An S corporation can purchase real estate, and nothing in the tax code prohibits it, but for most investors the structure creates more problems than it solves. The central issue is that S corporation shareholders cannot add the company’s mortgage debt to their tax basis, which caps the losses they can deduct from a leveraged rental. Getting the property back out later is worse: distributions of appreciated real estate are treated as taxable sales. An LLC taxed as a partnership avoids both problems, which is why tax advisors almost universally recommend it for holding property.
If you already have real estate inside an S corporation, or you have a specific reason to use one, the rules below are what shape the outcome.
Why Debt Basis Is the Core Problem
An S corporation shareholder can deduct losses only up to the sum of their stock basis and their debt basis. Stock basis is what you paid for your shares plus retained income and additional capital contributions. Debt basis exists only when you, the shareholder, have personally loaned money directly to the corporation.1Office of the Law Revision Counsel. 26 USC 1366 – Pass-Thru of Items to Shareholders
The corporation’s own debt does not increase your basis. Neither does personally guaranteeing that debt. Courts have consistently held that a guarantee alone creates no basis because the shareholder has made no actual economic outlay; the guarantee converts into basis only if the shareholder is actually called upon to pay.2Internal Revenue Service. S Corporation Stock and Debt Basis
Put $50,000 of equity into an S corporation that borrows $450,000 to buy a rental, and your tax basis is $50,000. If depreciation and expenses produce a $60,000 loss, you can only deduct $50,000. The other $10,000 is suspended until you restore basis.3Office of the Law Revision Counsel. 26 USC 1367 – Adjustments to Basis of Stock of Shareholders, Etc.
The result in a partnership or LLC is completely different. Federal regulations treat any increase in a partner’s share of partnership liabilities as a contribution of cash to the partnership, which increases basis.4eCFR. 26 CFR 1.752-1 – Treatment of Partnership Liabilities Same numbers: an LLC member’s basis would be $500,000, and the full $60,000 loss would be deductible subject to the passive activity rules. This single mechanic is the reason S corporations lose out on the tax benefits leverage normally delivers in real estate.
The Property Is Hard to Get Back Out
Suppose you conclude the S corporation was a mistake and want to move the property to yourself or into an LLC. Federal tax law treats that distribution as a deemed sale. If fair market value exceeds the adjusted basis in the corporation’s hands, which it almost always does once depreciation has run for a few years, the S corporation must recognize gain as if it sold the property at fair market value.5Office of the Law Revision Counsel. 26 USC 311 – Taxability of Corporation on Distribution That phantom gain flows through to shareholders on Schedule K-1, producing a tax bill with no cash behind it.
Partnerships and LLCs can generally distribute property to their members without triggering that recognition event. Once real estate is inside an S corporation, getting it out tax-free is essentially impossible unless you sell the stock instead of the property. Anyone considering the structure should understand that the asset may effectively be locked inside.
Financing Still Runs Through You Personally
Nearly all commercial real estate loans made to an S corporation require a personal guarantee from the principal shareholders. Lenders view the entity as an obstacle to collection because they cannot automatically reach the shareholders’ personal assets if the corporation defaults, so they close that gap with a guarantee.
You end up personally on the hook for the debt just as if you owned the property individually, but the IRS gives you no basis credit for taking that risk. The liability shield that motivated the corporate structure is partially undermined by the guarantee itself, and the tax benefit that would have offset the risk in an LLC does not exist here.
How Income and Losses Flow While You Hold the Property
The S corporation itself does not pay federal income tax. It files Form 1120-S and reports income, deductions, and credits to shareholders on Schedule K-1.6Internal Revenue Service. About Form 1120-S Each shareholder reports their allocated share on Schedule E of Form 1040.7Internal Revenue Service. About Schedule E (Form 1040), Supplemental Income and Loss Rental income, mortgage interest, property taxes, and depreciation are calculated at the corporate level and passed through in proportion to stock ownership.
Rental real estate is a passive activity by default, so net losses that reach the shareholder can generally only offset other passive income. Amounts you can’t use are suspended and carried forward until you generate passive income or dispose of the activity.8Internal Revenue Service. Topic No. 425, Passive Activities – Losses and Credits
Two exceptions loosen this. If you actively participate in the rental, you can deduct up to $25,000 of rental losses against non-passive income. That allowance phases out at $1 for every $2 of adjusted gross income above $100,000 and disappears at $150,000.9Office of the Law Revision Counsel. 26 USC 469 – Passive Activity Losses and Credits Limited If you qualify as a real estate professional (more than 750 hours in real property trades or businesses in which you materially participate, and more than half of your total personal services for the year in those activities), rental activities are no longer automatically passive. Someone with a full-time W-2 job outside real estate will not meet that test.
One point of confusion worth clearing up: rental income is not subject to self-employment tax regardless of entity structure. Using an S corporation does not save self-employment tax on rents because that tax was never there.
Tax When the S Corporation Sells the Property
Gain on a sale passes through to shareholders on Schedule K-1 and keeps its character. Cumulative straight-line depreciation is recaptured as unrecaptured Section 1250 gain, taxed at a maximum federal rate of 25%, while the remaining profit is long-term capital gain.10Internal Revenue Service. Topic No. 409, Capital Gains and Losses Shareholders report the unrecaptured gain on Schedule D.
Higher-income shareholders may also owe the 3.8% net investment income tax. It applies to the lesser of net investment income or the amount by which modified AGI exceeds $250,000 (married filing jointly), $200,000 (single), or $125,000 (married filing separately).11Office of the Law Revision Counsel. 26 USC 1411 – Imposition of Tax These thresholds are not indexed for inflation. Qualifying as a real estate professional and materially participating can reclassify the income as non-passive and take the surtax off the table.
Selling the stock rather than the property is a possibility. The gain is measured against your adjusted stock basis and treated entirely as capital gain, which avoids the 25% recapture rate on depreciation. Buyers usually prefer asset purchases for their own tax reasons, though, and will pay less for stock, so the net result is not always better.
Situations Where the S Corporation Rules Still Matter
A few pieces of the framework are worth knowing before you commit, and they cut in different directions.
Who Can Own Stock
An S corporation cannot have more than 100 shareholders, and every shareholder must be a U.S. resident individual, a qualifying trust, or an estate. Nonresident aliens, partnerships, and other corporations cannot own the stock.12Office of the Law Revision Counsel. 26 USC 1361 – S Corporation Defined Only one class of stock is allowed, so different distribution rights for different investors are off the table. Bring in the wrong investor and the S election terminates, converting the entity to a C corporation with double taxation. Partnerships and LLCs have no comparable restrictions.
Section 199A
The qualified business income deduction allows eligible taxpayers to deduct up to 20% of qualified business income from pass-through entities, including S corporations.13Office of the Law Revision Counsel. 26 USC 199A – Qualified Business Income The deduction was made permanent by the One Big Beautiful Bill Act signed in July 2025. Rental income qualifies only if the activity rises to the level of a trade or business. The IRS safe harbor under Revenue Procedure 2019-38 treats rental real estate as a qualifying business if the taxpayer keeps separate books and records, performs at least 250 hours of rental services per year (or in at least three of the last five years for properties held four or more years), and maintains contemporaneous logs.14Internal Revenue Service. IRS Finalizes Safe Harbor to Allow Rental Real Estate to Qualify as a Business for Qualified Business Income Deduction
1031 Exchanges
An S corporation can perform a like-kind exchange under Section 1031, deferring gain when it swaps investment or business real property for replacement property.15Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment The exchange must happen at the entity level. Standard timing applies: 45 days to identify a replacement, 180 days to close. Shareholders cannot peel off their share of the proceeds for separate exchanges. Partnerships have somewhat more flexibility to distribute interests before an exchange; an S corporation does not, because distributing property triggers gain under Section 311(b).
Former C Corporation Traps
If the S corporation was ever a C corporation, or absorbed C corporation assets in a tax-free transaction, two extra taxes lie in wait. The built-in gains tax hits appreciation that existed at the time of the S election if property is sold within the five-year recognition period, at the top corporate rate of 21%, and the same gain is then taxed again at the shareholder level.16Office of the Law Revision Counsel. 26 USC 1374 – Tax Imposed on Certain Built-In Gains Separately, if the corporation still carries accumulated C corporation earnings and profits and more than 25% of gross receipts come from passive sources like rent, an excess net passive income tax applies at 21%; three consecutive years of the same condition terminates the S election entirely.17eCFR. 26 CFR 1.1375-1 – Tax Imposed When Passive Investment Income of Corporation Having Accumulated Earnings and Profits Exceeds 25 Percent of Gross Receipts Neither tax applies to an S corporation that has always been an S corporation.
The rules add up in one direction. An S corporation can hold real estate, but the debt-basis limit strips out the leveraged-loss benefit, and the distribution rules make the decision effectively permanent. If the property has not been bought yet, an LLC taxed as a partnership is the structure to compare against before signing anything.