This is our third blog post in our continuing mini-series of blog posts revolving around the challenges and planning problems that crop up when property that investors intend to sell and defer the payment of their capital gain taxes is owned inside of a general partnership or limited partnership.
You might want to read the blog posts in order so that they make more sense. The first blog post
introduces the issues involved. We will begin with this blog post to delve into the various solutions available to investors/partners when they are confronted with this challenge.
Be Proactive
The first and most important piece of advice that I can offer real estate investors is to be proactive when you own property through an entity, whether it be a limited liability company with multiple investors, general partnership, limited partnership, corporation, Title Holding Trust, or other type of entity. The majority of challenges that arrive based on entity issues can be solved given sufficient time to work through the problem.
Evaluate All Options
There are numerous solutions to most entity related problems as outlined in my second blog post in this series. You should review each options with your legal and tax counsel prior to moving forward to ensure that you select the solution that is most appropriate for you. The various solutions will involve varying degrees of risk and you need to fully understand all of your options before you proceed.
The Safest Solution
O.K. I took the easiest one first, which is to change absolutely nothing. Keep the entity in place and continue to hold the real estate in the same entity.
The property would be listed and sold through the same entity and then the replacement property would be acquired by/in the same entity. Nothing changes, and therefore there is no risk. You would structure, report and complete your 1031 exchange using the existing entity.
The problem here is that most of the time the co-investors do not want to stay together and the operation is going to be wound down and the entity is going to be dissolved. So, while this is the safest solution, it is usually not an option.
The Next Best Option
When the safest solution is just not a solution, we look to the next best option, which is generally the 'drop and swap' strategy.
Drop and swap is a clever way of describing the strategy where the property is "dropped" out of the entity (i.e. the property is deeded out of the entity into the individual investors' names), held for a period of time (generally recommended at a minimum of 24 months in order to demonstrate the individual investors' intent to hold the property as an investment), and then "swapped" (i.e. 1031 exchanged) at the investor level. This allows each individual investor to determine the best strategy for them and the entity can be dissolved.
The investor must be extremely careful here. Deeding property out of certain types of entities can trigger other income tax problems, so always review the structures with your tax advisor before proceeding.
I will address the rest of the strategies in my next blog post of this mini-series shortly, so stay tuned.
Thursday, April 02, 2009
Wednesday, April 01, 2009
1031 Exchange Solutions When Property Owned in a Partnership (Partnership Interests)
I started a brief mini-series of blog posts regarding the problems encountered by real estate investors when property that they intend to sell is owned by a general partnership or limited partnership. You might want to read the blog posts in order so that they make more sense.
The first blog post describes the complex income tax planning issues involved when a taxpayer is selling real property that is owned in a general partnership or limited partnership. Partnership ownership can significantly complicate any 1031 exchange strategy.
Strategies for Partnership Issues in a 1031 Exchange
There are a number of income tax planning strategies or structures that can be put into place that may solve the problems described in my last post. The best strategies that are virtually full proof ideally require 24 months to plan and implement in order to structure a safe 1031 tax deferred exchange transaction, and the rest will have various degrees of risk involved.
The various strategies and structures include, but are not limited to, the following, which will be discussed in greater detail in future posts:
The first blog post describes the complex income tax planning issues involved when a taxpayer is selling real property that is owned in a general partnership or limited partnership. Partnership ownership can significantly complicate any 1031 exchange strategy.
Strategies for Partnership Issues in a 1031 Exchange
There are a number of income tax planning strategies or structures that can be put into place that may solve the problems described in my last post. The best strategies that are virtually full proof ideally require 24 months to plan and implement in order to structure a safe 1031 tax deferred exchange transaction, and the rest will have various degrees of risk involved.
The various strategies and structures include, but are not limited to, the following, which will be discussed in greater detail in future posts:
- Maintain partnership intact and stay together for 1031 exchange purposes
- Drop and Swap (1031 exchange at the partner's level)
- Swap and Drop (1031 exchange at the partnership's level)
- Set-up subsidiary single member limited liability companies (SMLLCs)
- Structuring an installment sale note to buy out one or more of the partners
- Using Section 704(b), which involves special allocation of boot to certain partner(s)
Property Owned Through a Partnership Can Complicate a 1031 Exchange
Partnerships Were the Entity of Choice
Real property investors who acquired real estate during the 1960s, 1970s and into the 1980s often set-up a general partnership or limited partnership in order to acquire and own the real property when multiple investors were involved. The general partnership (GP) or limited partnership (LP) were the entities of choice.
Today Partnerships Can Be a Problem
The general partnership or limited partnership made a lot of sense back then when multiple real estate investors were involved buying property together, especially since limited liability companies (LLCs) had not made their debut yet.
However, today, general partnerships and limited partnerships can be a significant problem when investors are trying to dispose of real estate that is owned in a partnership.
Real Property vs. Personal Property Interest
The issue is actually quite simple, but can become very complex. The real estate investor does not really own an interest in real estate. He or she owns a general or limited partnership interest in the general or limited partnership. The partnership interest is a personal property interest; it is not a real property interest. The partnership actually owns the real estate, and this is where the problem lies.
Sale of Property Held in a Partnership
The property is actually owned by the general or limited partnership. The partnership is the owner/taxpayer. Therefore, the partnership is the seller of the real property when the property is sold (not the investors/partners).
Partnership Can Complete a 1031 Exchange
The investors/partners merely receive a distribution of the cash proceeds from the partnership upon the closing of the sale transaction. The investor/partners did not sell an interest in real estate; the partnership did. So, the partnership can structure and complete a 1031 exchange and acquire replacement investment property. The replacement property must be acquired and owned by the partnership.
Partners Do Not Want To Stay together
The problem that is quite common today is that most of the investors/partners no longer want to stay together and want to terminate the partnership upon sale of the property and each go their separate ways. This creates a complex problem for those investors/partners that want to complete a 1031 exchange. It requires advanced tax planning because the investors/partners do not own an interest in real estate.
Solutions
You might be sweating a little bit right now if you own property in a general or limited partnership, but don't panic yet. There are solutions to this problem. Generally, the safest solutions need about 24 months in order to implement them correctly and be able to complete a 1031 tax deferred exchange. There are other solutions that may work and will carry some degree of risk, but are viable options when you do not have 24 months to plan ahead.
I will be discussing these various options in my next few blog posts, so stay tuned.
Real property investors who acquired real estate during the 1960s, 1970s and into the 1980s often set-up a general partnership or limited partnership in order to acquire and own the real property when multiple investors were involved. The general partnership (GP) or limited partnership (LP) were the entities of choice.
Today Partnerships Can Be a Problem
The general partnership or limited partnership made a lot of sense back then when multiple real estate investors were involved buying property together, especially since limited liability companies (LLCs) had not made their debut yet.
However, today, general partnerships and limited partnerships can be a significant problem when investors are trying to dispose of real estate that is owned in a partnership.
Real Property vs. Personal Property Interest
The issue is actually quite simple, but can become very complex. The real estate investor does not really own an interest in real estate. He or she owns a general or limited partnership interest in the general or limited partnership. The partnership interest is a personal property interest; it is not a real property interest. The partnership actually owns the real estate, and this is where the problem lies.
Sale of Property Held in a Partnership
The property is actually owned by the general or limited partnership. The partnership is the owner/taxpayer. Therefore, the partnership is the seller of the real property when the property is sold (not the investors/partners).
Partnership Can Complete a 1031 Exchange
The investors/partners merely receive a distribution of the cash proceeds from the partnership upon the closing of the sale transaction. The investor/partners did not sell an interest in real estate; the partnership did. So, the partnership can structure and complete a 1031 exchange and acquire replacement investment property. The replacement property must be acquired and owned by the partnership.
Partners Do Not Want To Stay together
The problem that is quite common today is that most of the investors/partners no longer want to stay together and want to terminate the partnership upon sale of the property and each go their separate ways. This creates a complex problem for those investors/partners that want to complete a 1031 exchange. It requires advanced tax planning because the investors/partners do not own an interest in real estate.
Solutions
You might be sweating a little bit right now if you own property in a general or limited partnership, but don't panic yet. There are solutions to this problem. Generally, the safest solutions need about 24 months in order to implement them correctly and be able to complete a 1031 tax deferred exchange. There are other solutions that may work and will carry some degree of risk, but are viable options when you do not have 24 months to plan ahead.
I will be discussing these various options in my next few blog posts, so stay tuned.
Tuesday, March 31, 2009
Dow Has Best Month Since 2002
More good news. This time it involves the Dow Jones Industrial Average, or Dow.
Dow Has Best Month since 2002
The Dow Jones Industrial Average, which is an average of 30 large stocks, had its best performing month ever since 2002, and it was the first positive monthly increase in almost a year!
Overall Tuesday Results
Overall Tuesday, the Dow rose 86.9 points, or 1.2%, to 7608.92, driven by gains in banking stocks and software maker Microsoft. For the month, the Dow rose 7.7%, its biggest monthly gain since October 2002, which turned out to be the start of the last bull market. Tuesday, the broader Standard & Poor's 500 index increased by 1.31% or 10.34, or 1.31%, to 797.87.
We still have a ways to go, but I believe that we have bottomed out and have already started our very slow crawl out of this hole.
Dow Has Best Month since 2002
The Dow Jones Industrial Average, which is an average of 30 large stocks, had its best performing month ever since 2002, and it was the first positive monthly increase in almost a year!
Overall Tuesday Results
Overall Tuesday, the Dow rose 86.9 points, or 1.2%, to 7608.92, driven by gains in banking stocks and software maker Microsoft. For the month, the Dow rose 7.7%, its biggest monthly gain since October 2002, which turned out to be the start of the last bull market. Tuesday, the broader Standard & Poor's 500 index increased by 1.31% or 10.34, or 1.31%, to 797.87.
We still have a ways to go, but I believe that we have bottomed out and have already started our very slow crawl out of this hole.
Wednesday, March 25, 2009
Good Economic News for the Real Estate Industry
New durable goods orders increased in February of 2009 and new home sales in the U.S. rebounded by 22.2%. This economic data indicates that the economic downturn is easing. The US Department of Commerce said that durable goods orders rose 3.40% (up $165.6 billion) in February of 2009. This rise in durable goods orders represents the largest increase in durable goods orders since December of 2007. So, there you have it. The sky is no longer falling! We have made it past the worst part of the economic cycle. We certainly have a long way to go, but it is not as bad as the media has been reporting.
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