Just because you intend to do business primarily in one particular state does not mean that you necessarily have to set up your company in that state.  On the contrary, you can organize your company in any state (or even foreign jurisdiction) and then register that company to do business in the state where you do most of your business.

You have probably heard that large corporations tend to select Delaware as their state of incorporation.  Usually, these companies are not headquartered in Delaware.  In fact, they probably do not have an office in Delaware at all.  So, why have a Delaware corporation if your business has nothing to do with Delaware?  And, does it have to be Delaware, or are there other advantageous “jurisdictions” to consider?

Corporations start up by “incorporating.”  All other forms, such as LLCs and partnerships, start up by “organizing.”  It means the same thing.

That is why the governing document for a corporation is called “Articles of Incorporation,” while the equivalent document for other companies is called “Articles of Organization.” 

Tax Implications

Let’s start by dispelling a common misconception.  It is true that some US states charge income tax, while others do not.  However, you should not be under the impression that you can avoid state taxes merely by setting up your company in a state that has no income tax.  That would be a fatal mistake.

Corporate taxation is determined by where the money is generated, not by state of incorporation. 

So, for example, if your company’s office is in California, and you sell widgets to Californians, you cannot escape state taxes merely by organizing your company in Nevada.  If only it were that easy, right?  You can be sure that many, many people have tried to do just that.  And, when the Department of Revenue catches on . . . well, it’s not pretty.

Therefore, when determining the jurisdiction for domiciling your company, tax implications should not be a primary consideration.  If you are going to try to escape state taxes by setting up in a different state, you do so at your own risk.

Confidentiality

This is one of the big differences among the different jurisdictions.  Just how easy is it for the public to see your business and personal information?

Transparent States

Some states, such as Florida, are extremely transparent.  A good deal of business information, including owners’ names and addresses, are easily accessible online.

For lawyers, this is very useful.  When we need to sue a company, we just go online to the Department of State’s website (www.sunbiz.org), and we can get most, if not all, the information needed for the lawsuit right there.  It’s great.

On the flip-side, however, this transparency may not always be the best from an owner/officer perspective.  Besides making it easy for lawyers to prepare lawsuits, Florida companies also open themselves up to “trolls.”

If someone wants to find out whether you have enough assets to be worth suing, they can do a quick search online and see all the ventures you have going in Florida.  Similarly, if you have neighbors or family members that might be prone to jealousy, they can also easily find out what you have going on financially.

This “concern” is very situational, of course.  For many small business owners, having your information in the public record may be of absolutely no consequence. 

In that case, just go ahead and organize in the state where you are doing business.  That is the simplest and most convenient thing to do.  It will simplify setting up company bank accounts, minimize the need for a professional registered agent, etc.  It’s just easier.

Privacy-Conscious States

There are a number of states that are much more protective of a company’s confidential information.  If you go to the State Department’s website in one of these states, you will be able to see that a company exists.  In some cases, you may even be able to see whether the company is currently active.  But, that is about it.  No other corporate information will be available to the public on those websites.

Most of the states in New England tend to guard corporate information, as do the common “asset-protection” states, such as Wyoming, Nevada and Alaska. 

Again, what is best for individual business owners is situational, but an argument could be made that it is really a better business practice to set up in a state that will protect your company’s confidential information.

There is a bit of a trade-off, however.

Registered Agents

If you are going to set up your company in one state, but then do business in another state(s), you will need to hire a registered agent in the state of incorporation/organization.

Example:  You live in Florida and plan to do business in Florida, but you want to incorporate in Delaware.  At the time of incorporation, you will be required to provide a “registered agent” that has a physical location in Delaware.   So, unless you have a buddy in Delaware that is willing to act as registered agent for your company (not a great idea, by the way), then you will have to hire a professional registered agent in Delaware.

The purpose of a registered agent is to receive official documents on behalf of the company, such as lawsuits, governmental correspondences, etc.  Registered agent services are not particularly expensive (less than $100/year is common), but it is an extra step.

Double Registration

Continuing the example above, hiring a Delaware registered agent is not the end of the initial set up.  Since you are planning to do business in Florida, you will still need to register your Delaware company as a “foreign company doing business in Florida.”

If you live in Florida, you have the option of acting as your own registered agent (also not a great idea), so you do not necessarily have to hire a professional company for those services.  Still, you will need to maintain two registrations in two different states.  So, that too is an extra measure.

Thankfully, in the US, all states make it relatively easy and inexpensive to register a business.  The biggest thing is remembering to file annual renewals in both states and keeping the registered agent paid.  If you miss a renewal deadline, your company will be “inactive” or, even, “dissolved.”  And, to reinstate, there is usually a fairly nasty penalty ($400-600).

Asset Protection States

The main reason big corporations have traditionally incorporated in Delaware has to do with the governing statutes.  First of all, Delaware is the state with the most extensive case precedent when it comes to business matters.  That is advantageous because it prevents surprise.

Since almost every corporate situation you can possibly imagine has been litigated at some point in Delaware, you know ahead of time where the Delaware courts stand on all essential issues.

The predictability of Delaware courts is valuable to companies, especially those doing business on a large scale.

Second, the Delaware laws have traditionally been owner/officer/director friendly.  At some point in history, Delaware made conscious decision to be protective of owners/officers/directors in order to encourage companies to incorporate in Delaware.  It worked.

Simply put, Delaware law makes it more difficult to impose personal liability on owners, officers and/or directors for the bad luck, negligence or, even, misconduct of their companies. 

Owners, officers and directors are the decision-makers for their companies, and they like the protection.  So, everyone flocked to Delaware.

Now, because Delaware has been so successful at attracting businesses, certain other states have basically adopted the same laws.  They don’t even try to be subtle about it.  If you look at the case law, you will find judges openly stating “we follow Delaware law.”

As a result, these days, it is no longer necessary to set up in Delaware in order to get the benefits traditionally associated with Delaware.  I refer to the group of states that actively vie for your company’s business through these kinds of incentives as “asset protection states.”

Best Jurisdictions

Delaware

Naturally, you cannot go wrong with Delaware.  The only drawback is that it is a little more expensive than the competition.  At this point, Delaware sees itself as the “gold standard,” so you have to pay a little more to be there.

Nevada

The first state to aggressively compete for corporate filings was Nevada.  I think Nevada wanted to establish itself as the “Delaware of the West.”  And, it was largely successful in this regard.

Progressive states like California and Washington tend to offer more protections to consumers and employees, and less to owners/officers.  So, that created a great opportunity for Nevada to set itself up as the closer-to-home alternative to Delaware.

Unfortunately, Nevada, your recent overhaul of your Corporate Divisions website, and accompanying fee hike, is a disaster.  Your system has become terribly frustrating to deal with.  Even your own employees hate it.  On top of that, you decided to start charging more???  No, I’m out.

Wyoming

These days — at the moment, at least — my favorite asset-protection state is Wyoming. 

Wyoming has a simple, user-friendly online system for registering companies, and the fees are cheaper than the other jurisdictions I have looked at.  Also, you can get a human being on the phone when you need one, and the human will be nice to you.

As for asset-protection, Wyoming staunchly adheres to Delaware law, so you get the same liability limitation features in Wyoming as you would in Delaware.

Other Options

I know from my research that there are some other good options out there as well, most notably Alaska and South Dakota.  I am sure they are lovely.  I just have not had a lot of personal experience with these other jurisdictions.

~ Jeff Harrington, Esq.

I. Overview of FIRPTA

Simply put, FIRPTA is legislation intended to insure foreign owners of US real property pay the capital gains tax when they sell their property.  After all, there is a natural temptation for someone living abroad to simply sell the property and disappear without paying tax.

The IRS knows this, so they have put the obligation on the buyer and the title agent to withhold 15% of the sale price (10% for qualifying transactions) as a sort of escrow for payment of capital gains tax.  So, it’s not the seller that gets in trouble if the withholding is not done.

Since it can be hard to go after the foreign seller, the law is aimed at the parties the IRS knows it can find and punish.

For the most part, the 15% is calculated on the sale price, not the profit realized by the foreign seller.  So, usually, the withholding is a substantial amount, which is why clients come to us for help.

For a title agent, dealing with foreign sellers represents tremendous liability.  In fact, our office often receives referrals from title companies that are less familiar with international transactions.

Title agents who are unaccustomed to dealing with FIRPTA can get freaked out and end up making the process more slow and painful than it needs to be.

II. The Typical Scenario

Sometimes the foreign investor does not know about FIRPTA when making the purchase.  So, instead of creating a domestic land trust or LLC to purchase the property, the buyer just makes the purchase in his or her own name.   Given the choice, that approach is not the best for many reasons.  Click here for other options.

However, there are other times when purchasing through a land trust or company is not an option.  For example, some lenders may require the borrower be a natural person.  It is not impossible to get a mortgage in the name of a company or trust, but it can certainly be more difficult.  That said, since foreign buyers usually do not rely on US financing for their purchases, this is not generally an issue.

When it is time to sell the property, these are the questions to ask:

(i)  Can I avoid the withholding requirement altogether?

(ii)  If I can’t avoid withholding, can I minimize the amount withheld?  (10% instead of 15%)

(iii)  If I can’t avoid withholding, can I at least get a quick refund?

Of course, each situation is a bit different, so do not hesitate to contact our office (free consultation) when you have a situation with a particular closing.  But, if you are looking to generally educate yourself, this article is for you.

III.  Withholding Requirement

First of all, how do you calculate the the withholding?  The IRS uses the term “amount realized” from the sale, which is defined as:

• The cash paid (usually the purchase price);
• The fair market value of other property; or
• The amount of any liability assumed by the transferee after the transfer.

Sellers often say to us “But, I’m not making any money on the sale.”  Ultimately, the amount of tax liability will depend upon the profit or loss from the transaction.  But, that determination happens at the end of the fiscal year when you file your tax return.  Unfortunately, for purposes of the FIRPTA withholding, you do not get to “self-declare.”

So, you may very well get the withholding back after you file your tax returns.  But, at the time of the closing, the IRS wants to hold onto 15% (or 10%) of the sale price for you. 

Who is a “US person”?

If the seller is any of the following, then FIRPTA does not apply:

• a citizen or permanent resident of the US
• a non-resident who meets the “substantial presence” test
• a domestic, multi-member LLC
• a domestic partnership
• a domestic corporation
• a trust domiciled in the US that has at least one trustee who is a US person
• any estate that derives income from within the US

Who is a “resident”?

If you have a green card (i.e. permanent resident), then you are a US person, irrespective of how many days you have been physically present in the US.

If you are not a permanent resident, but have spent 183 days or more in the US in the past three years, then you are considered a “US person” for tax purposes.  The calculation of the 183 days (i.e. the “substantial presence test”) is a bit complicated:

• a minimum of 31 days in the current calendar year
• each day present in the current year is counted as a full day
• each day present within the preceding year is counted as one-third of a day
• each day present within the year that is two years prior to the current calendar year is counted as one-sixth of a day

Tip: The easiest way to do the math is to access Homeland Security’s I-94 page online.  That will give you a clear record of the time you have spent in the US during the most recent five (5) years.

What if the property has more than one owner?

If the property is owned jointly by U.S. and foreign persons, the “amount realized” is allocated between the seller parties based on the capital contribution of each.

Example:  If there is one US investor and one foreign investor, and they each put in 50% of the price to acquire the property, then the “amount realized” for FIRPTA purposes will be half the sale price.

What if the owner is a company?

If the seller is a foreign corporation, then the company must withhold 35% of the gain it recognizes on the distribution to its shareholders.  So, using a foreign corporation as your investment vehicle is usually not smart.

IV. Exceptions

Residence that costs less than $300,000

Probably the most common exception is where the buyer intends to live in the property as a home, as opposed to acquiring the property for rental/investment purposes.  That will work, but only if the sale price is less than $300,000.

Additionally, for the first two years, a family member has to live in the property “for at least 50% of the number of days the property is used by any person.”  So, that means, the days the house is vacant do not count, but you cannot have a tenant in the property for more time than you or your family use the property.

Limited Liability Company as Seller

This is where things get interesting.  Real estate investors often hold their properties in LLCs, so this is the section that merits the most careful analysis.

First of all, if the LLC is registered in a foreign country, then it is subject to the FIRPTA withholding unless it is a single-member LLC and the owner is a US person.

The real question, though, is what to do with domestic companies.

Domestic LLCs

Disregarded Entity.  Under the tax code, there is the concept of a “disregarded entity.”  If the LLC has only one owner (i.e. member), and the owner has not made any special elections with the IRS, then the LLC will be considered a “disregarded entity.”  In that case, whether FIRPTA withholding is required or not will depend upon the status of the owner.  If that individual or entity is a non-US person, then the LLC is subject to the withholding.

Multi-Member LLC.  By contrast, if the LLC is has more than one owner, then the default classification (i.e. no specific election taken) is “partnership,” not a “disregarded entity.”  So, a multi-member domestic LLC will generally not be subject to withholding.

An LLC formed in the US can safely sign the non-foreign affidavit and forgo withholding if _

1. 1. 1. It has only one member and that member is a US person
      2. It is has more than one member 
      3. It has made the election to be taxed as a corporation (i.e. C-corp)

Sworn Statement

If the seller provides a declaration that he or she is not a foreign person, and provides a tax ID number (i.e. social security or EIN), then that will get the buyer and title agent off the hook.  Obviously, if the information is false, the seller will be guilty of perjury and could have problems with the IRS.  The same is true if the buyer and/or title agent actually knows the information is false.

No Gain or Loss

If the transfer was to a family member, or some other situation where there truly was no profit or loss on the transfer, then the seller can provide a notice to that effect.  In that case, the buyer and title agent will not be liable.  Just be sure a copy of that notice gets filed within 20 days of the closing at the Ogden Service Center, P.O. Box 409101, Ogden, UT 84409 .

This exception may also apply in short sales, but that is not automatic because the calculation is based on the sale price rather than proceeds.  So, contact our office on that one.

V. Waivers 

This is where your experienced, resourceful lawyer can really be helpful.  There are certain mechanisms available for obtaining waiver of the withholding requirement.  There are three in particular that provide some wiggle-room.

• The amount to be withheld is greater than the tax liability.  The withholding is calculated on the full sale price, even though you may have a mortgage to pay off.  Ultimately, of course, you will only have to pay tax on your profit, not the full sale price.  So, it could very well be that your tax liability is lower than the amount of the withholding.  When that is the case, we should be able to get you a waiver.

• Agreement to pay tax with conforming security.  Since the whole idea of FIRPTA is to make sure sellers pay the capital gains tax, the IRS will consider waiving the withholding requirement as long as it has other assurances the tax will be paid.  These are the forms of security that are generally acceptable:
  • bond with surety or guarantor
  • bond with collateral (the Ibis property would probably work)
  • letter of credit (if you have funds abroad, this may be an option)

Under this scenario, we (the title company) would first determine the exact amount of tax due on the transaction, and then make arrangements to provide assurances that the tax will be paid before April 15.  If we can do that to the satisfaction of the agent, the IRS will issue a waiver.

• Nonstandard application.  This analysis really has to be done case-by-case, though I can give you an example.  One client wanted to sell his property in order to raise enough money to meet the requirment for an investor visa (E-2). In that case, the argument was really quite compelling.  After all, the IRS just wants to know the seller will not disappear without paying tax.  Well, if the very reason for the sale is to be able to remain in the US on a long-term basis, that is pretty good assurance the seller will pay his taxes.  So, we were able to obtain a waiver.

Bear in mind it does take a little time to get the certificate back (up to 90 days) so, if you decide waiver is the way to go, you will want to get the application together sooner rather than later.

VI. Amount of Withholding

There is one situation where the amount of withholding is 10% instead of 15%.  That is where the buyer plans to live in the property (see details above), and the sale price is greater than $300,000 but less than $1 million.

Otherwise, at the time this article is published, the withholding is always 15%.

VII.  Refund of Withholding

In general, you would apply for refund after filing your return and paying any tax due.  So, how quickly you get your money back–assuming you are entitled to a refund–depends up on you . . . to a point.

You do not have to wait until April of the following year, but you do have to wait until the end of the fiscal year in order to file a complete return.  Some exceptions may apply, depending upon your circumstances, but that is the general framework.

Also, there are some mechanisms for early refund but that, again, would really only apply if the withholding were greater than the tax liability.  The criteria and process would be the same as in § V above.  If you do file for an early refund, the IRS has 90 days to respond.

 VIII.  Conclusion

As usual, the moral of the story is to seek out a lawyer sooner rather than later.  Certainly, if you are a foreign investor, it would be worth your while to meet with an H&S attorney to go over options regarding structuring your real estate investments.

~ Jeff Harrington, Esq.

The Opportunity Zone program has been around since 2017 but, since the Pandemic, it has received some beneficial tweaks you should know about.

Benefits

Some of the deadlines under the program have already passed, but the benefits still available are impressive.

The first thing you need to understand is that we’re really talking about TWO separate tax-saving opportunities.   We’ll call them GAIN #1  and GAIN #2.

GAIN #1 – Previous Capital Gains

Here, we’re talking about the capital gains you made in 2021 (or the first quarter of 2022).

You’re just sitting on this money at the moment, getting ready to pay taxes on it.  But, hold on.  There is an alternative.

If you act quickly, you can take those gains from 2021 and reinvest them in a Qualified Opportunity Zone Fund.  That will exempt those gains from your 2022 tax return.

Then, you can defer the tax on those 2021 gains until 2027.  So, you have six (6) years in which you can make money on Uncle Sam’s money.  Let me give you an illustration.

Example:  Let’s say you sold real property last year and made a profit of $500,000.  Depending on your tax bracket, you probably owe 20% in capital gains tax on that money, which would be $100,000.  Under this program, Uncle Sam basically says:

You can hold onto my $100,000 as long as you reinvest it in an Opportunity Zone.  And, whatever you earn on that money in the next six years, you get to keep. 

That is not a bad deal AT ALL.  But, brace yourself.  Here comes the crazy part.

GAIN #2 – Capital Gains from QF

Continuing with our example, if you leave that $100,000 investment in the Qualified Fund (QF) for at least 10 years, you are going to get all the capital gains derived from that investment TAX FREE.  Let that sink in.

Example:  Let’s say you find a good QF for your $100,000.  You can probably expect your Fund Manager to grow the fund at a rate of 10% to 15% per year.  That will essentially double your investment in five (5) years.  So, by year five, give or take, your $100,000 investment will have grown to $200,000.  And, by year ten (10), it will be worth $300,000.  That leaves you with a capital gain of $200,000 by the end of the 10-year cycle.

Guess what.  You will pay exactly zero taxes on that $200,000 gain. 

That, my friends, is rather amazing.

Now that we have your attention, look for follow up articles with details on _

• Who can invest in a QF?
• What kind of money qualifies for a QF?
• What kind of projects are in an Opportunity Zone?
• What is the risk analysis for a QF?
• How does a QF compare with a 1031 Exchange?
• Where do I find a QF to invest in?

~ Jeff Harrington, Esq.

The good news is that, for purposes of a QF, what is considered “capital gains” is not just proceeds from the sale of real estate.  In fact, all of the following are qualified capital gains:In order to get the tax advantages available under the Opportunity Zone program, you have to invest “qualified capital gains.”  So, it is not just any kind of money that can be invested in a Qualified Fund (QF).  For example, if you have put away some cash from your regular salary or other compensation, that money will not qualify for the tax benefits because it is not “capital gains.”

• Sale of Real Estate
• Sale of stocks and bonds
• Sale of shares in a corporation
• Sale of a partnership interest
• Sale of cryptocurrency 
• Sale of REIT
• Sale of land
• Sale of machinery
• Sale of timber and other natural resources
• Sale of unharvested crops and livestock
• Gains from leaseholds (at least 1 year old)

So, as long as the funds you intend to invest can be defined as “capital gains,” you can invest in a QF and receive the very advantageous tax benefits of the Qualified Opportunity Zone program.  That is one significant advantage of a QF over the traditional 1031 exchange.

See our related articles for more on how to take advantage of the Qualified Opportunity Zone program:

• What are the benefits of a QF?
• Who can invest in a QF?
• What kind of projects are in an Opportunity Zone?
• What is the risk analysis for a QF?
• How does a QF compare with a 1031 Exchange?
• Where do I find a QF to invest in?

~ Jeff Harrington, Esq.

These QOZs were created to spur economic growth by extending generous tax incentives to investors who invest their qualified capital gains into Qualified Opportunity Funds (QOFs).  Ultimately, the federal program open to ALL investors.

First, be aware that the investor can be either an individual or an entity.  Many people wisely hold their investments in an LLC or trust (even REITs).  That is not a problem.  Also,  the investor, whether an individual or entity, does not have to be a US citizen or US resident.

Foreign nationals can also invest in a Qualified Fund (QF).

If you do your investing through an entity, you will likely want to use that same entity as the “investor” in the QF.  However, if you may not be required to do so.

The analysis turns on the question of “Who is the taxpayor?”

If the investment vehicle you use is a “pass-through” entity, such that you report the gains/losses on your personal return, then you personally are the “taxpayor.”  In that case, you have the option.  You can either make the investment in the QF with the same investment vehicle — usually an LLC or trust–or you can make the investment in your individual name.

By contrast, if your investment vehicle is taxed as a C-corp, then that entity is itself the “taxpayor.”  So, you should use that entity as the investor in the QF.

Caveat:  In order to get into the Opportunity Zone program, you have to invest in a qualified fund (QF).  These QFs are privately owned and managed, so some of them may impose certain restrictions.  One common restriction is that you be an “accredited investor,” as defined in the tax code.  To be clear, this is not a requirement imposed by the federal program itself.  But, you may find it is a criteria imposed by managers of certain QFs

This article addresses just one specific aspect of the Qualified Opportunity Zone program.  Be sure to follow these links in order to get additinal information:

• What are the benefits of a QF?
• What kind of money qualifies for a QF?
• What kind of projects are in an Opportunity Zone?
• What is the risk analysis for a QF?
• How does a QF compare with a 1031 Exchange?
• Where do I find a QF to invest in?

~ Jeff Harrington, Esq.

According to the IRS:

Opportunity Zones are an economic development tool that allows people to invest in distressed areas in the United States. Their purpose is to spur economic growth and job creation in low-income communities while providing tax benefits to investors.

The legislation passed with bipartisan support.  The Republicans liked the tax savings, while the Democrats liked the investment in under-developed neighborhoods.

Where are the Opportunity Zones?

Congress left it to individual states to determine what areas would be designated as an Opportunity Zone.  (See List of Designated Tracts)  There are some nice interactive mapping tools available online as well.

With some notable exceptions, you can expect opportunity zones to be neighborhoods traditionally considered “under-developed” or “disadvantaged.”

Projects Permitted by a Qualified Fund

Keep the purpose of the legislation in mind, you will understand why Qualified Funds (QFs) are not permitted to invest in just any kind of project.  Here are some of the guidelines.

New Construction

QFs are not allowed to buy a property and simply throw some paint on it.  The project must be brand new construction or a “substantial rehabilitation,” which means the QF put more money into the improving the property than it did to purchase the property.

 Examples of Qualifying Projects

Generally, QFs are expected to invest in projects that bring a benefit to the community by creating jobs or otherwise.  Some examples include the following:

• Affordable Housing
• Community Revitalization
• Economic Development
• Infrastructure Investment
• Mixed-use Development
• Multifamily Residential
• Renewable Energy Investment
• Single Family Residential
• Small Business Development
• Workforce Housing

Profitability

Naturally, an important aspect of the projects is profitability.  You can expect good QF managers to make strategic decisions when determining what projects to undertake in the Opportunity Zone.  After all, investors not only receive the capital gains from the projects, but they also participate in the yearly cash flow.

See our related articles for more on how to take advantage of the Qualified Opportunity Zone program:

• What are the benefits of a QF?
• Who can invest in a QF?
• What kind of money qualifies for a QF?
• What is the risk analysis for a QF?
• How does a QF compare with a 1031 Exchange?
• Where do I find a QF to invest in?

~ Jeff Harrington, Esq.

Commonalities

Both 1031 Exchanges and Opportunity Zone Funds, called “Qualified Funds” (QF), give investors incentives to reinvest their capital gains.  Specifically, both programs permit investors to defer paying tax on their capital gains.  That essentially lets an investor make money on Uncle Sam’s money for free.  Legislators use this effective technique to encourage real estate investment and development.  There are, however, important differences between 1031 Exchanges and QFs.

Tax Savings

1031 Exchange – Indefinite Deferral

As many people know, when an investor sells a piece of real estate, the investor has an opportunity to take the initial investment money plus the profit and reinvest both in another property of equal or greater value.  The investor can continue this practice indefinitely, until death, and continue to defer the taxes.  This feature lends itself to investors rolling their money into increasingly expensive pieces of property, thereby growing their asset.  That is very nice, but the investor will eventually have to “pay the piper.”

QF – Deferral plus Forgiveness

Like 1031 Exchanges, QFs also provide tax deferral on capital gains.  One important difference, however, is that the investor will not continue rolling the money over into new projects indefinitely in order to escape paying the capital gains tax.

Under the OZ program, the tax due on the money invested in the QF (Gain #1) will have to be paid in 2027.  So, the ride does come to an end with respect to Gain #1.

However, as for the capital gains made through investment in the QF (Gain #2), that will be tax free as long as you keep the money in the QF for at least 10 years.  So, for Gain #2, you can take your money out without triggering any tax liability at all.

Liquidity; Original Principal

Here is another potential advantage to the OZ program.

1031 Exchange – All or nothing

When you roll your money into a 1031 Exchange, you have to invest all the money you got back from the sale of the property–i.e. both the initial investment and the capital gains.   That is why you will generally buy increasingly expensive replacement properties.  Otherwise, you have to pay taxes on any money not reinvested.

QF – Free up original principal

With a QF, you are not required to roll over the original capital investment.  If you so choose, you could take that money out and just reinvest the capital gains.

1031 Example:  Investor purchased a home for $300,000 and, two years later, sold it for $500,000.  If Investor does a 1031 Exchange, with full tax deferral, he must purchase a replacement property worth $500,000 or more.

QF Example:  Investor purchased a home for $300,000 and, two years later, sold it for $500,000.  If Investor invests in a QF, he can hold onto the $300,000 without any tax reprecussions.  He only needs to put the $200,000 capital gain into the QF.  After 10 years, Investor’s $200,000 investment in the QF generates a gain of $400,000.  At this point, Investor can take all his money out of the QF — i.e. $600,000 — tax free.

Deadlines

1031 Exchange – 45 days & 180 days

With a 1031 Exchange, the rule is that the sale of Property A and the purchase of Property B must be parts of a single integrated transaction.  That is why it is called an “exchange.”

• You have 45 days from the date you sell Property A to identify a potential Property B.
• The exchange must be completed no later than 180 days after the sale of Property A or within 180 of the due date to file your taxes (with extensions), whichever comes first.

The second deadline is not too hard to meet, but the first one can cause some stress.

QF – 180 days

The basic rule is the capital gains must be placed in a QF within 180 days of the sale of the asset.

There are some exceptions, all of which provide additional time for the reinvestment.  For example, if the investor is a partnership, the individual partners have 180 days from the end of the tax year (December 31st) to place the capital gains in a QF.

Note:  There are special rules on the timing for reinvestment of 1231 gains.

Often, an investor that misses the 45-day deadline for a 1031 Exchange can salvage the tax planning by placing the money in a QF instead.   

Control of Funds

1031 Exchange – Qualified Intermediary

As you may have learned from our previous article here, one of the major pitfalls with a 1031 Exchange is that the funds from sale of Property A can never be in the possession of control of the investor prior to purchase of Property B.  That is why it is crucial to use a Qualified Intermediary.  Failing to do so can easily disqualify the entire transaction and lead to penalties.

QF – Relaxed Rule

By contrast, investors in a QF are not subject to any “control” restrictions.  As long as the capital gains from sale of Property A are placed in a QF within the relevant timeframe — which, at a minimum, is 180 days, the tax benefits will be preserved.  That gives investors the ability to use the money in the interim, if they so choose.

Miscellaneous Differences

In some ways, the programs are simply different.  For example, there is no “like-kind” requirement when investing in a QF since the transaction is not strictly an “exchange.”

Similarly, when investing in a QF, the funds can be any kind of capital gains or 1231 gains.  (Click here for a list of qualifying funds)    With a 1031 Exchange, of course, the only money that can be reinvested is the original principal and capital gains from Property A.  So, the Opportunity Zone program is much broader in this sense.

Lastly, a QF is likely to bring some measure of diversification to the investment.  Most QFs are large enough to hold multiple projects of differing types.  (Click here for examples of qualifying projects).  That aspect potentially reduces risk, as compared to a 1031 Exchange, where all the money from Property A must go into Property B.

Conclusion

Objectively speaking, the Opportunity Zone program does seem to have certain advantages over the traditional 1031 Exchange program.  But, that is not to say investment in a QF is for everyone.

For example, I have investor clients who enjoy the “hands on” aspect of developing one project, selling, and reinvesting in another.  1031 Exchanges are perfect for them because they remain in control of all their projects, and they enjoy the work.

For most other investors, though, the Opportunity Zone program is an absolute jewel.  And, unless Congress decides to extend the program, it will not be available for too much longer.  So, get in while you can.

Now that we have your attention, look for follow up articles with details on _

• What are the benefits of the Opportunity Zone program?
• Who can invest in a QF?
• What kind of money qualifies for a QF?
• What kind of projects are in an Opportunity Zone?
• What is the risk analysis for a QF?
• Where do I find a QF to invest in?

~ Jeff Harrington, Esq.

Under Section 1031 of the tax code, you can sell your property and reinvest some or all of the proceeds in another property without paying taxes on the reinvested money. Here is how.

 Who qualifies?

Anyone and anything.  Individuals, C corporations, S corporations, partnerships (general or limited), LLCs, trusts and any other taxpaying entity are entitled to defer taxes through a 1031 exchange.

Timing

The simplest thing is a simultaneous swap of one property for another. That can be tricky to arrange sometimes, though. What if you are ready to sell but not yet ready to buy?

The rule is the sale of Property A and purchase of Property B must be mutually dependent parts of an integrated transaction. If you are not doing a simultaneous sale-purchase, then you will typically use an exchange facilitator and an exchange agreement. Here are the highlights.

• You have 45 days from the date you sell Property A to identify a potential Property B. The identification must be in writing, signed by you, and delivered to the seller or a qualified intermediary.
• The exchange must be completed no later than 180 days after the sale of Property A or within 180 of the due date to file your taxes (with extensions), whichever comes first.

Like Kind

The “like kind” requirement can be a treatise by itself if you are considering exchanges of personal property. Luckily, this article is limited to real property, which is much simpler. Most real estate will be like-kind to other real estate. Quality or grade do not matter. So, for example, a residential rental house is like-kind even with a vacant lot.

One notable exception is you cannot replace US real property with foreign real property.

Receiving Cash

Be careful about taking control of the sale proceeds from the sale of Property A. That can make the entire transaction taxable even if you do go on to use the money to purchase Property B. You want the proceeds to be designated for reinvestment in Property B and not be available for any other purpose.  One way to avoid receipt of proceeds is to use a qualified intermediary to hold the proceeds until the exchange is complete.

Read Part II on 1031 Exchanges

~ Jeffrey Harrington, Esq.

Part I of this series was an overview of the whole “exchange” process. In Part II, the focus was on common pitfalls and the use of a Qualified Intermediary. Here we will review restrictions regarding the identity of the seller and purchaser.

Spoiler Alert: With very few exceptions, the identity of the seller of Property A and the purchaser of Property B has to be the same.

Naturally, there are many important aspects of a 1031 Exchange, all of which are deserving of attention. We are choosing, however, to focus on matching the seller and buyer because that issue is particularly relevant to investors.

It is very common for real estate investors to join forces with other parties in joint ventures. So, for example, Joe Investor has accrued some equity in his investment property—we will call it “Property A”—and he would like to use the money to purchase a more valuable property, which we will call “Property B.” However, Joe Investor either does not have enough cash to purchase Property B on his own, or would rather share the risk with someone else. Certainly, this is a very typical scenario.

Under normal circumstances, Joe Investor would go out and find a Jane Investor to go in with him on the purchase of Property B. Joe and Jane would likely form an LLC or a land trust to hold Property B, each having an ownership interest corresponding with the amount of his/her capital contribution. Here is the kicker.

If Joe Investor sells Property A, which was titled in his name, and buys Property B with a company or land trust, he destroys the 1031 Exchange and loses the ability to defer tax.

It does not matter that Joe used the money from Property A to buy Property B – even if he did properly use a qualified intermediary (as discussed in Part II). The tax payer that sells Property A has to be the same taxpayer that buys Property B. For investors, this is a rather unfortunate restriction and an important pitfall of which to be aware.

There is an exception, though it would not help Joe Investor in our example. If Joe held title to Property A as a single-member LLC—where Joe was the single member—then he would be allowed to discard the LLC and purchase Property B in his personal name without losing the tax deferral benefits. That exception does not provide Joe the ability to purchase Property B with a co-investor, though. To do that, we will need an additional step.

The tax code does not prohibit Joe Investor from selling Property A, purchasing Property B in his own name, and then transferring Property B to an LLC or trust, which is owned jointly with Jane Investor.

Now, if Joe and Jane do the exchange this way, Jane will be exposed until Property B is transferred to the LLC/trust.  Joe could double-cross Jane.¹

If Joe and Jane trust each other explicitly, that risk might be acceptable.

As an attorney, I never ceased to be amazed at how many of these deals go wrong. I probably have a skewed view of the business world because only the transactions that go wrong are brought to my office. Nonetheless, that is just not smart business.

The solution is for Joe and Jane to execute a joint venture agreement stipulating that, while Joe will be the titleholder, temporarily, Jane has an equitable interest in Property B.

Now, I know what you are thinking. What if both Joe and Jane want to use proceeds from the sale of their respective Property A-s to purchase Property B? Well . . . every problem has a solution. Call my office.

~ Jeff Harrington

Unemployment Benefits under CARES Act

First, understand that unemployment benefits are handled at the State level.  So, that means there will be some delay and inefficiency in getting from Point A (federal legislation) to Point B (actual checks in the mail), and there will be some differences from State-to-State.  Our firm is headquartered in Florida, so we will provide some additional detail for Florida businesses.  That said, here is basically what everyone can expect.  Request Consultation

Pandemic Unemployment Assistance

The CARES Act includes a Pandemic Unemployment Assistance program (“PUA”), which expands the definition of a “covered individual.”

Eligible Workers

• full and part time employees (W-2)
• self-employed
• independent contractors (including gig workers)
• religious workers (workers laid off from churches)
• workers who do not have sufficient work history to normally qualify under State law

Qualifying Criteria

Workers who cannot work due to any one of the following circumstances:

• diagnosed with COVID–19 or experiencing symptoms and is seeking diagnosis
• a member of a household where someone has been diagnosed with COVID-19
• provides care for a family member or a member of the household who has been diagnosed with COVID-19
• takes care of a child or other person in the household who is unable to attend school or daycare as a result of COVID-19
• cannot reach the workplace because of a quarantine or isolation order
• has been advised to self-quarantine due to COVID-19 concerns
• was scheduled to commence employment (i.e. does not currently have a job) but now cannot go in due to COVID-19
• has become the breadwinner or major supporter for a household because the former head of the household died as a result of COVID-19
• had to quit his or her job as a direct result of COVID-19
• cannot work because the place of employment is closed as a result of COVID-19 (telework not an option)

Available Benefits

Covered individuals get the amount they would normally receive under State unemployment law (maximum of $275/week in Florida), plus an additional $600 per week.

So, a Florida employee could potentially get $875/week or $3,500/month.

How long do benefits last?

As long as the unemployment is due to the Coronavirus, regular benefits can extend up to 39 weeks in most states. However, the extra $600 per week is only available through July 31, 2020.  Note: Florida only provides 12 weeks of unemployment benefits. So, in Florida, once the 12 weeks runs out, the worker will continue to get just the $600/week under PUA.  Request Consultation

What is “furlough”?

Furlough is an unpaid leave of absence.  So, technically, the workers still retain their positions, but they cease working and do not earn a salary.  The idea, of course, is that furloughed workers will one day return to their jobs.  Also, workers usually continue to receive their company benefits during the furlough.

By contrast, being terminated or laid-off is permanent.  If the worker comes back to the company after being terminated or laid-off, then that “return” is actually new employment.  All previous arrangements are open for renegotiation.  That may be beneficial for the company, or maybe not . . .

Usually, furlough is temporary and short-term.  Otherwise it would make more sense to both the company and the worker to just terminate the employment and move on.  However, there is no defined limitation on how long a furlough can last. So, under the current circumstances, where workers probably cannot get another job for as long as the Coronavirus crisis continues, it seems likely we will see unusually long furloughs.

Advantages to furlough?

Yes, probably.  For most business owners, telling workers they are “furloughed” is a lot easier than saying “terminated.”

Most importantly, furloughed workers are entitled to unemployment benefits, including the extra PUA money.  So, as a business owner or manager, you do not have to terminate workers in order for them to receive benefits.

Let me hasten to qualify this statement by saying that, normally, whether a furloughed worker can collect unemployment or not is determined at the State level. Under PUA, though, the federal government has extended benefits to all furloughed employees as long as the meet the criteria above.

As a business owner, you would probably prefer to bring back your staff out of a sense of loyalty, as well as the fact that they are already trained.  So, the furlough option may be one to carefully consider.  Request Consultation

Potential Drawbacks

Taxable Income

As it stands now, these PUA payments will be counted as income for tax purposes as well as for determining eligibility for some welfare programs, though not for Medicaid or Children’s Health Insurance.  This may be only a minimal concern, though, since nobody is going to get rich off of unemployment payments, even with the extra PUA money.

Unemployment Tax Liability

If you are wondering if your business is going to have to pay higher unemployment rates in order to compensate for the additional payments to employees, the answer is “maybe.”  The CARES Act does not address this issue, probably because unemployment is administered at the State level.  So, the answer could be different on a state-by-state basis.  It is still too early to provide much guidance in this regard.  And, as a practical matter, it probably will not affect your decision-making, especially given the CARE Act tax breaks for businesses.

Other Considerations

Immediate Availability.  The normal one-week waiting period is waived under the PUA. So, unemployed or furloughed workers can apply immediately for unemployment benefits.

This is important because we are still waiting for the Families First business loans to become available.  However, the paid leave requirements went into effect April 1, 2020.  So, for companies that are in real danger of running out of money, terminating or furloughing can be a stop-gap measure.

Short Term/Work Share Programs.  This might make sense to a lot of employers. The concept of Work-Sharing or Short-Term compensation is where the company does not have enough work to give someone a full-time position but does have some work to offer. The conundrum for some workers is that they face losing their unemployment benefits if they take on work. That creates a sort of all or nothing scenario for them. It can be a disincentive to taking on partial or temporary work.

This kind of perverse disincentive is resolved by States that allow such short-term/work-share without penalty. Florida does have a short-term/work-share program, which could be very useful for businesses that have not completely shut down but are significantly affected by the Covid-19 crisis.

Our firm plans to discuss this option on a client-by-client basis.  Request Consultation

Conclusion

So, now you have all the pieces of the puzzle and can put together a plan of action for your business: business loans, tax breaks, paid leave, and unemployment. We all want what is best for our employees and, presumably, helping the company survive the Coronavirus crisis is in the employees interest. They will understand that. Now, it is a numbers game.

Understanding the interplay between the available business loans, tax breaks, paid leave obligations and unemployment benefits is the whole game at this point.  You have to weigh your options and make the best choices you can for your business. 

April 1, 2020 is here, so it is time to make decisions.  Our firm is here to help.  Request Consultation

~ Jeff Harrington, Esq.