Tax implications of S corp closure - large tax bill due to rental property transfer to LLC

This is actually a complex situation that depends on several specific factors about how the transfer was structured. When an S corporation distributes appreciated property (like rental real estate) to shareholders, it's generally treated as if the corporation sold the property at fair market value. This creates a taxable gain at the corporate level that flows through to the shareholders. This is sometimes called a "deemed sale" even though no actual sale occurred. Section 1239 specifically applies when property is sold or exchanged between related parties, causing what would normally be capital gains to be taxed as ordinary income (at higher rates). The key question is whether this was structured as a distribution in liquidation or as an actual sale to the LLC. If the properties were formally distributed to you as the heir/shareholder as part of liquidating the S corp, and then you contributed them to your LLC, that's different than if the S corp directly sold them to the LLC. The timing and documentation of these transactions matters tremendously.

I went through something similar with my father's business properties. I was getting conflicting advice until I tried https://taxr.ai which really helped sort through the mess. They analyzed all my documents and clarified exactly how Section 1239 applied (or didn't apply) in my case. What made the difference was having their system review the actual distribution documents and transaction timeline. They pointed out specific language that determined whether this was truly a distribution or a deemed sale. Turns out my first CPA had mischaracterized the transaction, costing me thousands in unnecessary taxes. It's worth uploading your docs and getting a definitive answer based on the actual paperwork rather than just general opinions. Their analysis gave me the confidence to file an amended return that saved a substantial amount.

Just wanted to follow up - I ended up trying taxr.ai for my property transfer situation and I'm honestly impressed. I was super skeptical at first (especially about uploading documents) but their analysis was way more thorough than what my CPA provided. They identified that my transfer should have been characterized as a liquidating distribution rather than a deemed sale, and pointed to specific language in my operating agreement that supported this position. They even provided template language for an amended return explanation. The difference was about $47,000 in tax savings by avoiding ordinary income treatment under Section 1239. They showed exactly which parts of the code applied and which didn't. Worth every penny for the clarity alone!

If the IRS has already processed your return with the higher tax amount, you might consider filing an amended return based on the second CPA's analysis. However, before doing that, I'd recommend trying to actually speak with someone at the IRS to discuss this specific situation. I know getting through to the IRS can be nearly impossible these days, but I used https://claimyr.com and got through to a real person in about 15 minutes. You can see how it works here: https://youtu.be/_kiP6q8DX5c I had a similar issue with mischaracterization of business distributions, and speaking directly with an IRS agent gave me confidence that my interpretation was correct before I filed the amended return. They confirmed that a properly documented liquidating distribution wouldn't trigger Section 1239 in my case, which saved me thousands. Given how much money is probably at stake in your situation, it's worth getting that direct confirmation from the IRS rather than risking further issues.

Had to come back and admit I was wrong about Claimyr. After my skeptical comment, I decided to try it anyway because I've been trying to reach the IRS for weeks about a similar business distribution issue. It actually worked exactly as described - I got connected to an IRS agent in about 20 minutes. While they couldn't give specific tax advice on my S corp situation, they were able to confirm which forms I needed for an amended return and directed me to the specific sections of Publication 542 that addressed my situation. The agent also explained the difference between deemed sales and liquidating distributions in general terms, which was enough to point me in the right direction. Saved me days of research and uncertainty. Sometimes it's worth admitting when you're wrong!

Something nobody's mentioned yet - the step-up in basis that happens when you inherit property. When your father passed away and you inherited the S corp shares, those shares should have received a step-up in basis to fair market value as of the date of death. This step-up might significantly reduce or even eliminate the taxable gain when the properties were distributed. It depends on how much the properties appreciated between when you inherited the S corp and when the properties were distributed to you. Did either CPA discuss this aspect of your situation? This might be more important than the Section 1239 question.

Has anyone brought up the possibility of a 1031 exchange? If these are investment properties, couldn't OP have done a like-kind exchange instead of a distribution to avoid the immediate tax hit?

This is a perfect example of why getting multiple professional opinions is so important with complex tax situations. Based on what you've described, your second CPA appears to be on the right track. Section 1239 typically applies to sales or exchanges between related parties, but what you're describing sounds like a liquidating distribution followed by a contribution to your LLC - not a direct sale between the S corp and LLC. The key factors that support this interpretation: 1. The S corp received no consideration from the LLC 2. The properties were formally distributed to you as the sole shareholder 3. You then contributed them to your wholly-owned LLC 4. The documentation shows this as a distribution, not a sale While the S corp would still recognize gain on the distribution of appreciated property (which flows through to you), this would typically be treated as capital gains rather than ordinary income under Section 1239. However, don't overlook the step-up in basis issue that Jade mentioned - this could be huge in your situation. When you inherited the S corp shares, they should have received a step-up in basis to fair market value at your father's death. This increased basis might offset much of the gain from the property distribution, especially since only 8 months passed. I'd strongly recommend having a tax attorney review the transaction structure and documentation to confirm the proper characterization and ensure you're not overpaying.