Posted by Bill Gatten on January 24, 1999 at 14:05:37:
Daniel, I’ve tried to post to your query, but I keep getting a message tht says I’m posting a duplicate message (??). I didn’t, but hey… here’s your answer.
The reference has to do with the invalidation of land trusts, not L/O’s. The point has to do with the IRS’ attempting to “fail” a land trust, in order to squeeze out more tax dollars. They do so by characterizing the transfer as a Partnership or Corporation In-Fact, because, it looks like a corporation or partnership (or association), or a security agreement… and walks and quacks like one: then it must be one. One of the tests they employ is seeking out any provision in the Agreement that impels the resident co-beneficiary to proceed with acquisition, whether he wants to or not.
If they find it to be no more than a Lease Option, the resident loses its tax write-off and the Optionor has to account for taxable rental income
If they find it to be a partnership, the beneficiaries might be entitled tax deductions only commensurate with their percentages of ownership and a transfer of Realty vs. Personalty may be taxable at full rate; and as well, the protection of non-partitionability of Personalty is lost (i.e. personal property cannot be partitioned by a judgement creditor, even including the IRS (e.g., see Keno on Trusts IICLE 1989)
If it?s a corporation (or an association, taxed as a corporation, then they get to tax the entity and the shareholders separately (?double taxation?)
If it?s a Lease Purchase, then the non-resident gets hit with capital gains and loses his 1031 exchange privileges, and all the p;rotective benefits of the trust are lost to both parties
In terms of a true Lease Option, it?s not a Contract for Sale unless it contains specific provisions for a mandatory purchase of the property at a predetermined amount by a predetermined time. That’s why active tax loss is not afforded the Optionee under and L/O unless it’s a Lease Purchase (and it IS then a Contract for Sale, and DOES provide tax benefits; but the Optionee must purchase the property, LIKE IT OR NOT, or face recapture of tax benefits and probably a non-performance suit by the seller).
In order for a L/O tenant to take tax write-off, it must have a Contract for Sale evidenced by the obligation to buy–win or lose (“the risks and burden of ownership”). However, in a 3d party co-beneficiary Land Trust Conveyance, the resident beneficiary gets the tax write off by virtue of having purchased a personal property beneficiary interest in a bona fide Land Trust for investment purposes, and by virtue of the “triple net” lease arrangement it has with the beneficiaries. The resident beneficiary has not, however, agreed upon a Purchase Price in advance because it is agreed that at the end of the trust the property will be sold at Fair Market Value irrespective of who buys it
In the beginning a MAV (Mutually Agreed Value) is determined to calculate the non-resident beneficiary?s (seller?s) “Equity Contribution (which he gets back at the end).” Next the resident beneficiary?s contribution is determined (e.g., all non-recurring closing costs, and mutually agreed-upon capital improvements during the term). . Here’s the ?Secret Sauce? (as it were):
Then at the trust?s termination, the contract provides that the trustee will sell the property (to anyone who wants to buy it) at Fair Market Value as determined by a mutually acceptable appraisal. Should the resident beneficiary choose to buy it (or refinance in its own name) at that time, he too will pay Fair Market Value… although his purchase price will be minus the Resident Beneficiary Contribution (paid in at inception), and minus his share of the Appreciation and Equity Build-up. This means that if the resident beneficiary has 100% of the profit due him: in order to own the property outright, he need merely pay off the existing loan(s) and return the Non-resident Beneficiary’s Contribution to him (his beginning equity and any non-recurring closing costs he may have paid at inception…if any): and the rest is his. If the profits are to be shared between beneficiaries, then the loan is paid off, the NRB?s initial contribution is returned along with whatever share of profits are due him (as per the appraisal), and the rest belongs to the RB.
Sorry to have confused the issue.