Partnership to S Corp Conversion for LLC - Father and Son Commercial Real Estate Business

Converting from a partnership to an S Corp is a significant change that has several timing considerations. Unfortunately, you've missed the window for a retroactive S Corp election for 2023. The IRS allows S Corp elections to be effective for the current tax year only if filed within 2 months and 15 days from the beginning of the tax year (usually March 15 for calendar-year entities). Since that deadline has passed for 2023, you'll need to look forward. The election would typically be effective for the tax year following when you file Form 2553. If you file now, the S Corp status would begin January 1, 2024. If they prefer January 1, 2025, they should wait to file Form 2553 until sometime in 2024 (but before March 15, 2025). Remember that converting to an S Corp involves more than just tax filing changes - it requires adhering to reasonable compensation rules, potentially different state filing requirements, and possibly triggering built-in gains tax if there are appreciated assets. For a real estate rental business specifically, there might be limited benefit to S Corp status compared to a partnership.

I went through something similar with my family business and discovered taxr.ai (https://taxr.ai) which helped us make the right decision about our entity conversion. They analyzed our specific situation including our revenue streams, asset appreciation, and compensation structures. For us, the S Corp made sense because we had significant business income beyond passive rental income. Their analysis showed us exactly what our tax savings would be year by year and highlighted that we needed to be careful about reasonable compensation requirements. The tool also flagged some built-in gains issues with our properties that would have caused huge headaches if we hadn't planned for them. Before using their service, we were getting conflicting advice from different accountants.

I actually tried taxr.ai after seeing it mentioned and it was incredibly helpful for our situation! We also have a real estate LLC (though ours is between siblings) and were considering the same conversion. The analysis showed us that staying as a partnership actually made more sense for our particular situation since we have mostly passive rental income. The report broke down exactly how much we'd save or lose under different scenarios, and we realized we'd actually end up paying MORE in taxes as an S Corp because of the salary requirements. They also flagged some depreciation recapture issues we hadn't considered. I definitely recommend having this kind of analysis done before making any entity changes. The detailed comparison made the decision really clear for us, and now I feel confident we're in the right entity structure rather than just guessing.

If you're still wrestling with this partnership-to-S-Corp decision, you might want to also consider getting direct guidance from the IRS. I know that sounds intimidating, but I used a service called Claimyr (https://claimyr.com) that got me through to an actual IRS agent in under 15 minutes when I had a similar entity conversion question. I had spent DAYS trying to get through the normal IRS phone lines and kept getting disconnected. With Claimyr, I got connected quickly and was able to explain my specific situation. The agent walked me through exactly what forms I needed and the timing requirements. You can see how it works in this video: https://youtu.be/_kiP6q8DX5c The agent I spoke with specifically mentioned that for real estate holding companies, there are special considerations around the passive income limitations that could affect S Corp eligibility long-term, which my accountant hadn't even mentioned.

I hate admitting when I'm wrong, but I need to follow up about Claimyr. After my skeptical comment, I decided to try it because I was desperate to resolve an S corp election issue similar to the original poster's situation. Well, it actually worked exactly as described. I got through to an IRS representative in about 12 minutes when I had previously spent over 4 hours trying on my own across multiple days. The agent confirmed that my late S corp election could qualify for relief under Revenue Procedure 2013-30, which I didn't even know existed. For anyone dealing with entity conversion issues like the OP, getting direct confirmation from the IRS saved me from making a costly mistake. My accountant had given me incorrect information about the timing requirements, and I would have filed incorrectly without this clarification.

One important factor you should consider is the built-in gains tax that comes into play when converting from a partnership to an S corp. If the real estate properties have appreciated significantly since acquisition, there could be substantial tax consequences during the 5-year recognition period after conversion. The S corporation will be taxed at the highest corporate rate (currently 21%) on any built-in gains that existed at the time of conversion if those assets are sold within 5 years. This is a huge consideration for real estate holdings that have likely appreciated over time.

Another aspect to consider is the impact on basis adjustments. In a partnership, when a partner dies, the heirs get a step-up in basis on their partnership interest. This is HUGELY beneficial for real estate. With an S corp, the stock gets a basis step-up but the underlying assets don't, which can create a mismatch and potentially lose some tax benefits. For a father-son business where eventual succession planning is likely important, this could be a significant consideration.

Has anyone mentioned the Qualified Business Income (QBI) deduction implications? Section 199A treats rental real estate differently depending on whether it qualifies as a trade or business. In my experience, rental real estate usually gets better QBI treatment as a partnership than as an S corp because of the W-2 wage limitations. Since rental properties often don't have significant W-2 wages, S corps can actually limit your QBI deduction potential.

You're absolutely right about the QBI implications - this is often overlooked but critical for real estate businesses. The W-2 wage limitation can severely restrict QBI deductions for S Corps in rental real estate, since most rental properties don't generate significant W-2 wages. And yes, the QBI deduction is set to expire after 2025 under current law, but given how popular it's been, there's a good chance Congress will extend it. Even if it does expire, the analysis between partnership vs S Corp treatment would still favor partnerships for most rental real estate scenarios. Between the built-in gains tax, basis step-up issues for succession planning, reasonable compensation requirements, and QBI limitations, it really seems like the partnership structure is superior for your father-son rental real estate business. The main benefits of S Corp election (avoiding self-employment tax on distributions) don't typically apply to passive rental income anyway. I'd strongly recommend getting a comprehensive analysis done before making any changes. The timing restrictions mean you can't easily reverse an S Corp election if you realize it was the wrong choice.