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Creative Structures for Real Estate AcquisitionsCameron L. Hess, Esq.California State Bar (Tax Section)Corporate and Pass Through Entities Sectionwww.wkblaw.comwww.wkblaw.comCreative Structures for Real Estate AcquisitionsThis 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 coverBasic knowledgeAdvance strategies and hairball thoughts.

www.wkblaw.comwww.wkblaw.comReal Estate Acquisition BasicsWho/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

www.wkblaw.comwww.wkblaw.comSimple Acquisition StructureCo-TenancyCo-Tenancy as Buyer:

BasicsNot really an entity per se.2+ owners who holds deed to real estateNo 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

www.wkblaw.comwww.wkblaw.comSimple Acquisition StructureCo-TenancyCo-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% liableTransfer Right: May freely sell (1st purchase right?)Special Allocations:None (but debt okay?)www.wkblaw.comwww.wkblaw.comSimple Acquisition StructureCo-TenancyCo-Tenancies (v Partnership) How distinguish

Guidance: Rev. Proc. 2002-22Limited to ruling requests by syndications, not a safe harborBut practitioners follow because it incorporates mostly common law, but some areas are different. Identify what is permitted - EXAMPLES.May have co-tenancy agreementA 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)

www.wkblaw.comwww.wkblaw.comCo-TenancyTax Computations 100% at Co-tenant LevelAggregate 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 level1031 Exchange each tenant decides.

www.wkblaw.comwww.wkblaw.comCo-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

www.wkblaw.comwww.wkblaw.comCreative Co-Tenancy Acquisition StructureExample 2: One co-tenant B wants liability protection or estate planning:

Co-tenancy RecommendationCo-tenant assigns his/her interest into a separate LLC, LP or QSSC.Helps with gift planning - larger minority interest/control discounts.

www.wkblaw.comwww.wkblaw.comGeneral PartnershipAcquisition StructureCalifornia: 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 LawLegal entity 1994 RUPAincreased entity attributes. RUPA Section 16307 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.)www.wkblaw.comwww.wkblaw.comGeneral PartnershipAcquisition StructureCalifornia 1994 RUPAR/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 protectionsSpecial AllocationsYesPartners Personal CreditorsLimited to charging order RUPA 16504. But, court can order sale. Buyer is mere transferee.www.wkblaw.comwww.wkblaw.comGeneral PartnershipsTax LawCheck-the-box partnership or corporation.Most pick partnership Subchapter K applies - complexCapital accounts, substantial economic effect.Termination, Section 708(b)(1)(B) - >50%/12 mthReporting: net items separately reportable (Form K-1)Elective inside basis adjustments; mandatory step-down redemptions/sales

Section 761 simple investment partnerships can elect out. www.wkblaw.comwww.wkblaw.comR/E Acquisition Strategies - PartnershipsSection 761 Election Out1.761-2 - Requirements. Own the property as co-ownersRight to separately dispose of interestsNo active managementGCM 200216005 co-owner requirementCo-ownership determined by state lawLLCs and LPs cannot elect out. RUPA GPs no/uncertain.Old law-yes: Hager v. Comr, (1981) 76 TC 759; PLR 9214001Now: Co-tenancy in partnership gone, but partition right stayedwww.wkblaw.comwww.wkblaw.comCreative 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?

BenefitsNontaxable merger (B Reorg) continuity of business?Avoid cancellation/renegotiation of leases/major govt contracts.Nontaxable exchange of partner interest.DrawbacksCorp status not really needed for tax purposes deem pro-rata distribution-- contribution to Corp for shares may be a 351 transactionwww.wkblaw.comwww.wkblaw.comAcquisition Structure - Limited PartnershipCalifornia 2008 RULPA (1+ GP and 1+ LP)

R/P Ownership: Entity owner of R/EActivity Level: Not restricted P-ship/Genl PtrsDissociationNot permitted of limited partnerTransfer Right: Yes, but Tree not partnerManagement: General Partner Ltd Partners Restricted15903.03Liability:GP(s) only; LPs not liableSpecial Allocations:Okay & common

www.wkblaw.comwww.wkblaw.comLimited PartnershipTaxationSubject to partnership tax rules.However with respect to Limited Partners: Section 469Limited 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 LPsLimits tax basisLimits at-risk amountLimits allocable lossesNote: proposed regs (2011) Interest in Limited Partner = any entity interest if owner does not participate in management.

www.wkblaw.comwww.wkblaw.comAcquisition Strategy - Limited P-ship AllocationsStrategies for Real Estate Limited PartnershipsIncreasing Deductions to Limited PartnersAdd 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.

www.wkblaw.comwww.wkblaw.comAcquisition Strategy - LLCState Law:Separate statutory type of entityCreated in 1994 by California Beverly Killea Act.Blends corporate and partnership features.1 or more persons as owners (members). All members have limited liabilityManaged: member-managed or separate managersMay have officers.www.wkblaw.comwww.wkblaw.comLimited Liability CompanyTax Law:Inspired Check-the-box regulationsTaxed 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.www.wkblaw.comwww.wkblaw.comCreative Strategies - LLCs4 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 Feeswww.wkblaw.comwww.wkblaw.comS CorporationForm 2553 filed to elect pass-through treatmentTax 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 ShareholderBut:Ownership limited must be qualified shareholderMere dissolution of S Corp. triggers taxable event;^ Mere dissolution not taxable for partnership

www.wkblaw.comwww.wkblaw.comR/E Acquisitions - S CorporationS 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 CorpS Corp = only funding source to buy R/E.Real estate not the principal asset of business, incidental.

www.wkblaw.comwww.wkblaw.comUnusual Acquisition Strategy Better option?LLC Acquires Real Estate. LLC Elects S Corp. StatusWhy a S Corp for Tax Purposes?Avoid California LLC FeeBut, avoid issue of keeping record of minutesDrawbackNot easier; No basis to member-shareholder from entity debtsIf dissolve, will be taxable eventAll S Corp requirements must be metOR INSTEAD:

LP Acquires Real Estate, but LLC is the GPMinimizes California LLC Fee ($0 - $11,790).Old concerns?: LLC with substantial assets?

www.wkblaw.comwww.wkblaw.comS 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)

www.wkblaw.comwww.wkblaw.comS Corp = acquirer using QSSSCScenario: 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 Estatewww.wkblaw.comwww.wkblaw.comS Corp = acquirer using QSSSCStrategy QSSSC formed, merges into targetTriangular Reorg, but QSSSC = acquirer (Ts shareholders get stock in parent.)QSSSC disregarded. Therefore statutory merger (A Reorg) [Less stringent]

ShareholdersQSSSCStockReal estatewww.wkblaw.comwww.wkblaw.comS Corp = acquirer using QSSSStrategy 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]

ShareholdersLLCStockReal estatewww.wkblaw.comwww.wkblaw.comCan an Individual Do This?Variations (Does not work)Individual A wants to acquire TA 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)

www.wkblaw.comwww.wkblaw.comGetting out of Entities? 1031 ExchangeTraditional1031 Drop & Swap StrategiesScenario: 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 saleBuy-out and later sale not part of single transactionwww.wkblaw.comwww.wkblaw.comTo find out how we can help you through the complexities of todays legal issues, give us a call or email us at reachus@wkblaw.comChoose A Legal Partner Thats Committed To Your SuccessSACRAMENTO OFFICE10640 Mather Blvd., Suite 200Mather, CA 95655T: (916) 920-5286F: (916) 920-8608WALNUT CREEK OFFICE1350 Treat Blvd., Suite 400Walnut Creek, CA 94597T: (925) 478-7308F: (925) 202-2868www.wkblaw.comwww.wkblaw.com