What a Lender’s Counsel Thinks About in a Real Estate Transaction – Part I

In today’s competitive environment, having information and knowledge may often mean having a tremendous advantage over the competition, the difference in closing a transaction quickly, or even closing it at all. If the idea is to be as prepared as one can, thus making the closing as good an experience as possible for the broker and the buyer (a.k.a. borrower), then one sure way is to know what to expect from the Lender and its counsel. With that in mind, Mitchell C. Fogel , of the Boca Raton, Florida law firm of Fogel & Pekale, LLP, offers these nuggets of information to help you close your deal and/or earn your fees.

1. Whose on first, What’s on Second, and I Dunno’s on Third

It may seem obvious, but the loan will NOT fund - and the deal will NOT close - without establishing in detail and delivering to the lender and its counsel critical, current and complete information about the borrower, the seller and, when applicable, the guarantor(s). That means the names of all the parties and, where entities are involved, the formation and governing documents of the applicable entities. As simple as this seems, it is often one of the biggest areas of breakdown in getting the loan ready to close. One of the parties (usually the buyer, but often the guarantors) may form a new entity; may assign the contract to a previously unknown entity (such as a Exchange Accommodation Titleholder in a reverse 1031 exchange); may change the owners, principals or managers of a critical entity; or may modify the governing documents of a vital entity. To avoid delays in closing, always make sure that the most current information and documents - and all amendments or modifications - are timely delivered to the lender and its counsel.

2. Life begins at Contract-ception.

In every deal I have been a part of as counsel for buyer, seller or lender, there has been a written contract executed by the necessary parties to the deal. Lender’s counsel must have a complete and legible copy of the contract (including any and all exhibits thereto, amendments thereof, and other related documentation), and will use the contract in preparing the lender’s closing checklist, a document that provides what materials, conditions, and data that must be delivered, satisfied and/or prepared prior to closing. Also, any changes to the contract - a 1031 exchange addendum, for example - must also be received by such counsel or the closing may be delayed.

3. Show me the Money

If the contract calls for a deposit, or a number of deposits, make sure each has been delivered to the applicable escrow agent and ensure evidence of each deposit is given to the lender and its counsel.

4. Now, show me the Survey

In most real estate transactions, unless the subject property is a condominium unit, it is in the best interests of the buyer to have a current survey of the subject property prepared, and it should show and label all applicable title matters. With the survey, the buyer and lender can make an informed decision about the property, its condition and matters that affect title to it. Lender’s counsel will need to have sufficient time to review the survey and related matters that affect the subject property, PLUS the survey must be certified correctly (usually to the lender, the title insurance company, the buyer, and the closing agent).

5. He said, She said

Effective communication among the essential parties is critical to having a smooth closing. Therefore, the lender’s counsel must receive, early in the process, the names and contact information of all parties and their representatives (i.e., lawyers) in the transaction. Often the broker can be a tremendous asset in this area.

6. What’s mine is mine and what’s your is mine

In a real estate deal - and the loan that funds it, the Buyer’s “status of title” is what is most important to the Lender and its counsel. The Lender decides to make its loan, and determines what the loan terms will be, based upon a number of factors. One of the most significant factors is the priority of its lien on the Lender’s primary collateral. Reviewing title matters can be quite complex, requiring Lender’s counsel to read and analyze many documents, some of which may be very old and hard to read. It is not uncommon to include the services of a surveyor or other professional in determining the applicability of some title documents. Title review can be challenging and can take quite a bit of time. So, do not delay having a title search performed (and where applicable, a title insurance commitment issued) and having it delivered to Lender’s counsel as soon as possible. Lender’s counsel will not advise its client to close a loan unless it is certain that Lender’s lien will be in the position Lender requires as to the Loan.

We will post the second half of "What a Lender's Counsel Thinks About in a Real Estate Transaction" next week. In the mean time, if you have any questions or comments about the contents of this article, please contact Mr Fogel, toll free, at866-829-7472 or in the Palm Beach area at 561-393-9111. If you have questions regarding an upcoming real estate closing and the possibilities of deferring capital gains tax on the sale, please contact us at 888-367-1031.

IRS Gives OK to Non-Safe-Harbor Reverse Exchange

In January, the IRS issued a Private Letter Ruling (PLR 200901004) approving a reverse improvement exchange under §1031 that did not comply with Revenue Procedure 2000-37 (the “safe harbor” exchange guidelines issued by the IRS).

There were two unusual features to this exchange –

• It is a “non-safe-harbor” reverse exchange, and
  
  
• The replacement property is an improvement built on property (easements) owned by the taxpayer.

These are issues for which no specific guidance or approval had been previously issued by the IRS. Usually, like-kind replacement real estate has been thought to require ownership of real property as distinguished from an improvement constructed on land already owned by the taxpayer.

As described in the PLR, the taxpayer proposed to exchange “Old Facility” for “New Facility.” Old Facility was to be sold to an unrelated third party. Taxpayer was to hire a contractor (Accommodator) to build New Facility on easements already owned by Taxpayer or acquired by Taxpayer prior to the exchange. The contractor would initially own and finance the construction of the New Facility independently of the Taxpayer. Following completion of New Facility, the contractor would transfer ownership of New Facility to Taxpayer (presumably using the exchange cash to service debts of the contractor).

This is the substance of the proposed exchange described by the PLR. However, there are more complicated relationships in the transaction which can be summarized as follows –

• The contractor was a domestic subsidiary of a foreign corporation which also owned the Taxpayer. However, the contractor is not a related party to Taxpayer because the parent is a foreign corporation which is excluded from the definition of a related party.
  
  
• The contractor had no equity in the project other than funds from its parent foreign corporation.

Unlike the DeCleene Case, the ruling does not examine whether the contractor acting as Accommodator possessed the benefits and burdens of ownership, whether it was acting as Taxpayer’s agent or whether the exchange is a step transaction resulting in the Taxpayer acquiring improvements on its own property. The ruling does imply that an exchange can be structured using an accommodator for property in which the taxpayer has a substantial ownership interest or over which it otherwise exercises control.

As with all PLRs, this opinion was issued as a private letter ruling to the taxpayer requesting a ruling, and therefore it cannot be cited as precedent. The Internal Revenue Service has the right to change its position on this matter without notice. If you have questions about structuring your improvement or reverse exchange, please give us a call at 888-367-1031.

Luna-TIC Fringe

Michael Franklin, author of this entry, is an Executive Vice President of Los Angeles-based FORT Properties Inc. He has graciously allowed us to borrow his thoughts about the recent economic crisis as it relates to the Tenant in Common (TIC) industry.

The past year has undoubtedly been the most challenging in recent memory for those involved in commercial real estate. Tenant-in-common (TIC) sponsors have felt the pressures and, in some high profile cases, have succumbed to the rapid changes in our economy. As in all areas of the commercial real estate sector, however, there are TIC sponsors that are reacting proactively to the challenges and there are those that won't survive the downturn. What are the major issues facing TIC sponsors in 2009? and who will live to see another deal?

A Business Model Issue, Not an Industry Issue

The past year was a few high profile TIC sponsors fail completely or take to the sidelines. While it may be expedient to view this as an indictment of the entire industry, those familiar with these firms recognize the reality - the stresses on this sector have magnified the fault lines of companies whose business models work only in the best of times.

Transparency and 'skin in the game' provide the incentive for sponsors to act with integrity. Each TIC investment must stand on its own merits. Those who invest in the asset inherently invest more comprehensive due diligence and are more realistic about the property's prospects - after all, this sponsor is willing to own the asset.

Refinancing - The Elephant in the Room

The majority of TIC investments were financed through Commercial Mortgage-Backed Securities (CMBS) vehicles. With an estimated $40 billion in CMBS loans for the TIC industry alone coming due in the next three years, the choices available may be difficult. Lenders have shown a skeptical willingness to extend existing term and the ability to extend the term may cost dearly.

Borrowers can also turn to more traditional sources of lending to refinance a property though they face the same challenges as all commercial real estate borrowers in addition to the burden of educating traditional lending sources about TICs. One challenge inherent in the TIC structure continues to prove difficult for all lenders - creating a comfort level in dealing with the multiple owners of a TIC asset.

Commercial real estate transactions have been paralyzed by the unwillingness (or inability) to lend. Supply cannot be manufactured without debt and fears within the market have made debt difficult to obtain. TICs are particularly susceptible to this environment as investors hoping to utilize a 1031 exchange find it increasingly difficult to find a buyer who can obtain financing.

There is Good News

While the evolution of the industry will result in far fewer TIC sponsors, those that remain will have done so because their business model is investor focused and realistic. These same sponsors will certainly have a history of strategic acquisitions and exceptional asset management or they would have been unable to obtain financing during these turbulent times.

TIC investments remain an outstanding strategy for certain investors. Well capitalized, strong sponsors will ensure that this option remains viable and attractive long after the economic crisis has passed.

For more information on thoughts addressed in this article contact Michael Franklin at 213-572-0222. If you have questions about 1031 exchanges and Tenant-in-Common Interests, please visit our website or give us a call at 888-367-1031.

New 1031 Exchange Regulation in Colorado

Colorado House Bill 09-1254, sponsored by State Representative Joel Judd and State Senator Ted Harvey, has been unanimously passed by the 67th General Assembly of the State of Colorado. This legislation is designed to create consumer protections relating to Section 1031 Like-Kind Exchanges facilitated by Qualified Intermediaries (QI) and Exchange Accommodation Titleholders, otherwise known as Exchange Facilitators.

For the past two years a group of QIs committed to responsible business practice has served as a resource team for legislators promoting this bill. The team, comprised of members of the Federation of Exchange Accommodators (FEA), included committee leader Brent Abrahm of Accruit, Mary Lou Schwab of Bankers Escrow; Paul Holloway of Land Title Exchange Corporation; David Wright of 1031 Corporation Exchange Professionals - a subsidiary of 1stBank; Scott Saunders of Asset Preservation; Suzanne Goldstein Baker of Investment Property Exchange Services, Inc. (IPX1031); and Max Hansen of American Equity Exchange, Inc. Abrahm, Baker, and Hansen also serve on the FEA’s Board of Directors.

Abrahm, CEO of Denver-based Accruit, LLC, explains that “the like-kind exchange (LKE) was added to the Internal Revenue Code in 1921 to promote business reinvestment in our economy. It is important, especially during difficult economic times like the present, that this ultimate stimulus tool be governed in the best interests of the consumers and businesses that utilize it. We applaud Representative Judd and Senator Harvey for supporting legislation that protects the integrity of the services provided by QIs doing business in Colorado. It’s been an honor to be a resource for this landmark legislation, which will ensure appropriate business standards for all QIs in the state.”

The FEA, which represents Qualified Intermediaries nationwide, requires that its members follow a strict code of ethics consistent with the legislation presented by Representative Judd. Billions of dollars in like-kind exchanges for real estate and other business assets are transacted each year, and House Bill 09-1254 will ensure that all Colorado Exchange Facilitators follow secure banking procedures that provide sufficient liquidity of funds to meet their obligations to their clients.

“The FEA Code of Ethics very specifically provides every member organization a set of standards and business processes to safely handle assets and business funds,” says Hugh Pollard, President of the FEA. “With proper due diligence, no client should have reason to fear doing an LKE. Each client should ask detailed and specific questions about how their money will be invested and they should make sure that their QI provides proper financial assurances.”

For more information on the new Colorado regulation and the protections it provides or for more about section 1031 operating principles, please give us a call at 888-367-1031.

Like Kind vehicles under Section 1031

A new private letter ruling (PLR 200912004) says that vehicles that share characteristics of both cars and light general purpose trucks - including SUVs, minivans, cargo vans and crossovers - are of "like kind" for section 1031 purposes.

The IRS observes that in the past few decades motor vehicles have evolved in a manner which blurs the distinction between cars and light-duty trucks.

The “safe harbor” for determining which vehicles are like-kind to each other has been by reference to the General Asset Classes found in Reg. §1.1031(a)-2(b)(2) or the Product Classes found in Sectors 31, 32 and 33 of the North American Industry Classification System (NAICS). Vehicles which are found in the same Asset Class or Product Class have been deemed to be like-kind.

PLR 200912004 observes that personal property exchanges can be like-kind for a 1031 Exchange even if they are not in the same Asset or Product Class and that no inference is to be drawn from the fact that properties are not in the same Asset or Product Class.

As noted above, the Asset and Product Classes are “safe harbors” and not the exclusive way to determine if personal property is like-kind.

Accordingly, cars, light general purpose trucks and vehicles that share characteristics of both cars and light general purpose trucks (13,000 lbs) (e.g., crossovers, sport utility vehicles, minivans, cargo vans and similar vehicles) are like-kind for 1031 Exchange purposes even though they are in different Asset or Product Classes.

Caveat: This opinion was issued as a private letter ruling, and therefore it cannot be cited as precedent, and the Service has the right to change its position on this matter without notice.

For more information on depreciable tangible personal property and like-kind exchanges, please visit our 1031 exchange website, www.1031cpas.com, or give 1031 Corporation a call at 888-367-1031.

Intangibles Can Qualify as Like Kind Property for Section 1031 Exchanges

A new Chief Counsel Advice (CCA 200911006) declares that intangibles such as trademarks, tradenames, mastheads, etc., that can be valued separately and apart from goodwill qualify as like-kind property for a Section 1031 exchange.

This is a policy change from past thinking of the IRS as expressed in PLR 200602034 - issued as a Technical Advice Memorandum - which said that such intangibles could not be of like kind to similar intangibles of any other business because they were closely related to, and part of, the goodwill of the business being sold. Goodwill of a business being sold is not considered to be like kind to the goodwill of any other business being purchased.. The CCA also reverses IRS’s position in FAA 20074401F, which stated that newspaper mastheads and customer-based intangibles were too closely related to goodwill to ever be like-kind.

The CCA declares that the IRS should not follow the position set forth in PLR 200602034. The IRS says that except in rare and unusual situations, intangibles such as trademarks, tradenames, mastheads, etc. can be valued separately from the goodwill of a business and thus are eligible for an exchange for like-kind intangible property.

If you have questions about intangibles and whether they may qualify for a section 1031 exchange, please give us a no obligation, toll free call at 888-367-1031.

IRS Says Okay for EAT to hold Partnership Interest

Under the rules of §1031, a taxpayer is required to receive real estate as replacement property for an exchange of real estate. In a recent Private Letter Ruling (PLR 200909008), the taxpayer was using the services of an Exchange Accommodation Titleholder (EAT) to take and hold title to a replacement property until his relinquished property could be sold (reverse exchange). The taxpayer's desired replacement property was real estate owned by a partnership in which the taxpayer was a 50% owner and Partner B was the other 50% owner. The only asset of the partnership was qualifying real estate. Taxpayer desired to become the 100% owner of the real estate. Ordinarily, the taxpayer would have to become the purchaser of real estate to complete a tax-deferred exchange of real estate.

In the case of this Private Letter Ruling, the EAT took ownership of the 50% interest in the partnership owned by Partner B (versus taking title to 50% of the real estate owned by the partnership). At this point, the partnership was comprised of the taxpayer and the EAT as 50/50 owners. When the taxpayer’s relinquished property was sold, the EAT transferred the 50% partnership interest to the taxpayer as replacement property for the taxpayer’s exchange. In effect, the taxpayer had acquired the 50% interest in the real estate owned by Partner B by becoming the 100% owner of the partnership.

While Section 1031(a)(c)(D) precludes the exchange of real estate for a partnership interest, under Revenue Ruling 99-6, the acquisition by a partner of all the remaining interests in a partnership is treated as the acquisition of a pro rata share of the assets of the partnership (in this case, real estate). The partnership is deemed to have made a liquidating distribution of the real estate to the taxpayer and the partnership “disappears.”

For more information on 1031 exchange and partnership issues, please visit our website or give us a call at 888-367-1031.