LIKE-KIND REPLACEMENT PROPERTY IN A DEPRESSED MARKET

Transcription

1 LIKE-KIND REPLACEMENT PROPERTY IN A DEPRESSED MARKET A Presentation for the ABA Tax Section Sales, Exchanges & Basis Committee by Todd D. Keator, Thompson & Knight LLP, Dallas, TX Max A. Hansen, American Equity Exchange, Inc., Dillon, MT Oil & Gas Interests as Replacement Property Qualifying Interests Recapture Sale vs. Lease Tax Partnerships

2 Qualifying Interests Fee Interest in Minerals Working Interest Royalty (including overriding royalties) Net Profits Interest Not Production Payments Recapture Recapture generally rolls over in 1031 Exceptions: Section 1254 property for non-section 1254 property (and vice versa) Developed property for undeveloped property?

3 Sale vs. Lease 1031 requires a sale, not a lease. Pembroke v. Helvering, 70 F.2d 850 (D.C. Cir. 1934); Crooks v. Comm r, 92 T.C. 816 (1989). Trap: Retained royalty converts a sale into a lease for federal tax purposes. Example: X, the owner of a working interest, sells the working interest to B in return for $100 cash and retains an overriding royalty. The transaction is a sublease for federal income tax purposes, rather than a sale cannot apply. Alternatively, suppose X, the owner of the working interest, sells 90% of the working interest to Y and retains 10% of the working interest. X has sold (rather than leased) the 90% interest because X retains no continuing non-operating interest in the property sold. Sale vs. Lease, cont d Potential Solutions: Retain part of working interest, not a royalty (a different business deal). Carve-off royalty to separate taxpayer prior to negotiations with buyer (requires non-tax business purpose to avoid step transaction challenge). Typical business purposes: minimize state tax (e.g., TX margin tax); ability to issue profits interests tied solely to royalties; ability to raise money from tax-exempt investors; isolate liabilities. For producing properties, re-write royalty not to be a royalty (e.g., use a term shorter than the expected life of the burdened properties).

4 Tax Partnerships Jointly operated oil & gas properties generally constitute a tax partnership. Must elect out under 761(a) for 1031 to apply. All members must consent (a practical problem). Election may be formal (blank Form 1065) or deemed (evidenced by the intent of the parties, e.g., a written agreement). What about TIC Properties? Unsophisticated investors and Rev. Proc CMBS Loan Servicers not your friendly neighborhood bankers! Where are all the good property managers? When the business projections go south Hidden costs & bankruptcy

5 Future TIC Investment Debt? -Thanks but no thanks Minimize the co-owners What is the role of the Sponsor? Strength of the Master Lessee Need for large capital improvements Is it a good piece of real estate? Are DST s the answer? Rev. Ruling approval of the structure Restrictions No future contributions Limitations on additional capital contributions Limitations on renegotiating existing loans Mandatory cash distributions

6 Are DST s the answer?, cont d Investor Benefits Easier financing only one Borrower No need for separate SPE s Less chance of holdout votes since beneficial interest (BI) owner is not allowed vote DST is borrower so qualification of separate investors is not needed More investors means smaller minimum investments DST BI qualifies for tax free exchange Are DST s the answer?, cont d Investor Caveats Sponsor is typically the Trustee/Master Lessee of the Trust Passive investment Investor s only rights are to receive distributions Still subject to vacancies, economic downturns and loan defaults Not realistic if big capital improvements needed

7 Acquisition of Wind Rights What does state law say about wind rights? Next level of issues Definition of interests and payments received What additional easements are needed What are the benefits of ownership? What About Agricultural Property? Ag property values have held more solidly than other property classes Ag property with recreational attributes Ag properties offer triple revenue source and other benefits Ag property values have held more solidly than other property classes Oil, gas and minerals Timber Wind generation Conservation easements Water sales or leasing Depreciation Lease income Crop subsidy payments Lessened opportunities for drive by shootings

8 Busting a 1031 Exchange 1031 is mandatory if it applies. See Redwing Carriers, Inc. v. Tomlinson, 399 F.2d 652 (5 th Cir. 1968). Potential methods to bust a 1031 exchange: Different taxpayer acquires replacement property. Structure as separate sale and purchase transactions, instead of an exchange. Taxpayer should touch the cash. Consolidated groups may trigger 311(b) gain. Thank You For Attending Today s Presentation