2009 ABA Real Estate Presentation Final

860 views

Published on

Here are the power point slides from a presenation I did with Cary Rodin and Tim Watt for the Atlanta Bar Association\'s real estate section

0 Comments
0 Likes
Statistics
Notes
  • Be the first to comment

  • Be the first to like this

No Downloads
Views
Total views
860
On SlideShare
0
From Embeds
0
Number of Embeds
3
Actions
Shares
0
Downloads
14
Comments
0
Likes
0
Embeds 0
No embeds

No notes for slide

2009 ABA Real Estate Presentation Final

  1. 1. “ Three Things All Practitioners Should Understand” Cary Rodin John “Trey” Webb Timothy J. Watt Presented by: Real Estate and Tax Law Joint Section Breakfast Thursday, November 5, 2009
  2. 2. Debt Forgiveness Income
  3. 3. Goals for presentation PAGE <ul><li>What constitutes debt forgiveness income? </li></ul><ul><li>What are the exceptions to debt forgiveness income? </li></ul><ul><li>To which taxpayers do the exceptions apply? </li></ul>Debt Forgiveness Income
  4. 4. What constitutes debt forgiveness income? PAGE <ul><li>Gross income – clearly realized accession to wealth Glenshaw Glass Co. 55-1 USTC ¶9308 </li></ul><ul><li>Code Section 61 – Defines gross income </li></ul><ul><li>IRC 61(a)(12) – Includes income from the discharge of indebtedness </li></ul>Debt Forgiveness Income
  5. 5. PAGE <ul><li>Types of debt forgiveness income </li></ul><ul><ul><li>Abatement or cancellation of debt by the lender </li></ul></ul><ul><ul><li>Repurchase of the debt for less than full amount </li></ul></ul><ul><ul><li>A related party repurchase of debt </li></ul></ul><ul><ul><li>Substantial modification of the terms of the debt </li></ul></ul><ul><ul><li>Contribution of debt to capital of the company </li></ul></ul><ul><ul><li>Exchange of debt for equity in the company </li></ul></ul>Debt Forgiveness Income
  6. 6. Debt Forgiveness Income <ul><li>Example One – Repurchase of debt by a related party </li></ul><ul><li>Two individuals are members of a partnership that owns a commercial building. Partner A (investor) owns 80% of the member units and Partner B (operator) owns 20%. The partnership owns a building that has a current FMV of $5 million and debt of $8 million. Partner A buys the debt from the lender for $4.5 million. The partnership has debt forgiveness income of $3.5 million. </li></ul>PAGE
  7. 7. Debt Forgiveness Income <ul><li>Example Two – Substantial modification of debt terms </li></ul><ul><li>Homebuilder S corporation is struggling to service its debt. The company owes $1.75 million on lots that are currently not being developed. The owner negotiates a workout with the bank to reduce the interest rate to zero and delay payments for two years at which time the entire remaining debt will be due. The FMV of the renegotiated debt instrument is $1.5 million. The S corporation has debt forgiveness income of $250,000. </li></ul>PAGE
  8. 8. Debt Forgiveness Income <ul><li>Exceptions to debt forgiveness income under 108(a) </li></ul><ul><ul><li>Bankruptcy in a Title 11 case </li></ul></ul><ul><ul><li>Insolvency </li></ul></ul><ul><ul><li>Qualified Farm Indebtedness </li></ul></ul><ul><ul><li>Qualified Real Property Indebtedness </li></ul></ul><ul><ul><li>Qualified Principle Residence Indebtedness </li></ul></ul>PAGE
  9. 9. Debt Forgiveness Income <ul><li>Bankruptcy </li></ul><ul><li>Must be a Title 11 case </li></ul><ul><li>Either discharged by the court or in a plan approved by the court </li></ul><ul><li>No debt forgiveness income even if the taxpayer is made solvent </li></ul>PAGE
  10. 10. <ul><li>Insolvency </li></ul><ul><li>Measured by the excess of the total amount of outstanding debt over the FMV of the total assets </li></ul><ul><li>Abatement of income only to the extent of insolvency </li></ul>Debt Forgiveness Income PAGE
  11. 11. <ul><li>Example Three </li></ul><ul><li>Taxpayer has total assets with a fair market value of $4 million and total debt of $5 million. The lender forgives $2 million of unsecured debt. The taxpayer has $2 million of debt forgiveness income. $1 million can be excluded under the insolvency exception. If the debt was discharged in a Title 11 bankruptcy case, the entire $2 million of debt forgiveness income can be excluded. </li></ul>Debt Forgiveness Income PAGE
  12. 12. <ul><li>Big question for bankruptcy and insolvency exclusions – </li></ul><ul><li>Which taxpayers bankruptcy or insolvency matters? </li></ul><ul><li>For C corporations and S corporations, insolvency and bankruptcy are viewed at the corporate level. </li></ul><ul><li>For partnerships, insolvency and bankruptcy are viewed at the partner level. </li></ul>Debt Forgiveness Income PAGE
  13. 13. <ul><li>Example Four </li></ul><ul><li>Real estate company is in default on its debt. It is owned by two individuals A & B. Individual A is personally insolvent and individual B has substantial other assets. Real estate company has assets with a FMV of $1 million and debt of $2.5 million. Individual A is personally insolvent due to other real estate investments to the extent of $5 million. The lender reduces the debt to the FMV of the property. The cancellation of debt income is $1.5 million. </li></ul><ul><li>If the company is an S corporation, no debt forgiveness income is recognized for tax purposes because insolvency is measured at the corporate level. </li></ul><ul><li>If the company is a partnership, the partnership reports debt forgiveness income to the partners of $750,000 each. Individual A is personally insolvent and can exclude the income. Individual B recognizes $750,000 of debt forgiveness income on his tax return. </li></ul>Debt Forgiveness Income PAGE
  14. 14. <ul><li>Reduction of tax attributes </li></ul><ul><li>In bankruptcy and insolvency cases </li></ul><ul><li>Ordering rules </li></ul><ul><ul><li>net operating loss and net operating loss carryovers; </li></ul></ul><ul><ul><li>general business credit carryovers; </li></ul></ul><ul><ul><li>the minimum tax credit; </li></ul></ul><ul><ul><li>net capital loss and net capital loss carryovers; </li></ul></ul><ul><ul><li>the basis of the debtor's property (both depreciable and non-depreciable); </li></ul></ul><ul><ul><li>any passive activity loss or credit carryover from the taxable year of the discharge; and </li></ul></ul><ul><ul><li>foreign tax credit carryovers. </li></ul></ul><ul><li>Taxpayer can make an election to reduce the basis of depreciable property first </li></ul>Debt Forgiveness Income PAGE
  15. 15. <ul><li>Ordering rules for reduction of basis of property </li></ul><ul><li>Real property used in a trade or business or held for investment (other than § 1221(a)(1) real property) that secured the discharged indebtedness immediately before the discharge; 108 </li></ul><ul><li>Personal property used in a trade or business or held for investment — but not inventory, accounts receivable, and notes receivable that secured the discharged indebtedness immediately before the discharge; </li></ul><ul><li>Remaining property used in a trade or business or held for investment — but not inventory, accounts receivable, notes receivable, or § 1221(a)(1) real property; </li></ul><ul><li>Inventory, accounts receivable, notes receivable, and § 1221(a)(1) real property; and </li></ul><ul><li>Property not used in a trade or business nor held for investment. </li></ul>Debt Forgiveness Income PAGE
  16. 16. <ul><li>Foreclosure, deed in lieu of foreclosure and abandonment of property </li></ul><ul><li>Recourse versus non-recourse debt </li></ul><ul><li>If non-recourse debt, entire amount treated as a sale of the property </li></ul><ul><li>If recourse debt, treated as sale up to lower of debt or FMV of property </li></ul><ul><li>Debt in excess of FMV is cancellation of debt income </li></ul>Debt Forgiveness Income PAGE
  17. 17. <ul><li>Example Five – Taxpayer transfers property with a basis of $5 million and a fair market value of $4.5 million to bank to avoid foreclosure. The current debt on the property is $7 million. </li></ul><ul><li>If the debt is non-recourse, the taxpayer has a gain from sale of property of $2 million </li></ul><ul><li>If the debt is recourse, the taxpayer has a loss of $500,000 and cancellation of debt income of $2.5 million </li></ul><ul><li>The difference in treatment can be significant if the taxpayer is insolvent or in bankruptcy. </li></ul>Debt Forgiveness Income PAGE
  18. 18. <ul><li>Qualified Real Property Indebtedness </li></ul><ul><li>Taxpayer can make an election to exclude from income discharge of indebtedness income related to qualified real property indebtedness. </li></ul><ul><li>Election not available for insolvent taxpayers or discharges in bankruptcy case. </li></ul><ul><li>Debt that is acquired or assumed to acquire, construct or substantially improve real property used in a trade or business. </li></ul><ul><li>Limited to amount that debt exceeds FMV of the property. </li></ul><ul><li>Taxpayer making election must reduce other depreciable property used in a trade or business </li></ul><ul><li>Partnership – qualification of debt determined at partnership level, election is made at the partner level </li></ul>Debt Forgiveness Income PAGE
  19. 19. <ul><li>Purchase money debt </li></ul><ul><li>Allows taxpayer to reduce the basis of acquired property in lieu of recognizing debt forgiveness income </li></ul><ul><li>Must be a note from original seller </li></ul><ul><li>Not available if original seller has assigned note </li></ul><ul><li>Taxpayer cannot be insolvent or in bankruptcy </li></ul>Debt Forgiveness Income PAGE
  20. 20. <ul><li>Deferral of income in certain restructurings </li></ul><ul><li>Added by the American Recovery and Reinvestment Act of 2009 </li></ul><ul><li>Taxpayer can elect to defer recognition of income </li></ul><ul><li>Election will override other statutory exceptions </li></ul><ul><li>COD income in 2009 and 2010 deferred until 2014 </li></ul><ul><li>Income recognition spread over 5 years </li></ul><ul><li>Applies to reacquisition of applicable debt instruments from a trade or business </li></ul><ul><li>Income is accelerated if taxpayer dies, liquidates or sells all of the assets, or ceases to do business (including disposal of a pass-through entity interest). </li></ul>Debt Forgiveness Income PAGE
  21. 21. <ul><li>Election is made at the entity level ( causing problems for partners with varying circumstances) </li></ul><ul><li>Rev Proc 2009-37 provides relief for partnership </li></ul><ul><li>Partnership can make a partial election </li></ul><ul><li>Allocate deferred amount among partners in any manner </li></ul>Debt Forgiveness Income PAGE
  22. 22. <ul><li>Example Six – Election to defer income </li></ul><ul><li>Partnership has two partners that each own 50%. In 2009, the partnership has $100,000 of debt discharge income. Partner A is insolvent and does not want to make an election to defer the recognition of income. Partner B does not qualify for another exception and wants to make the election. The partnership can make a partial election for 50% of the COD income. The recognized income is allocated to Partner A and the deferred income is allocated to Partner B. If neither the partnership nor the partner take any action to accelerate the income, Partner B will recognize $10,000 of COD income in years 2014 – 2019. </li></ul>Debt Forgiveness Income PAGE
  23. 23. Passive Activities and Real Estate Professionals
  24. 24. PAGE <ul><li>Passive Activity Loss rules – Abbreviated Summary </li></ul><ul><li>Exception/Special Rules for Real Estate Professionals </li></ul><ul><li>Qualifying as a Real Estate Professional </li></ul>Agenda
  25. 25. PAGE <ul><li>Tax Reform Act of 1986 </li></ul><ul><li>Internal Revenue Code §469 </li></ul><ul><li>Imposes a general restriction on currently deducting net tax losses from passive activities </li></ul>Overview of Passive Loss Rules
  26. 26. PAGE <ul><li>Individuals </li></ul><ul><li>Estates and Trusts </li></ul><ul><li>Closely-held C corporations </li></ul><ul><li>Personal Service Corporations </li></ul><ul><li>NOT partnerships or S corporations, but partners and shareholders may be subject on their distributive share </li></ul>Taxpayers Subject to §469
  27. 27. PAGE <ul><li>Passive losses are only deductible against passive income </li></ul><ul><li>If there is an aggregate passive loss, each passive loss is carried forward indefinitely </li></ul><ul><li>Unused suspended losses are deductible as a nonpassive loss upon a complete disposition in a taxable transaction </li></ul>Effect of Passive Activity Limitations
  28. 28. PAGE <ul><li>Any trade or business in which taxpayer does not materially participate </li></ul><ul><li>“ Any rental activity” (regardless of material participation) </li></ul><ul><li>For real estate professionals, a rental activity in which taxpayer does NOT materially participate </li></ul>Definition of a Passive Activity §469(c)
  29. 29. PAGE <ul><li>Mr. A, an attorney, is a partner at a law firm where he logs over 1500 chargeable hours annually. Additionally, Mr. A is an equity owner/investor in two rental real estate LLCs (unrelated to his law practice) that generate significant pass-through losses each year. Mr. A has no involvement or participation in the management and operations of the RE LLCs other than being an equity owner/investor </li></ul>Example #1
  30. 30. PAGE <ul><li>Regular, continuous, and substantial involvement </li></ul><ul><li>Generally, any work in an activity done by an individual (or spouse) who owns an interest in the activity </li></ul><ul><li>Exceptions to what constitutes “participation” </li></ul>Material Participation IRC §469(h)
  31. 31. PAGE <ul><li>More than 500 hours </li></ul><ul><li>Substantially all </li></ul><ul><li>More than anyone else (and > 100 hours) </li></ul><ul><li>Significant participation activities exceed 500 hours </li></ul><ul><li>Nickel and dime test (5 of last 10 years) </li></ul><ul><li>Personal service activity (any 3 preceding years) </li></ul><ul><li>Facts and circumstances (and > 100 hours) </li></ul>Seven Tests for Material Participation Temporary Treasury Reg. §1.469-5T(a)
  32. 32. PAGE <ul><li>Only need to meet one of the seven tests </li></ul><ul><li>Tests are exclusive </li></ul><ul><li>Applied annually on an activity by activity basis </li></ul><ul><li>Additional limitations imposed on Limited Partnership interests </li></ul><ul><ul><li>Garnett v. Commissioner , 132 T.C. No. 19, (06/30/09) </li></ul></ul><ul><ul><li>Thompson v. United States , 87 Fed. Cl. 728, 104 A.F.T.R. 2d 2009-5381 (07/20/09) </li></ul></ul>Material Participation, Cont’d
  33. 33. PAGE <ul><li>Mr. B owns and operates 10 rental houses. He devotes 150 hours per year to performing services at each house (Total of 1500 hours). These services consist of renting the properties, cleaning and repairing the houses, evicting tenants, collecting the rent, and various other activities. Mr. B also receives dividend and interest income for the year from investments, which does not constitute passive activity income. He incurs losses from each of the properties for the year. He would like to offset the losses from his real estate activities against his dividend and interest income, but he cannot do so if the real estate losses are passive activity losses </li></ul>Example #2
  34. 34. PAGE <ul><li>Greater flexibility to currently deduct rental real estate losses </li></ul><ul><li>Rental real estate owned by a real estate professional will NOT automatically constitute a passive activity </li></ul><ul><li>Instead, the rental real estate income or loss will be treated as non-passive if the taxpayer materially participates in the activity </li></ul>Special Rules for Real Estate Professionals IRC §469(c)(7)(B)
  35. 35. PAGE <ul><li>Taxpayer still must annually meet the material participation test for each rental activity, separately </li></ul><ul><li>General rule in the case of multiple rental activities </li></ul><ul><ul><li>Each interest in rental real estate will be treated as a separate rental activity </li></ul></ul><ul><ul><li>Unless real estate professional taxpayer elects to aggregate all rental real estate activities into a single activity </li></ul></ul>Real Estate Professionals, Cont’d
  36. 36. PAGE <ul><li>To meet the material participation test when can’t meet the test for each rental activity separately </li></ul><ul><li>Includes rental activities owned through limited partnerships </li></ul><ul><ul><li>The more stringent material participation threshold for limited partnership interests may “taint” the taxpayer’s material participation test for ALL rental real estate activities </li></ul></ul>Election to Aggregate Rental Real Estate Activities
  37. 37. PAGE <ul><li>Trap for the unwary </li></ul><ul><ul><li>Election formally made with the timely filing of taxpayer’s income tax return </li></ul></ul><ul><ul><li>Irrevocable unless there is a material change in the taxpayer’s facts and circumstances </li></ul></ul><ul><ul><li>Consequences of not filing or missing the election (as ruled by the courts) are strict disallowance of aggregation treatment </li></ul></ul><ul><ul><li>Former passive activities </li></ul></ul><ul><ul><li>Considered one activity for carryforward losses and treatment of gains </li></ul></ul>Election to Aggregate Rental Real Estate Activities, Cont’d
  38. 38. PAGE <ul><ul><li>Satisfy two tests: </li></ul></ul><ul><ul><li>More than one-half of the personal services performed in trades or businesses by the taxpayer during such tax year are performed in real property trades or businesses in which the taxpayer materially participates </li></ul></ul><ul><ul><li>Such taxpayer performs more than 750 hours of services during the tax year in real property trades or businesses in which the taxpayer materially participates </li></ul></ul><ul><li>Year-by-year test </li></ul>Qualifying as a Real Estate Professional
  39. 39. PAGE <ul><ul><li>Real Property Trades or Businesses </li></ul></ul><ul><ul><li>Any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing or brokerage trade or business </li></ul></ul>Qualifying as a Real Estate Professional, Cont’d
  40. 40. PAGE <ul><li>Mr. C owns 10 rental houses and devotes 150 hours of service per year to managing each property (Total of 1500 hours). He also sells life insurance and works 800 hours per year in that job. </li></ul><ul><li>Mr. C should make an election to aggregate all his rental real estate activities to be classified as a real estate professional under IRC §469(c)(7) . </li></ul><ul><ul><li>He satisfies the &quot;more than half&quot; test </li></ul></ul><ul><ul><li>Likewise, he satisfies the &quot;750-hour&quot; test </li></ul></ul><ul><ul><li>He materially participates in the real estate trade or business under the “more than 500 hour” test </li></ul></ul>Example #3
  41. 41. PAGE <ul><li>Contemporaneous documents are not required if extent of participation can be established by other means </li></ul><ul><ul><li>May include appointment books, calendars, or narrative summaries </li></ul></ul><ul><li>Numerous cases addressing documentation </li></ul><ul><ul><li>Taxpayers were often not believable </li></ul></ul><ul><ul><li>Hours could rarely be substantiated by the records provided </li></ul></ul>Documentation of Participation
  42. 42. PAGE <ul><li>When evaluating whether a taxpayer’s business activities are passive or non-passive, additional considerations should also be made </li></ul><ul><ul><li>Definition of an activity </li></ul></ul><ul><ul><ul><li>Including grouping and combining activities that are an appropriate economic unit and meet a facts and circumstances test, Reg. §1.459-4 </li></ul></ul></ul><ul><ul><li>Determination of participation in an activity </li></ul></ul><ul><ul><li>Activities that are not rental, Reg. §1.469-1T(e)(3)(ii) </li></ul></ul><ul><ul><li>$25,000 offset for active participation in rental real estate, §469(i) </li></ul></ul><ul><ul><li>Former passive activities </li></ul></ul>Other Considerations
  43. 43. PAGE <ul><ul><li>Limited partnership interests, §469(h)(2), Reg. §1.469-5T(e) </li></ul></ul><ul><ul><li>Working interests in oil and gas property, §469(c)(3) </li></ul></ul><ul><ul><li>Publicly traded partnerships , §469(c)(3) </li></ul></ul><ul><ul><li>Recharacterization of net income rules (self-rental) </li></ul></ul><ul><ul><li>Choice of entity </li></ul></ul><ul><ul><ul><li>Doing business through C corps. and Limited Partnerships may have less favorable results under the PAL rules </li></ul></ul></ul><ul><ul><ul><li>Senra v. Commissioner, T.C. Memo. 2009-79 (4/15/09) </li></ul></ul></ul><ul><ul><li>State income tax conformity with PAL rules </li></ul></ul>Other Considerations, Cont’d
  44. 44. Business Formation Choice of Business Entity
  45. 45. PAGE <ul><li>Menu of business and legal formations </li></ul><ul><li>Considerations of the tax advisor </li></ul><ul><li>Income tax characteristics of LLCs, Partnerships, </li></ul><ul><li>C Corps. & S Corps. </li></ul>Agenda
  46. 46. PAGE <ul><li>Sole Proprietorship </li></ul><ul><li>General Partnership </li></ul><ul><li>Limited Liability Company (“LLC”) </li></ul><ul><ul><li>Including single member LLC (“SMLLC”) </li></ul></ul><ul><ul><li>Subchapter C Corporation (“C Corp”) </li></ul></ul><ul><ul><li>Includes: </li></ul></ul><ul><ul><ul><li>Personal Service Corp. </li></ul></ul></ul><ul><ul><ul><li>Professional Corp. </li></ul></ul></ul><ul><ul><li>Subchapter S Corporation (“S Corp”) </li></ul></ul><ul><ul><li>Hybrid Ownership </li></ul></ul>Business and Legal Formations
  47. 47. PAGE <ul><li>Limited vs. Unlimited liability </li></ul><ul><li>Number of tax levels </li></ul><ul><li>Can current losses be used by the owners? </li></ul><ul><li>What are the capital gain and ordinary tax rates (Federal & state)? </li></ul><ul><li>Ease of transferability of any appreciated property (inside the entity) to beneficial owners </li></ul><ul><li>Ability to make special allocations of income/loss among the owners </li></ul><ul><li>Eligibility requirements for being an owner </li></ul><ul><li>Ease of maintaining a high tax basis for purposes of deducting losses </li></ul><ul><li>Transferability of ownership interests </li></ul>Considerations for the Tax Advisor
  48. 48. PAGE Shopping Center Direct Ownership Profit/Loss Cash Flow No Legal Entity Sole Proprietorship Mr. & Mrs. Jones Taxed Entity
  49. 49. PAGE <ul><li>Simplest form – direct ownership </li></ul><ul><li>Unlimited liability to owner if something bad happens </li></ul><ul><li>Taxation </li></ul><ul><ul><li>1 level </li></ul></ul><ul><ul><li>Owner directly includes income (loss) of the venture on Schedule E in Form 1040 </li></ul></ul><ul><ul><li>Most instances: gets long-term capital gain treatment if property is held more than 1 year </li></ul></ul><ul><ul><li>Tax Rate </li></ul></ul><ul><ul><ul><li>Capital gain 15%/25% + state </li></ul></ul></ul><ul><ul><ul><li>Up to 35% if ordinary income or short-term capital gain plus state tax </li></ul></ul></ul><ul><li>Transferability – if real estate has to be transferred, may attract transfer costs and perhaps banking issues regarding the debt, if any </li></ul>Sole Proprietorship
  50. 50. PAGE Limited Liability Company Mr. Jones Mrs. Jones Shopping Center Profit/Loss Cash Flow Profit/Loss Cash Flow 80% 20% Taxed Entity
  51. 51. PAGE <ul><li>Relatively simple to form </li></ul><ul><li>Can be single member or have multiple members </li></ul><ul><li>Operating Agreement </li></ul><ul><ul><li>Recommended if there are two or more members </li></ul></ul><ul><ul><li>Non-restrictive as to who can be a member </li></ul></ul><ul><ul><li>Individuals </li></ul></ul><ul><ul><li>Partnerships/LLCs </li></ul></ul><ul><ul><li>Corporations </li></ul></ul><ul><ul><li>US/foreign individuals or entities </li></ul></ul><ul><li>Limited liability to members normally </li></ul>Limited Liability Company
  52. 52. PAGE <ul><li>Taxation </li></ul><ul><ul><li>1 level of tax – member level </li></ul></ul><ul><ul><li>Members include profit/loss and other tax attributes in their respective tax returns </li></ul></ul><ul><ul><ul><li>Individual – Form 1040 </li></ul></ul></ul><ul><ul><ul><li>Corporation – Form 1120/1120S </li></ul></ul></ul><ul><ul><li>Tax rate depends on the legal form of the member </li></ul></ul><ul><ul><ul><li>Individual rates: 15% - 35% + state tax </li></ul></ul></ul><ul><ul><ul><li>C Corporations (earning under $10 million) – up to </li></ul></ul></ul><ul><ul><ul><li>34% + state tax </li></ul></ul></ul><ul><ul><ul><li>C Corporations have no special rates for long-term capital gains </li></ul></ul></ul>Limited Liability Company
  53. 53. PAGE <ul><li>Transferability </li></ul><ul><ul><li>LLC member units can be sold without selling the real estate </li></ul></ul><ul><ul><li>New members can be easily added if cash or property is required in the future </li></ul></ul><ul><ul><li>Real Property can be transferred out of the LLC without major tax consequences in most instances. </li></ul></ul><ul><ul><li>Mortgage issues could create a problem on transfers of the property itself </li></ul></ul>Limited Liability Company
  54. 54. PAGE C Corporation Mr. Jones Mrs. Jones Dividends Cash Flow Dividends Cash Flow 80% 20% Shopping Center $10 Million Tax Level Up to 34% + state tax (C Corporation) Taxed on Dividends
  55. 55. PAGE <ul><li>Easy to form – more complicated to operate from a legal standpoint </li></ul><ul><li>Non-restrictive as to who can be a shareholder </li></ul><ul><ul><li>Individuals </li></ul></ul><ul><ul><li>Partnerships/LLC </li></ul></ul><ul><ul><li>Corporations </li></ul></ul><ul><ul><li>US/Foreign – individuals or foreign entities are OK </li></ul></ul><ul><li>Transferability of shares is fairly simple. Transferability of appreciated assets out of the C Corp is difficult because of tax issues. </li></ul><ul><ul><li>C Corporations should be used to hold real estate in only very unusual circumstances - AVOID </li></ul></ul>C Corporation
  56. 56. PAGE <ul><li>Tax Considerations </li></ul><ul><li>Double Taxation </li></ul><ul><ul><li>Corporate level </li></ul></ul><ul><ul><li>Shareholder level – dividends </li></ul></ul><ul><li>Tax Rates </li></ul><ul><ul><li>Graduated up to 34% (under $10 Million) + state tax </li></ul></ul><ul><ul><li>No separate long-term capital gain rates like we have for individuals </li></ul></ul><ul><li>Shareholders report no income from the corporation’s operations unless a dividend is paid </li></ul>C Corporation
  57. 57. PAGE <ul><li>Losses are to be used only if the corporation: </li></ul><ul><ul><li>Becomes profitable in the future, </li></ul></ul><ul><ul><li>Was profitable in the past and can carry the loss back to a prior year , or </li></ul></ul><ul><ul><li>Files a consolidated corporate tax return and other corporate members included in the consolidated return are profitable. </li></ul></ul><ul><li>Transfers of appreciated property to shareholders will result in gain recognition to the corporation and most likely to the shareholders. Treated as a sale or exchange at the corporate level. </li></ul>C Corporation
  58. 58. PAGE <ul><li>Appreciated real estate in a C Corporation can cause major problems of the shareholder dies with a large taxable estate – creates both estate tax and income tax issues </li></ul>C Corporation
  59. 59. PAGE Shopping Center $10 Million (FMV) $2 Million ( Basis) 100% C Corporation Mr. Jones (C Corporation) FMV of stock - $7 Million <ul><li>Assumptions </li></ul><ul><li>Taxable estate - $12 Million </li></ul><ul><li>Husband is widowed </li></ul><ul><li>FMV of stock is reduced because of embedded tax liability </li></ul>Subject to Estate Tax Subject to corporate level tax if real estate is sold after death
  60. 60. PAGE S Corporation 100% Hybrid Entities U.S. Individuals Management Company Owner Keep Salaries Low Reduce payroll taxes Shopping Center 75% Corporate Investors 25% LLC
  61. 61. PAGE Hybrid Entities <ul><li>Use Pass-throughs only </li></ul><ul><li>Corporate owners will not allow S Corp election </li></ul><ul><li>Use two-tiers to place corporate owners as direct owners of the LLC </li></ul><ul><li>Reduce payroll taxes </li></ul>
  62. 62. Characteristics of Entity Types PAGE Characteristic Sole Proprietorship Single Member LLC LLC Partnership Limited Partnership Limited Liability NO YES YES ( unless provided otherwise) NO (General partners: unlimited liability) YES/NO (General partners: unlimited liability, Ltd Partners: no liability) Levels of Taxation One (Sch. C on 1040) (Sch. E on 1040) One (Sch. C on 1040) (Sch. E on 1040) One (flow thru) (Sch. E on 1040) One (flow thru) (Sch. E on 1040) One (flow thru) (Sch. E on 1040) Certainty of Tax Status Yes Yes (Check the Box) Disregarded entity Yes (Check the Box) Like a partnership Yes (Check the Box) Partnership Yes (Check the Box) Partnership State Taxation One Depends (Some follow Federal, others treat as separate Corp) Depends (Some tax as Corp., some impose fees) Few / None (may withhold for non-residents) Few / None (may withhold for non-residents)
  63. 63. Characteristics of Entity Types, Cont’d PAGE Characteristic Sole Proprietorship Single Member LLC LLC Partnership Limited Partnership Self-Employment Tax Yes Yes Depends (active members, yes) Yes Yes / No (General partners: yes, Ltd Partners: no) Participation No Restrictions No Restrictions No Restrictions No Restrictions State Dependent (General partners: no restrictions, Ltd Partners: restricted) Continuity of Life N/A Yes Yes No (Partner withdraws, it’s dissolved – Vote of partners keep it) No (Partner withdraws, it’s dissolved – Vote of partners keep it) Deduct Fringe Benefits Health - Yes Other - No Health - Yes Other - No Health - Yes Other - No Health - Yes Other - No Health - Yes Other - No
  64. 64. Characteristics of Entity Types, Cont’d PAGE Characteristic Ltd Liability Ptnship Ltd Liability Limited Ptnship S -Corporation Professional Corporation C- Corporation Limited Liability State Specific State Specific YES ( unless provided otherwise) YES YES ( unless provided otherwise) Levels of Taxation One (Sch. E on 1040) One (Sch. E on 1040) One (generally) (flow thru) (Sch. E on 1040) Two Two Certainty of Tax Status Yes Yes (Check the Box) Partnership Yes (Timely filing of election) Yes Yes State Taxation Few / None (may withhold for non-residents) Few / None (may withhold for non-residents) Depends (may withhold for non-residents) Yes Yes
  65. 65. Characteristics of Entity Types, Cont’d PAGE Characteristic Ltd Liability Ptnship Ltd Liability Limited Ptnship S -Corporation Professional Corporation C- Corporation Self-Employment Tax Not Clear (probably Yes) Not Clear (probably Yes, General Ptnrs, No Limited Ptnrs) No No No Participation No Restrictions State Dependent (General partners: no restrictions, Ltd Partners: restricted) No Restrictions No Restrictions No Restrictions Continuity of Life No (Partner withdraws, it’s dissolved – Vote of partners keep it) No (Partner withdraws, it’s dissolved – Vote of partners keep it) Yes Yes Yes Deduct Fringe Benefits Health - Yes Other - No Health - Yes Other - No Health – Yes Other – No (if >2% owner) Health - Yes Other - Yes Health - Yes Other – Yes
  66. 66. PAGE <ul><ul><li>QUESTIONS? </li></ul></ul>Business Formation & Choice of Business Entity

×