Corporations that elected S corporation status during the years 2000 through 2003 got a small break in the American Recovery and Reinvestment Act enacted this year.  For these S corporations, the built-in gain recognition period was shortened from 10 years to 7 years.  This means that now may be a good time to sell built-in gain assets.

Special rules apply when an existing C corporation converts to an S corporation.  If the corporation has appreciated assets at the time of the conversion, it must pay corporate-level income tax at the highest rate (currently 35%) on the amount of that appreciation (called “built-in gain”) when the assets are sold during the recognition period.  The recognition period is usually the 10 years following the S corporation election.  The Recovery Act shortens the recognition period to 7 years.

What does this mean?  If you converted a C corporation to an S corporation in 2002, prior to the Recovery Act you could not sell any built-in gain assets and avoid corporate-level taxation until 2012 (assuming no offsetting losses).  After the Recovery Act, you can sell those assets in 2009 or 2010 and avoid the extra tax.  Likewise, a corporation that made an S corporation election in 2003 can sell built-in gain assets without corporate-level taxation in 2010.  After 2010?  The recognition period returns to 10 years, meaning that a 2003 S corporation will have to wait until 2013.

Obviously, this won’t do much good for most businesses.  But if your business made an S corporation election in 2000 – 2003, at a time when it had built-in gain assets, and you want to sell those assets in the next year, this is a real boon.