Title Holding Land Trusts

A Powerful Strategy For Exchangors and Their Clients

Experienced real estate investors (and their professional advisers) who practice creative deal structuring techniques as a primary focus of their business (such as members of the Society of Exchange Counselors, the National Council of Exchangors, and CCIM's)… have long understood the powerful advantages available to creative investment strategies by way of IRC Sec. 1031 Tax Deferred Exchanges, and IRC Sec. 453 Installment Sales.

Real estate professionals also realize that these dealmaking strategies become even more powerful during the tight-money cycles that regularly occur in the American economy. What they may not be fully aware of is how the skilled and calculated use of the Illinois Title Holding Land Trust adds yet another powerful dealmaking catalyst to the Exchangor's arsenal, often providing more flexible "catalytic" solutions for enhancing many types of Exchanges, as well offering more powerful options to Installment Sales or "wraps".

The unprecedented scale of the historic worldwide "Liquidity Crunch" affecting the economy here in the first decade of the 21st century, places a premium on dealmaking skill-sets like never before. Understanding how to create liquidity when there is none is now critical in helping mitigate the loss of confidence and rapid and total collapse of the world's credit markets.

Super Cata-swap-alytic Expedite A Deal-ocious

She tried… but Mary Poppins couldn't say it better! The Illinois Title Holding Land Trust brings several significant advantages to deal structuring that can alleviate tax issues, cash shortages; while at the same time offering controlling property with most of the benefits and little of the headaches, and offering estate planning and asset protection features and easier distribution of equitable interests in certain instances.

In a practical viewpoint, Equity Holding Land Trusts bring a potent added dimension for more dynamic facilitation of creative deal structuring, often providing

Better Solutions For Future Flexibility (especially in lieu of Starker and even the increasingly popular "title-parking" Reverse Starker Exchanges - in many instances)

Quicker Resolution of contemplated transactions

Greater Options for Path To Cash Solutions

Broader field for Another Player or Solution for Putting Pieces of Transactions Together

The primary advantages offered by Land Trusts in achieving the above benefits are derived from two intrinsic features that allow:

1) Parking the title in a neutral trustee and delaying actual sale while giving most rights of ownership to Acquiring Party.
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2) IRS inclusion of Beneficial Interests in an existing Land Trust to be treated as "like-kind" property for 1031 exchange of real estate.

Giving The Boot To Boot! (IRS Revenue Ruling 92-105)

A taxpayer's interest in an Illinois land trust constitutes real property which may be exchanged for other real property without recognition of gain or loss under section 1031 of the Code, provided the requirements of that section are otherwise satisfied. (This holding is not applicable if an arrangement involving an Illinois land trust creates an entity such as a partnership. Consult with your exchange tax counsel).

The holding in this Revenue ruling also applies to an interest in a similar arrangement created under the laws of any state, pursuant to which:

1. The trustee has title to real property,
2. Beneficiaries control the trustee in dealing with the title to the property, and
3. Beneficiaries have the exclusive control of the management of the property, the exclusive right to the earnings and proceeds from the property, and the obligation to pay any taxes and liabilities relating to the property.

http://www.texas1031.com/case_rul/92-105.htm

http://www.irs.gov/irb/2004-33_IRB/ar07.html

http://www.1031x.com/IRS1031Exchange2004-33Doc.cfm

Scenarios

Here are just a few of the situations in which a Land Trust can play an significant role in dramatically improved results for all parties to a structured transaction:

Installment Sales Alternative for Don't Wanter

When - Seller has low basis property he no longer wants; but he wants to avoid taxes, and stay in the investment real estate game. He realizes installment sale poses future tax traps if he sells the note or trades it for property. He has been unsuccessful at exchanging for other property. Wants path to cash and/or solution for putting together acquisition of property for future investment. RE Investor wants low cost seller financing for liquidity purposes and to achieve investment objectives through purchase money debt structuring.

Situation - Blackacre has a small strip retail shopping center on the edge of a declining neighborhood, and several older rental homes on a three-acre parcel adjacent to the shopping center. Property in near-term redevelopment zone. Whiteacre wants to acquire the property for current income and future redeployment of infrastructure - but has limited cash, and is looking for owner carryback financing.

How - Blackacre puts property to be Relinquished into Land Trust set to terminate in seven years; assigns a Co-Beneficial Interest in the Land Trust to Whiteacre. Whiteacre gives Land Trust a seven-year master lease agreement to obtain use of Blackacre's property for investment purposes, giving Blackacre equivalent of 10% down payment; monthly cash flow through lease payments; and relief from management of property.

Blackacre finds upleg Replacement property in form of well-managed apartment building held by Grayacre. Grayacre is unwinding his affairs for retirement and estate planning purposes. Grayacre likes the tax-deferred aspects, as well as the several planning options Blackacre's Land Trust Co-Beneficiary Interest provides. Grayacre accepts Blackacre's Co-Beneficiary Interest in Land Trust in exchange for Grayacre's equitable interest in Replacement apartment building.

Result - Whiteacre achieves desired property acquisition; Blackacre achieves objectives of disposing of unwanted property; obtaining desired upleg property.

Mambo Kings (Turning a Starker III Delayed Exchange into an Illinois Mambo)

When - Cash offer on table from buyer. Relinquishing Party doesn't want cash sale due to capital gains taxes; also hasn't found suitable Replacement property; prefers more flexibility in making offers on, and time frames for locating, suitable replacement property.

Situation - Baker offers $1M cash for Able's low basis property. For tax reasons, Able does not wish to take cash; also wants more flexibility in finding Replacement property as he has a trip planned in three weeks; and likes having more options for deal structuring as well.

How - Able puts property to be Relinquished into an Illinois title holding Land Trust. Able assigns a Co-Beneficiary Interest in the Land Trust to Baker. Trustee holds Baker's cash in Land Trust contingency fund. Baker gives Land Trust a master lease agreement to obtain use of Able's property for investment purposes.

Baker now has control of desired property, and benefits related thereto. Able has avoided taxable sale, but has Baker locked in as taker for property to be Relinquished - while also providing Able with substantial flexibility by way of having tradable Beneficiary Interest in Land Trust; as well as $1M available cash for both more flexibility in structuring acquisition of Replacement property… and more time for locating same.

Able finds $1.2m Replacement property held by Charlie. Charlie wants to sell his property for all cash. Able exchanges Able's Beneficial Interest in Land Trust to Charlie for the Replacement property; also gives Charlie a senior note for $210k secured by Replacement property to balance equities.

Result - Able obtains new $1.2M Replacement property, increases estate value, avoids tax hit; also derives new basis/additional tax write-offs from upleg property. Baker and Charlie instruct Trustee to terminate the Land Trust and sell property to Baker for $1m cash. Charlie also sells the carryback note to a note investor to get remaining cash (less any discount taken by note investor). Baker gets property desired; Charlie gets cash he needed.

The IRC Sec. 121 Exclusion - Primary Residence

Section 121 of the Internal Revenue Code ("121 exclusion") provides that property that has been held and used by you as your primary residence for at least 24 months out of the last 60 months can be sold, and you can exclude from taxable income up to $250,000.00 in capital gains if you are single (per owner/person) and up to $500,000.00 in capital gain taxes for a married couple filing a joint income tax return.

IRC Section 121 Income Tax Strategies

In most cases, the Sec.121 exclusion can only be used in conjunction with real property that has been held and used as your primary residence. It does not apply to second homes, vacation homes, or any kind of property that has been held for rental, investment of use in your business. However, with very careful and proactive income tax planning, it is now possible to combine the benefits of the 1031 exchange with a Sec. 121 exclusion.

There are three (3) possible scenarios when combining a 1031 exchange with a 121 exclusion, which are outlined below.

Rental Property Converted to Primary Residence (No Prior 1031 Exchange)

The first scenario consists of rental property that you acquired out right (i.e. it was not acquired as part of a prior 1031 exchange transaction), which you decide to convert into your primary residence so that you can take advantage of the $250,000.00 tax-free exclusion per person ($500K for a married couple) via the 121 exclusion.

The only requirement with this strategy is that you move into the investment property (i.e. convert it from investment property into your primary residence) and live in and use it as your primary residence for at least 24 months.

Once you have lived in and used it as your primary residence for at least 24 months you can sell the property and qualify for the Sec. 121 tax-free exclusion. Remember that the 121 exclusion will only exclude capital gains from your taxable income; it does not exclude any depreciation recapture amounts that might exist from the time held as investment property.

Rental Property Converted to Primary Residence (Prior 1031 Exchange)

In this scenario, because you acquired the real property as your like-kind replacement property in a prior 1031 exchange, you should hold the property as investment property for 12 to 18 months, or more, in order to demonstrate that you had the intent to hold the like-kind replacement property for investment. You will then move into the investment property after the 12 to 18 months and convert it into your primary residence. You must live in and use it as your primary residence for at least 24 months.

The American Jobs Creation Act of 2004 added one additional requirement that applies when your property was originally acquired as part of a prior 1031 exchange transaction. You must now hold or own the property for a minimum of five (5) years before you can qualify for the IRC Sec.121 exclusion. You do not have to live in the property for five (5) years; you only have to own it for five (5) years. The same issue regarding depreciation recapture applies here also.

Primary Residence Converted to Rental Property

The final scenario consists of you (and your spouse, if applicable) owning, living in and using a property as your primary residence. The challenge is that your capital gain significantly exceeds the $250,000.00 (or $500,000.00) tax-free exclusion permitted under the 121 exclusion, and if you sell your property the amount of capital gain that exceeds the 121 exclusion limitation would be painfully taxable.

The Internal Revenue Service issued Revenue Procedure 2005-14, which allows you to move out of your primary residence and convert it into investment property. The question is how long must you hold the property as investment property? Various sources recommend holding as investment property for at least 12 to 24 months or more in order to demonstrate that you did in fact have the intent to hold it as investment property. Once you have held the property for a sufficient period of time, you can sell the property and qualify for the 121 tax-free exclusion and for a 1031 exchange - so that you can defer the balance of the capital gain into more investment properties.

You would sell the property, exclude the $250,000.00 or $500,000.00 in capital gains from your taxable income and complete a 1031 exchange for the balance of the sale transaction to defer the rest of your capital gain, including any depreciation recapture, into the purchase of another like-kind rental property.

This "doubling-down" sequence is a great income tax planning strategy when you have a highly appreciated primary residence.

Always Seek Advice of Counsel; Build Your Technical Team

It is extremely important for Investors to consult with their legal, tax and financial team before entering into any tax-deferred like-kind exchange. It is even more critical to immediately consult with the advisors when a 1031 exchange appears likely to fail. It may be possible to save all or a portion of the tax-deferred benefits with the proper expert guidance.

We always recommend that Investors choose a team of experts to help advise them in building their real estate investment portfolio. The team should at least consist of a professional attorney, accountant, broker, and escrow officer, who are experts in the areas in which the Investor is working.