Several years ago, hardly anyone had heard of limited liability companies (“LLC”). Now businesses operate as LLCs in all states, and the press and media have nothing but good things to say about them. Is all the hype justified? Much of it is, especially where the business involves the ownership of real estate. Limited liability companies offer an unprecedented combination of corporate-like liability protection and partnership pass-through taxation. In addition, if anonymity is a goal, you can achieve this by naming the LLC whatever name you desire so long as it is followed by the words “limited liability company” or a variation or abbreviation of these words.

Unlike limited partnerships, limited liability company “members” don’t have to limit their participation in the firm’s management to protect their personal assets from the firm’s creditors. Yet they can qualify for true partnership taxation.

LLCs also have a number of distinct advantages over S corporations for many businesses. They are not restricted to a single class of stock as S corporations are, so LLC members have a greater ability to allocate gains, losses, deductions, and credits. Also, there are no limits on the number or kind of shareholders, giving LLCs greater access to capital. In addition, LLCs have certain tax advantages over S corporations when it comes to the ownership of real estate.

All of this makes LLCs the entity of choice for holding real estate for start-up ventures. However, should established investments be transferred into an LLC? The answer is maybe. If the real estate is presently held in the name of one or more individuals, the property could and probably should be transferred and held in an LLC so as to achieve the liability protections to which the owners of LLCs are availed. In the case of multiple individual owners, holding property in an LLC will also provide for centralized management of the real estate, avoiding disputes that occasionally arise between individuals holding real estate as tenants-in-common. The transfer of real estate by an individual into an LLC generally will not result in a taxable event for income tax purposes.

Similarly, if the real estate is presently owned by a general partnership, the general partnership can usually be converted to an LLC, thus achieving liability protection, without causing a taxable event for income tax purposes. In fact, the conversion of a general partnership to an LLC can typically be accomplished without even changing your federal identification number because both entities are treated as partnerships under the tax code. There are very few circumstances today in which a general partnership is the entity of choice for real estate investments or for other types of businesses.

If the real estate is presently owned by an established corporation and the real estate has appreciated since it was purchased, the tax cost of converting to an LLC is probably prohibitive because distributing the real estate from the corporation will result in a taxable event.

In summary, most start-up real estate ventures should typically be organized as LLCs, and existing ventures should at least consider converting to an LLC.

If you’re like most people, you don’t like to think about planning your estate. But it’s an important part of ensuring the financial security of your loved ones. One of the easiest and most common tools used in estate planning is a program of giving gifts. Gifts can reduce the size of your estate that is subject to tax while still passing on wealth. Gifts can also serve a function in your income tax planning by shifting income-producing property to others who are in a lower tax bracket. Not only will gifts enable you to remove assets from your estate, but gifts will also enable you to remove future appreciation of such assets from your estate.

While many gifts are subject to gift taxation, you can give away up to $12,000 (2008) per recipient per year free of gift tax. These gifts also do not reduce the amount that you can pass free of estate tax. There is a great deal of flexibility in the types of property that can be transferred. Qualifying gifts can be money, real estate, stocks or other business interests, or even a life insurance policy. The gift may also be made through a trust so that the actual distribution of the property can be made at a time when the recipient has the maturity to deal with the asset.

You can give up to $24,000 (2008) per recipient per year if you’re married and your spouse consents to “split” your gifts. This is useful for spouses who do not own an equal amount of property. The spouse with less property can consent to gifts made by the wealthier spouse, thereby effectively doubling the amount that the wealthier spouse can give away tax free.

One important thing to remember when you make a gift of appreciated real estate is that the recipient must take your basis in the real estate. This means that if the recipient sells the real estate, any gain on the sale will be measured using what you paid for the real estate, not what the real estate was worth when he or she received it. In contrast, if real estate is transferred to another through your estate, the recipient can use the value of the real estate at that time in measuring any gain on the sale of the real estate. This increase in the tax basis is known as receiving a “stepped-up” basis. Consequently, choosing the right asset to give is an important aspect of any gift-giving program.

If used properly, a program of gift-giving can benefit everyone involved. If you have any questions about the best way of using gifts as part of your overall financial plan, please contact us.

A well-known, but sometimes overlooked, way to buy and sell real estate without paying tax at the time of the transaction is through the use of “like-kind” exchanges. In a like-kind exchange, investment property is traded for other investment property. The person transferring one piece of property receives different property but keeps the same basis as that for the old property. That way, the gain is deferred while other tax attributes are preserved.

Of particular interest are the flexible features that make a like-kind exchange an especially useful technique. First, properties do not have to be of identical type to qualify as like-kind. To take a few examples, commercial buildings may be exchanged for unimproved lots, farm land for city lots, and even cooperative housing stock carrying occupancy rights for a condominium interest in the same property.

Second, properties do not have to be exchanged at the same time. Therefore, it is not necessary to have already located the exchange property to make a like-kind exchange (an important consideration if the end of a tax year is looming). It is sufficient that the exchange property be identified within 45 days after the relinquished property is given up and that the identified property be received within 180 days.

To illustrate how these exchanges can work,
consider the following example:
Fred owns an interest in an office building. He bought it years ago for $10,000, but today it is worth at least $100,000. Fred has decided to move to Florida and convert his office building interest into an ownership share in a Florida apartment building. Allison wants to buy Fred’s office building interest, and for tax reasons she wants to own the building interest by December 31. Fred wants to avoid the high tax he would have to pay after a cash sale.

A solution is a deferred like-kind exchange. Fred transfers his building interest to Allison on December 31. Allison agrees to locate and buy a Florida apartment building interest of equal value suitable to Fred. (Fred can even insist that Allison put the purchase price in escrow, so long as Fred has no independent right to use the purchase price.) After Allison finds and buys the Florida property, she transfers it to Fred, and the like-kind exchange is completed. Provided the 45/180 day rules along with other requirements are satisfied, Fred receives the Florida property tax-free, with the same basis and holding period he had in the office building.

In fact, it is even possible to not include Allison in the latter transaction if a Qualified Intermediary is used. For example, Fred could sell his office building to Allison with the proceeds of the sale held by the Qualified Intermediary until Fred identifies a new piece of real estate (must be accomplished within 45 days) and closes on the new piece of real estate (must be accomplished within 180 days). At the second closing, the monies held by the Qualified Intermediary would be paid to the seller of the second piece of real estate and the like-kind exchange would be successfully completed without any further participation by Allison.

As you can see, a like-kind exchange can be an excellent planning tool. Even in situations where it is impractical to arrange a completely tax-free transaction, like-kind exchanges may still reduce the immediate tax consequences of altering your investment holdings. However, as with most tax planning strategies, in order to qualify for like-kind exchange tax treatment and benefit from the accompanying tax savings, certain technical requirements must be met. Careful planning should therefore be undertaken in arranging the transactions.