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CREATIVE STRUCTURES FOR REAL ESTATE ACQUISITIONS Cameron L. Hess, Esq. California State Bar (Tax Section) Corporate and Pass Through Entities Section
CREATIVE STRUCTURES FOR REAL ESTATE ACQUISITIONS This program is for educational purposes only and should not be relied upon for any purpose. Anything herein that is accurate is a result of the law of random events. Program will cover Basic knowledge Advance strategies and hairball thoughts.
REAL ESTATE ACQUISITION BASICS Who/What Acquires Real Estate – Entity Choices Sole Owner (not really a structure) Tenancy in Common (not really an entity) Partnership (or Limited Partnership, sometimes LLP?) Limited Liability Company (Nevada LLLP?) S Corporation
SIMPLE ACQUISITION STRUCTURE CO-TENANCY Co-Tenancy as Buyer: Basics Not really an entity per se. 2+ owners who holds deed to real estate No substantial activities (basic activities okay) When Used (most common) Unplanned (just-did-it) Planned (liked it) Syndications (loved it) promoters/brokers promoting trading into to go from managed property to unmanaged property
SIMPLE ACQUISITION STRUCTURE CO-TENANCY Co-Tenancies as Buyer Title: Co-owners (i.e., in co-tenancy) Activity Level: No substantial (basic services okay) Land, apt, commercial, not hotel (NY Apt: – security guard = basic) Management: Owners (all) may manage But, okay to have Mgt Co 100% owners for sale, loan, major lse. Liability:Co-owners 100% liable Transfer Right: May freely sell (1st purchase right?) Special Allocations:None (but debt okay?)
SIMPLE ACQUISITION STRUCTURE CO-TENANCY Co-Tenancies (v Partnership) – How distinguish Guidance: Rev. Proc Limited to ruling requests by syndications, not a safe harbor But practitioners follow because it incorporates mostly common law, but some areas are different. Identify what is permitted - EXAMPLES. May have co-tenancy agreement A limited common bank account is okay (no safe harbor) Major actions (sale, finance) require 100% consent Common law (case decisions) provide further guidance ?? - Can co-owners let X be attorney-in-fact to sell/finance property? (Service asking for guidance)
CO-TENANCY Tax Computations – 100% at Co-tenant Level Aggregate theory – not pass-through, but shares No P-ship return; no K-1, no P-ship TEFRA exam. Co-tenant computes own share. Co-tenant makes all elections: bonus depreciation, CODI QRPBI exclusion. PAL rules at co-owner level 1031 Exchange – each tenant decides.
CO-TENANCY ACQUISITIONS – WHEN? Example 1: United Way and American Red Cross Sacramento Chapters want to buy real property to use as an office. Neither need whole building. Consider Co-tenancy Because: Minimizes complexity – no nonprofit issue – no operations overlap. Co-tenancy agreement says who uses each space. Co-tenants split bills, co-insure (both trustworthy) No new entity; no additional reporting. Risk of problems here probably low. Minus: If one non-profit moves or wants to refinance
CREATIVE CO-TENANCY ACQUISITION STRUCTURE Example 2: One co-tenant B wants liability protection or estate planning: Co-tenancy Recommendation Co-tenant assigns his/her interest into a separate LLC, LP or QSSC. Helps with gift planning - larger minority interest/control discounts.
GENERAL PARTNERSHIP ACQUISITION STRUCTURE California: 1994 RUPA: Definition: An association of two or more persons to carry on as coowners of a business for profit (RUPA 16601) Includes joint ventures, syndications pooled transaction. California Corporate Law Legal entity – 1994 RUPA increased entity attributes. RUPA Section – slight partner asset protection. No personal liability unless judgment names partner, only after partnership cannot satisfy judgment (unless partner waives his/her right to require the creditor go after the partnership first, partnership bankrupt or court grants permission.)
GENERAL PARTNERSHIP ACQUISITION STRUCTURE California 1994 RUPA R/P Ownership: Entity owns underlying assets. Activity Level Not restricted (P-ship or partners) Dissociation: Absolute right (16602(a)). Transfer Permissible, but tree not a partner (no rights/access) Liability Yes, but some protections Special AllocationsYes Partners Personal Creditors Limited to charging order RUPA But, court can order sale. Buyer is mere transferee.
GENERAL PARTNERSHIPS Tax Law Check-the-box – partnership or corporation. Most pick partnership Subchapter K applies - complex Capital accounts, substantial economic effect. Termination, Section 708(b)(1)(B) - >50%/12 mth Reporting: net items separately reportable (Form K-1) Elective inside basis adjustments; mandatory step-down – redemptions/sales Section 761 – simple investment partnerships can elect out.
R/E ACQUISITION STRATEGIES - PARTNERSHIPS Section 761 Election Out Requirements. Own the property as co-owners Right to separately dispose of interests No active management GCM – co-owner requirement Co-ownership determined by state law LLCs and LPs cannot elect out. RUPA – GPs – no/uncertain. Old law-yes: Hager v. Comr, (1981) 76 TC 759; PLR Now: Co-tenancy in partnership gone, but partition right stayed
CREATIVE ACQUISITION – P-SHIP ELECTS TO BE A CORP. Example 3: High tech GP – business and real estate in one entity; N Corp buyer wants both – N offers stock in N. Should a High Tech GP elect corporate tax status in contemplation of N Corps acquisition? Benefits Nontaxable merger (B Reorg) – continuity of business? Avoid cancellation/renegotiation of leases/major govt contracts. Nontaxable exchange of partner interest. Drawbacks Corp status not really needed for tax purposes – deem pro-rata distribution -- contribution to Corp for shares may be a 351 transaction
ACQUISITION STRUCTURE - LIMITED PARTNERSHIP California 2008 RULPA (1+ GP and 1+ LP) R/P Ownership: Entity owner of R/E Activity Level: Not restricted – P-ship/Genl Ptrs DissociationNot permitted of limited partner Transfer Right: Yes, but Tree not partner Management: General Partner Ltd Partners Restricted Liability:GP(s) only; LPs not liable Special Allocations:Okay & common
LIMITED PARTNERSHIP Taxation Subject to partnership tax rules. However with respect to Limited Partners: Section 469 Limited Partner. Harder to satisfy PAL rules. Active Participation – cannot use 100 hours, must be 400 hours. 3 Tests, not 7 Tests. At-Risk/Allocation Rules – recourse debts not allocable to LPs Limits tax basis Limits at-risk amount Limits allocable losses Note: proposed regs (2011) – Interest in Limited Partner = any entity interest if owner does not participate in management.
ACQUISITION STRATEGY - LIMITED P-SHIP ALLOCATIONS Strategies for Real Estate Limited Partnerships Increasing Deductions to Limited Partners Add a partial deficit make-up at dissolution. Partners get losses beyond capital account up to make-up (May also get losses for qualified nonrecourse deductions) Service Partner Allocations: Example 4: GP cannot get capital account, but wants an equivalent credit: Assume money partner put in 300,000 for 75% interest; GP wants 25% and equal treatment. Recommendation: Service partner receives $0 capital account, but 25% interest. Service partner gets preferred allocn: $100,000 of profit 1st tier profit upon a sale, in addition to shared 25% profit.
ACQUISITION STRATEGY - LLC State Law: Separate statutory type of entity Created in 1994 by California Beverly Killea Act. Blends corporate and partnership features. 1 or more persons as owners (members). All members have limited liability Managed: member-managed or separate managers May have officers.
LIMITED LIABILITY COMPANY Tax Law: Inspired Check-the-box regulations Taxed as either corporation, partnership or disregarded entity (single member) – members elect. Odd: can even elect to be an S Corporation. Most of the time, subject to Subchapter K, but: Limitation on liability affects allocations and at risk amounts. California - $800 fee + LLC Fee ($900 - $11,790) on Total Income > $250,000.
CREATIVE STRATEGIES - LLCS 4 Ideas on LLCs for Real Estate Acquisitions: Why: LLCs benefit developing/lead person as he has same asset protection as other members. All can be members. When: Popular use, including for securitized loan financing. Control: To retain control, two classes voting and nonvoting member, may avoid loss of control by manager. LLC Fees: Consider tiered model – LLC as GP and individuals as limited partner to reduce LLC Fees
S CORPORATION Form 2553 filed to elect pass-through treatment Tax Issues/Benefits Excess passive investment income (if E&P) Built-in gains tax (if former C Corp) But, no Accumulated Earnings Tax; Persl Holding Co. tax Profits taxed once – to Shareholder But: Ownership limited – must be qualified shareholder Mere dissolution of S Corp. triggers taxable event; ^ Mere dissolution not taxable for partnership
R/E ACQUISITIONS - S CORPORATION S Corporations are usually not preferred for R/E acquisitions. However: The Mean Parent Option: Lock-up of appreciation in S Corp. to tax discourage dissenting child-shareholder from departing? Better yet, start as C, and lock up any sale for 10 years due to built in gain tax! But, there may be non-tax reasons: Former C Corp S Corp = only funding source to buy R/E. Real estate not the principal asset of business, incidental.
UNUSUAL ACQUISITION STRATEGY – BETTER OPTION? LLC Acquires Real Estate. LLC Elects S Corp. Status Why a S Corp for Tax Purposes? Avoid California LLC Fee But, avoid issue of keeping record of minutes Drawback Not easier; No basis to member-shareholder from entity debts If dissolve, will be taxable event All S Corp requirements must be metOR INSTEAD: LP Acquires Real Estate, but LLC is the GP Minimizes California LLC Fee ($0 - $11,790). Old concerns?: LLC with substantial assets?
S CORP R/E ACQN STRATEGIES – GOOD AND BAD? Example: Can S Corp form QSSSC to acquire real estate held by T under reorg? (Stock Acquisition): Scenario: S Corp wants T Co.s R/E. Owner of T wants interest in S Corp. Concerns: Ts unknown liabilities (Contamination) + T what if might not satisfy the substantially all requirement for a triangular reorganization (Sections 368(a)(2)(D) and 368(a)(2)(E)) (see next slide)
S CORP = ACQUIRER – USING QSSSC Scenario: S Corp wants T Co. (with R/E) If does simple A Reorg, S Corp takes real estate directly. Contamination liability? If forms C Corp sub = other issues? Shareholders A Reorg? Real Estate
S CORP = ACQUIRER – USING QSSSC Strategy – QSSSC formed, merges into target Triangular Reorg, but QSSSC = acquirer (Ts shareholders get stock in parent.) QSSSC disregarded. Therefore statutory merger (A Reorg) [Less stringent] Shareholders QSSSC Stock Real estate
S CORP = ACQUIRER – USING QSSS Strategy – Note – same result would happen if instead of QSSC, a single member LLC (disregarded) was used. LLC disregarded. Therefore statutory merger (A Reorg) [Less stringent] Shareholders LLC Stock Real estate
CAN AN INDIVIDUAL DO THIS? Variations (Does not work) Individual A wants to acquire T A forms two S Corps. Two S Corps having 50/50 ownership in LLC. What happens if T (Target R/E Corp) merged into LLC? LLC is not disregarded, this is not an A reorganization (two surviving entities, not one) T may be deemed acquired by 2 S Corps? This may be a taxable transaction? (not a good strategy)
GETTING OUT OF ENTITIES? – 1031 EXCHANGE Traditional1031 Drop & Swap Strategies Scenario: A,B,C own real estate in (LLC, LP); C wont exchange. Entity distributes real estate out to A,B,C, they then co-own as TIC. Permissible for B &C to do a Section 1031 exchanges? Magneson/Bolker pre-date current law. Recommendation: If one partner wants out, buy them out on a long-term note. Must be bona fide – actual duty to pay, even if no later sale. Remaining partners stay in exchange. Buy-out partner prior to any contract for sale Buy-out and later sale not part of single transaction
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