1031 EXCHANGES & SALE- LEASEBACK TRANSACTIONS

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1 1031 EXCHANGES & SALE- LEASEBACK TRANSACTIONS MSCPA REAL ESTATE COMMITTEE Stan Wyrwicz Senior Managing Director Bob Miller Managing Director Mike O Mara Director NOVEMBER 21, 2013

2 DISCLAIMER Any information contained in this presentation is not intended to be legal, accounting, tax, investment or other professional advice. With respect to the content of this presentation, the authors do not make any expressed or implied warranty about the accuracy, completeness, or usefulness of any information, product, or process described herein. Always engage competent legal and tax advisors when considering any transaction.

3 AGENDA About Calkain Section I: IRC Section 1031, a brief overview What is a tax deferred (1031) exchange? Bene7its of a 1031 exchange Requirements for a 1031 exchange General guidelines for deferring gain 10 Steps for a 1031 exchange Why is a Quali7ied Intermediary (QI) needed? What is the role of the QI? Important deadlines and rules in a 1031 exchange Zero cash 7low exchanges Questions

4 AGENDA Section II: Sale- leaseback strategies What is a sale- leaseback? Sale- leaseback market Why Calkain? Reasons companies do sale- leasebacks Reasons private equity 7irms do sale- leasebacks Reasons investors buy sale- leasebacks Is your client selling their company, too? Questions Calkain s Boston Team

5 ABOUT CALKAIN Leader in brokering the sale of net leased real estate the principal asset replacement used in 1031 exchanges Established in 2005 Over $8 billion in sales National commercial real estate services 7irm, focusing on net lease investments. Largest number of net lease investment brokers on East Coast Leader in advising its corporate clients in single tenant and portfolio sale- leasebacks Boston of7ice 10 Post Of7ice Square Headquarters Reston, Virginia (Washington, D.C. suburb)

6 WHAT IS A TAX DEFERRED (1031) EXCHANGE? A 1031 exchange refers to the IRC section that provides for the tax deferred exchange of real estate. A tax deferred exchange is a method by which a property owner trades one or more relinquished properties for one or more replacement properties of like- kind, while deferring the payment of federal income taxes and some state taxes on the transaction. The like- kind exchange under Section 1031 is tax deferred, not tax free. When the replacement property is ultimately sold (not as a part of another exchange), the original deferred gain, plus any additional gain realized since the purchase of the replacement property, is subject to tax.

7 BENEFITS OF 1031 EXCHANGE A section 1031 exchange is a technique available to postpone or potentially eliminate taxes due on the sale of qualifying real estate. Tax savings allow for ef7icient leveraging and upsizing of investments exchanges allow for diversi7ication or consolidation of assets. Different types of real estate can be exchanged (eg.vacant land exchanged for an apartment building.) Improved cash 7low by deferring tax payments. Zero cash 7low transactions provide minimal cash out7low.

8 REQUIREMENTS OF A 1031 EXCHANGE Qualifying Property Certain types of property are speci7ically excluded from 1031 treatment: property held primarily for sale; stocks; interests in a partnership; certi7icates of trusts or bene7icial interest. Proper Purpose Both the relinquished property and replacement property must be held for productive use in a trade or business or for investment. Exchange Requirement The relinquished property must be exchanged for other property, rather than sold for cash and using the proceeds to buy the replacement property.

9 GENERAL GUIDELINES FOR DEFERRING GAIN The value of the replacement property must be equal to or greater than the value of the relinquished property. The equity in the replacement property must be equal to or greater than the equity in the relinquished property. The debt on the replacement property must be equal to or greater than the debt on the relinquished property. All the net proceeds from the sale of the relinquished property must be used to acquire the replacement property.

10 10 STEPS FOR A 1031 EXCHANGE Owner enters into sales contract to sell property (relinquished property). Owner enters into an Exchange Agreement with a Quali7ied Intermediary (QI). Owner assigns sales contract to sell relinquished property to QI. Owner conveys title of relinquished property directly to purchaser at closing. Net sales and proceeds are sent to QI at closing.

11 10 STEPS FOR A 1031 EXCHANGE Owner identi7ies replacement property within 45 days Owner contracts to purchase replacement property. Owner assigns purchase contract to buy replacement property to QI. Closing of the replacement property occurs within 180 days. QI purchases replacement property with exchange funds from the sale of the relinquished property and directs the seller to convey.

12 WHY IS A QUALIFIED INTERMEDIARY (QI) NEEDED? The taxpayer cannot receive the sales proceeds or take constructive receipt of the funds. The use of a QI is a safe harbor established by the Treasury Regulations. The sale proceeds go directly to the QI, who holds them until they are needed to acquire the replacement property. The QI then delivers the funds directly to the closing agent. QI can be engaged after the sales contract is signed but must be engaged prior to closing of relinquished property.

13 WHAT IS THE ROLE OF THE QI? Provide initial and ongoing consultation on exchange strategies, options and solutions. Prepare all 1031 exchange documents including the Exchange Agreement, Assignment of Rights, and Notice of Assignments. Open a segregated escrow account for every exchange with 100% guaranty of funds through a combination of FDIC and other coverage. Work closely with Calkain as well as the owner s tax and legal advisors to complete the exchange. NOTE: Calkain is not a QI. We work with numerous QI s.

14 IMPORTANT DEADLINES AND RULES IN A 1031 EXCHANGE 45 days after sale of relinquished property to identify potential replacement properties in writing, signed by taxpayer, delivered to a QI. 3 Property Rule: Up to 3 properties without regard to their value. 200% Rule: Any number of properties can be identi7ied but their total value cannot exceed 200% of the relinquished property. 95% Rule: Any number of properties can be identi7ied but the taxpayer must acquire properties with a FMV of at least 95% of all identi7ied properties. Transfer must be completed within 180 days of transfer of relinquished property (or the date of the Federal return, if earlier.)

15 ZERO CASH FLOW EXCHANGES Zeroes are highly leveraged properties, usually 88% plus, with credit rated tenants (CVS, Walgreens, etc.), and all rental income dedicated toward debt service, thus producing zero cash 7low for the property owner. When utilized in a section 1031 exchange, a Zero is a unique form of replacement property which, under certain circumstances, enables the property owner to defer the taxes resulting from the transfer of a distressed and/or highly leveraged relinquished property. Equity priced as a % of the debt. Permits highly leveraged owner to live for another day.

16 QUESTIONS C O M PA N I E S

17 WHAT IS A SALE- LEASEBACK? A company sells real estate that it owns and occupies to an Investor and leases it back on a long- term basis. Monetizes unrealized value of the property s built- up equity It raises inexpensive capital for the company to re- deploy to more productive uses. It is an equity transaction, the sale of a corporate asset It s not entirely about the real estate, it s about the company s ability to pay the rent for 10 to 40 years. Accounting rules are changing, operating lease treatment will likely go away in the future.

18 SALE- LEASEBACK MARKET Sale- Leasebacks are pervasive Fortune 100 companies Family owned businesses Large publicly- held, credit rated companies Underwritten and distributed like corporate bonds Wall Street competes for the businesses and prices them similarly to corporate bonds Middle- market companies Calkain s specialty Not rated Closely held Often some level of 7inancial strain

19 WHY CALKAIN? Leader in advising and structuring sale- leasebacks Have closed over $1.7 billion of closed transactions. Stan Wyrwicz and Bob Miller lead nationwide program from Boston Technical knowledge and expertise to structure complex transactions Strategically located of7ices Extensive contact list of principals and advisors Download Sale- Leaseback Strategies Maximizing Values

20 REASONS DO SALE- LEASEBACKS Raise working capital Pay- off expensive junior debt Buy or build a new building Retire a parent to Florida Acquire another company Buy out a partner Pay unfunded pension liabilities Reinvest proceeds to higher equity returns of Company s core business

21 REASONS PRIVATE EQUITY FIRMS DO Return capital to LPs Increase yields, reduce risk Arbitrage SALE- LEASEBACKS Real estate ROIs are relatively low More buyers can afford to acquire company without its real estate

22 REASONS INVESTORS BUY SALE- LEASEBACKS High yield returns with security of real estate Passive- no operating responsibilities Unattractiveness of investment alternatives Tax advantages of owning real estate Mortgage 7inancing readily available

23 IS YOUR CLIENT SELLING THEIR COMPANY, TOO? The total net proceeds from 2 transactions- the sale of the real estate, then the sale of the Company, exceed the net proceeds from a single transaction in which the real estate is sold as part of the Company Commercial real estate usually sells at about twice the multiples of cash 7low than so companies Middle- market companies typically sell at 4 to 6 times the EBITDA, whereas their real estate sells for its net operating income (NOI)capitalized at 7% to 10%, which is the same as multiples of 14 to 10 times NOI.

24 QUESTIONS C O M PA N I E S

25 CALKAIN S BOSTON TEAM Calkain Companies 10 Post Of7ice Square Suite 1300 Boston, MA Stan Wyrwicz, Senior Managing Director (617) swyrwicz@calkain.com Bob Miller, Managing Director, Corporate Sale- Leasebacks (617) rmiller@calkain.com Mike O Mara, Director (617) momara@calkain.com