Note

1031 Tax-Deferred Exchange Options

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There is a common misconception that all tax-deferred exchanges are complicated and require all properties, relinquished and replacement, to close concurrently. Fortunately, the most common exchange variation, the delayed exchange (also referred to as a deferred or “Starker” exchange, Starker v. U.S., 602 F.2d 1341), provides Exchangers with more flexibility and options in acquiring the replacement property than the simultaneous exchange. The delayed exchange begins when the Exchanger’s first relinquished property is sold and is completed when the last replacement property is acquired within the prescribed exchange period. To provide the required notice to the relinquished property buyer(s) and the replacement property seller(s) the Purchase and Sale Contract for each property should include an “exchange cooperation”.

The standard industrial / commercial real estate purchase agreement that we use in our sale transactions in Los Angeles County has standard 1031 Exchange language. This would apply to all commercial real estate types such as retail, office, industrial, or multi-family apartment buildings.

The use of a Qualified Intermediary (also known as an “Accommodator” or “Facilitator”) is the most common method used to complete a valid delayed exchange quickly and easily. The Qualified Intermediary is an independent party to the exchange transaction, who performs the function of creating the reciprocal trade of properties for the exchange, holds the exchange funds and supplies the necessary exchange documents, such as the Exchange Agreement, Assignments and Closing Instructions. The Exchanger assigns the rights in the Sale Contract for the relinquished property and in the Purchase Contract for the replacement property to the Qualified Intermediary, who essentially becomes the “seller” of the relinquished property and the “buyer” of the replacement property. To avoid actual or constructive receipt of the exchange funds by the Exchanger the proceeds from the sale of the relinquished property are held by the Qualified Intermediary until they are needed for the acquisition of the replacement property. In both simultaneous and delayed exchanges in which a Qualified Intermediary is used to create the reciprocal exchange of properties the IRS allows “direct deeding” of the relinquished property from the Exchanger to the buyer and of the replacement property from the seller to the Exchanger, thereby avoiding the necessity of the Qualified Intermediary holding title to any property. Revenue Procedure 90-34, 1990-1 C.B. 552. Direct deeding avoids the assessment of double state, county, or local documentary transfer taxes and any liability on the part of the Qualified Intermediary for environmental hazards that may exist on the property.

The Treasury Department issued Regulations in 1991 that clarified the acceptable methods to properly identify replacement property. See Treas. Regs. §1.1031(k)-1(b)-(e). First, the Exchanger must receive all replacement property within the earlier of 180 days after the date on which the Exchanger transferred the first relinquished property, or the due date (including extensions) for the Exchanger’s tax return for the tax year in which the transfer of the first relinquished property occurs. Second, the Exchanger must identify the replacement property to be acquired by the end of the Exchange Period within 45 days of the transfer of the first relinquished property. These time periods are very strict and cannot be extended even if the 45th day or 180th day falls on a Saturday, Sunday or legal holiday. The proper identification of replacement property is critical and if not made in a timely manner the exchange fails and the entire transaction is taxable. The rules are as follows: (a) the replacement property identification must be in writing and signed by the Exchanger, (b) it must be delivered by mail, fax or hand delivery to a party to the exchange transaction (usually the Qualified Intermediary) by midnight of the 45th day, (c) the replacement properties must be unambiguously described, such as by a street address, tax lot number, legal description or the like, and (d) the Exchanger may list up to three properties of unlimited value, but if more than three properties are listed, their total aggregate fair market value may not exceed 200% of the aggregate fair market value of the relinquished property. It is essential in a delayed exchange to adhere to these rules and deadlines established for identifying and acquiring the replacement property. Failure to comply with these rules may result in a failed exchange.

Note

Choosing a Legal Business Entity: Corporation, LLC or Sole Proprietorship?

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Choosing a legal business entity is one of the biggest decisions a small business owner will make. When deciding on an entity, one should consider the exposure of personal assets to liability, potential tax advantages, the ability to transfer ownership and the management structure desired.  When leasing or buying an commercial warehouse or manufacturing building, your business entity will be placed either on the lease form as Lessee, or it will hold fee title to the property you buy.  On the flip side, landlords often use LLC’s to hold title to industrial properties in Southern California and Los Angeles.  The LLC is now the favored holding entity for commercial real estate.  Here is a primer on the most common entities:

Sole Proprietorship: If a business is owned by one owner and is not incorporated, it is a sole proprietorship, which is a simple and inexpensive way to conduct a business. It’s also the most prevalent type of small business in the country. The owner is taxed on individual tax returns. The big drawback with sole proprietorships is that the owner is fully liable for business obligations, meaning that personal homes, cars and savings can be pursued by creditors.

Limited Liability Company: As liability increases, business owners should consider a limited liability company, which can cost between $200 and $250 to set up. LLCs protect owners from individual liability, while still allowing the owners full or limited management rights as they desire. As a separate legal entity, an LLC can own property, incur debts, enter into contracts and be a party to civil actions. LLCs offer several taxing options. If the LLC has two or more members, the entity can choose to be taxed as a partnership or a corporation. An LLC that elects corporate treatment may opt for S corporation treatment. If no election is made, the IRS will tax the entity as a partnership.

Partnerships: Partnerships consist of an association of two or more persons who have not incorporated and carry on a business for profit as co-owners. Partnership arrangements are flexible, allowing partners to split ownership and profits however they wish–general partnerships, limited partnerships or a limited liability partnership. General partnerships can be formed without any formalities. General partners are liable for the obligations of the partnership, and each partner can bind the partnership contractually with third parties. A limited partnership requires at least one general and one limited partner, with the limited partner having no management responsibility. Limited partners are liable only for the money invested in the partnership, while the general partner remains liable for all partnership obligations. Through their individual tax returns, partners pay taxes on their interest in the partnership’s profits and losses.

Corporations: Corporations are advantageous because they shield personal assets, allow free transfer of ownership and ensure continued existence if a shareholder dies or leaves. A corporation is a separate legal entity that can own property, sue and be sued, and has status as a separate taxpayer. To organize as a corporation, articles of incorporation must be filed with the state. Corporations must also establish bylaws, issue shares and hold annual meetings. Ownership is through stock, which can be categorized in different classes and freely transferred. Corporations can be taxed either as C corporations or S corporations, which refer to their respective subchapters in the Internal Revenue Code. The S corporation does not pay taxes; instead, the income and deductions pass through to the shareholders, who are taxed on their individual tax returns. A C corporation pays tax on its net taxable income, but shareholders must also pay tax on dividends they receive. C corporations can obtain tax deductions for business expenses, which are not available to other entities.

Market Trends & Indicators

CMBS Delinquencies Soar, Industrial Defaults Low Compared to Hotel, Multi-Family, and Retail

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CMBS issuance, industrial, retail, hotel, office
The secondary market for commercial real estate is just beginning to show new life, with the first successful sale of a commercial mortgage-backed securities (CMBS) package in over a year and several new issues in the wings spurred by the strong investor interest on that initial offering. But the positives of renewed activity are tempered by more bad news on the performance of those commercial bond deals made before the freeze.

According to a new report from commercial research provider Trepp, delinquent loans in commercial mortgage securities jumped 85 basis points to 5.65 percent at the end of November. That figure is up from just 4.8 percent a month earlier.

The delinquency rate was highest in the hotel sector, where defaults skyrocketed from 8.67 percent in October to 14.09 percent in November. According to Trepp, the upsurge came from a single Extended Stay Hotel loan. Without it in the mix, the hotel delinquency rate would have increased only 64 basis points, to a little over 9 percent.

Based on Trepp’s analysis, delinquencies on multifamily CMBS loans rose to 8.78 percent in November, up from 7.66 percent the previous month. All other sector’s showed slighter increases. Retail edged up from 4.53 percent to 4.78 percent. Industrial increased from 3.18 percent to 3.33 percent. Office loan delinquencies crept up from 3.08 percent to 3.14 percent.

Trepp says there were $65.2 billion in CMBS loans in special servicing at the end of November, an increase of $8.2 billion, or 14 percent, compared to October.  There are very few CMBS related distressed properties in the Los Angeles area.  from dsnews.com.  image from wsj

Market Trends & Indicators

California leading growth in nation’s green jobs economy

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New green jobs sprouted faster than the overall workforce expanded in California and across the nation from 1998 to 2007, according to a study released Wednesday by the Pew Charitable Trusts.

Even in the current economic downturn, investments in venture capital projects such as energy-efficiency programs and renewable energy are expected to continue expanding, fueled by billions of dollars in federal economic recovery grants, the research foundation predicted in its “Clean Energy Economy” report.

California led the nation in all categories measured. In 2007 alone, clean energy spurred the opening of 10,209 businesses with 125,390 jobs in the state. Venture capital investments in the Golden State totaled nearly $6.6 billion from 2006 to 2008, about five times greater than investments in runner-up Massachusetts.  Fields that will need more workers include clean energy production, energy efficiency, environmentally friendly manufacturing, and conservation and pollution control. Excerpts from Los Angeles Times 11/09.

This month, Standard BioDiesel expanded into Los Angeles County by leasing a land site to collect cooking oils from restaurant kitchens to process into biodiesel.  They plan on expanding to a larger land parcel within 12 months.

Governmental

An Overview – Property Tax & Assessment Process

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County of Los Angeles, California, United StatesIt takes three separate Los Angeles County offices, Assessor, Auditor-Controller, and Treasurer and Tax Collector to produce and account for your property tax bill and payment.

Assessor.  The Los Angeles County Assessor establishes the assessed value of your property by appraising the value of that property under applicable State laws. The assessed value is then placed on a list with all other properties in Los Angeles County and this list is called the “Assessment Roll.” The Assessor also approves and applies all exemptions, which are added to the Assessment Roll. The Assessment Roll is then presented to the Los Angeles County Auditor-Controller for further processing.

Auditor-Controller.  The Los Angeles County Auditor-Controller adds direct assessments to the Assessment Roll then applies the tax rates, which consists of general (1%) levy and debt service (voter & bonded) tax rates to the value to create an Extended Assessment Roll. The Extended Roll is then sent to the Los Angeles County Treasurer and Tax Collector for individual tax bill distribution and payment collection.

Treasurer and Tax Collector.  The Los Angeles County Treasurer and Tax Collector receives the Extended Roll, prints and mails the property tax bills to the name and address on the Extended Roll. The Treasurer and Tax Collector collects secured and unsecured taxes. Secured taxes are taxes on real property, such as vacant land, structures on land, i.e. business/office building, home, apartments, etc. Unsecured taxes are taxes on assessments such as office furniture, equipment, airplanes and boats, as well as property taxes that are not liens against the real property.