C-corporation structure is not without its advantages in specific, limited situations. Understanding the full picture is essential for making an informed decision.
| Pros | Cons |
| Strong Liability Protection: A C-corp provides a robust legal shield between business debts and the shareholders’ personal assets, provided corporate formalities are maintained.[32] | Double Taxation on Sale: This is the primary disadvantage. Profits are taxed at the 21% corporate rate and again up to 23.8% at the shareholder level, severely reducing net proceeds. |
| Flexible Ownership: Ownership is represented by shares of stock, which can be easily sold, gifted, or transferred to others without affecting the legal ownership of the real estate itself.[32] | Trapped Tax Losses: If the property generates a tax loss (e.g., from depreciation), that loss cannot be used by shareholders to offset their other personal income. It is stuck inside the corporation. |
| Easier to Raise Capital: It is generally simpler to bring in new investors by selling shares of stock in a C-corporation compared to adding members to an LLC or partners to a partnership. | No Step-Up in Basis at Death: When a shareholder dies, their heirs inherit the stock with a stepped-up basis, but the corporation’s underlying real estate does not get a step-up. This creates a major embedded tax liability. |
| No Limit on Number of Owners: Unlike an S-corporation, which is limited to 100 shareholders, a C-corporation can have an unlimited number of owners.[33] | Complexity and Cost: C-corporations have stricter record-keeping and regulatory requirements, such as mandatory annual meetings and board minutes, making them more expensive and complex to maintain.[7, 32] |
| Good for “Dealer” Status: For a business that is actively flipping a high volume of properties, the income is ordinary income anyway. The 21% flat corporate tax rate might be lower than the top individual ordinary income rates (up to 37%). | Tax on Refinancing Proceeds: If the corporation refinances a property and distributes the tax-free loan proceeds to shareholders, that distribution can become a taxable dividend to them, creating tax out of debt. |
The Paper Trail: Navigating Key IRS Forms in Your C-Corp Sale
A real estate sale generates a significant amount of paperwork for the IRS. Knowing which forms are involved helps you understand how the transaction is reported and tracked by tax authorities.
- Form 4797, Sales of Business Property. This is the primary form the C-corporation uses to report the sale. It is where the sale price, adjusted basis, and total gain are calculated. The form is divided into parts to handle different types of assets and gains, but for a simple building sale, the final gain is calculated in Part III and then carried to the main corporate tax return.
- Form 1120, U.S. Corporation Income Tax Return. This is the standard annual income tax return for a C-corporation. The total gain calculated on Form 4797 flows to Form 1120, where it is combined with the corporation’s other business income and expenses to arrive at the final taxable income for the year. The 21% corporate tax is calculated on this final number.
- Form 1099-S, Proceeds From Real Estate Transactions. You will not file this form, but you will receive a copy. The closing agent or attorney who handles the transaction is legally required to file Form 1099-S with the IRS, reporting the gross proceeds of the sale and who received them. This is how the IRS knows a sale occurred and cross-references it with your corporate tax return.
- Form 1099-DIV, Dividends and Distributions. After the corporation pays its tax and decides to distribute the remaining cash to its owners, it must issue a Form 1099-DIV to each shareholder. This form reports the exact amount of the dividend paid. The corporation sends one copy to the shareholder and another to the IRS, which allows the IRS to match the dividend income reported on your personal tax return.
Frequently Asked Questions (FAQs)
Is the capital gains tax rate for a C-corp different from its regular income tax rate? No. A C-corporation pays a flat 21% federal tax on all its net income, whether it comes from regular business operations or from long-term capital gains on a property sale.
Can a C-corporation use a 1031 exchange to defer capital gains? Yes. A C-corporation can use a Section 1031 “like-kind” exchange to sell a property and defer the corporate-level tax by reinvesting the proceeds into a new, similar property under strict IRS timelines.
Can I avoid double tax by paying myself a large bonus instead of a dividend? No, not entirely. While a “reasonable” salary or bonus is a deductible expense for the corporation, the IRS can reclassify excessive compensation as a “disguised dividend,” which would then be subject to double taxation.
Do I still pay tax if the C-corp sells the property at a loss? No. If the property is sold for less than its adjusted basis, the corporation has a capital loss. This loss cannot be used to offset ordinary business income but can be used to offset other capital gains.
Is it ever a good idea to hold rental property in a C-corp? No, almost never for long-term holds. The double taxation on sale and the trapping of tax losses inside the corporation make it a highly inefficient structure for typical buy-and-hold real estate investors.
What happens to the property’s basis if I inherit C-corp stock? Your stock gets a “step-up” in basis to its value at the date of death, but the property inside the corporation does not. This is a major disadvantage, as a huge, embedded tax liability remains.
Does depreciation recapture apply to a C-corporation? Yes. The gain created by past depreciation deductions is “recaptured.” However, unlike for individuals, the recaptured amount is not taxed at a special rate; it is simply added to the total gain and taxed at 21%.