Presenting a live 90-minute webinar with interactive Q&A Tax Strategies for Real Estate LLC and LP Agreements: Capital Commitments, Tax Allocations and Distributions Structuring Provisions to Achieve Tax Benefits and Avoid Common Pitfalls THURSDAY, MAY 7, 2015 1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific Today’s faculty features: Brian J. O'Connor, Partner, Venable , Baltimore Steven Schneider, Director, Goulston & Storrs , Washington, D.C. The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10 .
Tips for Optimal Quality FOR LIVE EVENT ONLY Sound Quality If you are listening via your computer speakers, please note that the quality of your sound will vary depending on the speed and quality of your internet connection. If the sound quality is not satisfactory, you may listen via the phone: dial 1-866-328-9525 and enter your PIN when prompted. Otherwise, please send us a chat or e-mail sound@straffordpub.com immediately so we can address the problem. If you dialed in and have any difficulties during the call, press *0 for assistance. Viewing Quality To maximize your screen, press the F11 key on your keyboard. To exit full screen, press the F11 key again.
Continuing Education Credits FOR LIVE EVENT ONLY For CLE purposes, please let us know how many people are listening at your location by completing each of the following steps: In the chat box, type (1) your company name and (2) the number of • attendees at your location Click the SEND button beside the box • In order for us to process your CLE, you must confirm your participation by completing and submitting an Official Record of Attendance (CLE Form) to Strafford within 10 days following the program. The CLE form is included in your dial in instructions email and in a thank you email that you will receive at the end of this program. Strafford will send your CLE credit confirmation within approximately 30 days of receiving the completed CLE form. For additional information about CLE credit processing call us at 1-800-926-7926 ext. 35.
Tax-Related Drafting Tips for Real Estate LLC and LPs Strafford Brian J. O’Connor Steven R. Schneider
Introduction Understand the partners and their tax characteristics. Learn the general economics/business deal (e.g., capital commitments, preferred versus common interests, compensatory interests, distributions (including tax distributions), special partners, etc.). Create an everyday working relationship, therefore needs to be cooperative in addition to adversarial. 5
Review the Economics Simple versus complex sharing arrangements. Types of preferred interests. Guaranteed payments versus gross or net income allocations. Equity-based compensation. Profits only interests under Rev. Proc. 93-27 and Rev. Proc. 2001-43. Distribution waterfall. Other: tax distributions, reimbursement of expenses, special one-time distributions; capital calls; partner loans 6
Distributions General . The distribution section describes the partners’ rights to cash or property distributions. Separate paragraphs often cover operating vs. capital events vs. liquidating distributions. Liquidation with Capital Accounts vs. waterfall. Tax language should address partner reimbursements or other up-front cash distributions. Withholding. Taxes paid by the partnership on behalf of a partner are typically treated as a deemed distribution to the partner whose income is requiring the withholding. This is common when the partnership is required to withhold on distributions to a foreign or out-of-state partner. Tax Distributions. Ensure partners have cash to pay taxes. 7
Tax Distributions Typically documented as an advance on the partner’s rights under the more general distribution provisions. Sometimes distributions are treated as a loan to the partner. Think of distribution as a tax loan. For GP, interest rate is the hurdle rate. More often requested by GP who is more likely to have phantom income on promote, especially if an IRR waterfall. Generally equal to share of net income multiplied by maximum applicable rate for type of income. Variables: Actual versus assumed rates, partners subject to • different tax rates, losses followed by profits, quarterly versus annual distributions. 8
Elections and Audits Elections : Agreement should address how partnership-level tax elections are made. The two main elections unique to partnerships relate to section 754 inside basis adjustments and section 704(c) allocations of built-in gains or losses among the partners. Audits : Tax Matters Partner (TMP) generally represents the partnership before the IRS and in federal civil tax litigation and is required to keep the other partners informed. Generally, the TMP must be a manager and member. Although the identity and authority of the TMP may sound boring, it is often a critical question when later controversy arises and the details are often overlooked in the drafting process. 9
Audits - Keeping the LP Informed TMP keeps all partners “reasonably informed of the progress of any tax audit, examination, appeals proceedings, litigation, or other tax proceeding relating to the income or operations of the Company.” Allow partners to provide input on IRS communication Obtain partner approval for IRS settlement agreements Court petition Extend statute of limitations 10
Special Partners REITs Tax-Exempts Foreign Partners 11
REIT Partners Where one of the members is a REIT, it will seek to impose the following types of restrictions on the joint venture’s operations in order to ensure compliance with the REIT requirements: Real estate asset holding and income limitations; No prohibited transactions (e.g., condo sales); Limitations on loans (mezz debt or secured by real property); Limitations on leases (related party and personal property restrictions); and Arm’s -length transactions with REIT owners. 12
Tax-Exempt Partners Tax-exempt entities are generally subject to the unrelated business income tax for investment returns funded with “acquisition debt.” However, there is a Real Estate Financing Exception for “qualified organizations” that use specific types of debt to acquire or improve real property. To meet the Real Estate Financing Exception, qualified organizations who invest through a partnership must meet the Fractions Rule. To be Fractions Rule compliant, partnership allocations must satisfy the following two requirements on actual and prospective basis: Safe harbor allocations: The most significant economic factor in satisfying these rules is that the partnership liquidate with positive capital accounts in lieu of a cash waterfall. Disproportionate allocation rule: A qualified organization’s share of overall income for any year cannot exceed its lowest share of overall loss for any year. 13
Foreign Partners Partnerships are required to withhold taxes on a foreign investor’s share of real estate income because special “FIRPTA” rules treat the partner’s income from real estate as subject to U.S. taxation even if the income is not otherwise subject to U.S. tax. A partnership agreement typically treats this withholding as a partner distribution or loan. Certain partners may be subject to reduced withholding, but the partnership should require the partner to provide specific documentation to the partnership to receive the reduced rate. 14
Example 1: Capital Account Basics Section 704(b)
Property contribution; income allocation; distribution Facts: A contributes Building with $100 gross fair market value, subject to $30 of debt. In year one the partnership allocates $10 of section 704(b) book income to A and distributes $4 of cash to A. Effect on Capital Ending Capital Account Account Increase by net FMV of +$70 $70 property contributed Increase by income +$10 $80 allocation Decrease by -$4 $76 distributions 16
Tax Allocations – sections 704(b) and 704(c) How taxable income and loss are shared among the partners. Most of the allocation language relates to the economic/book allocations and in general taxable income will follow these book allocations. If a partner contributed an asset with built-in appreciation or depreciation, special rules require that such built-in tax gain or loss is allocated back to the contributing partner. 17
Tax Allocations – section 704(b) Partnership agreements typically break the book allocations down into two sections. The primary allocation section describes the general business deal, such as allocating profits in accordance with relative capital or profit percentages (i.e., “Percentage Interests”). The regulatory allocation section overrides the first section and is designed to comply with the book income tax regulatory safe harbors. 18
Recommend
More recommend
