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Presentation on theme: " CREATIVE STRUCTURES FOR REAL ESTATE ACQUISITIONS Cameron L. Hess, Esq. California State Bar (Tax Section) Corporate and Pass Through Entities."— Presentation transcript:

1 CREATIVE STRUCTURES FOR REAL ESTATE ACQUISITIONS Cameron L. Hess, Esq. California State Bar (Tax Section) Corporate and Pass Through Entities Section

2 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.

3 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

4 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

5 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?)

6 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)

7 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.

8 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

9 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.

10 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.)

11 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.

12 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.

13 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

14 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

15 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

16 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.

17 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.

18 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.

19 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.

20 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

21 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

22 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.

23 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?

24 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)

25 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

26 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

27 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

28 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)

29 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

30 To find out how we can help you through the complexities of todays legal issues, give us a call or us at CHOOSE A LEGAL PARTNER THATS COMMITTED TO YOUR SUCCESS SACRAMENTO OFFICE Mather Blvd., Suite 200 Mather, CA T: (916) F: (916) WALNUT CREEK OFFICE 1350 Treat Blvd., Suite 400 Walnut Creek, CA T: (925) F: (925)

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