Tax Benefits of Repositioning Real Estate

Tax Professionals' Resource
February 4, 2013 — 1,369 views  
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In today’s depressed real estate market, it is important to take advantage of the downward trend. If you know how the system works, you can use a few strategies to get tax benefits and business opportunities. This type of repositioning of real estate can be very beneficial.

There is a transaction that has become rather popular, which involves a joint venture between a homebuilder (or a real estate developer) and an equity partner. This venture would operate through a limited liability company (LLC).

The equity partner invests in the venture and takes 50% voting interest in the LLC. The homebuilder makes a co-investment in the form of cash or other property. In exchange, the homebuilder takes back a small equity interest, 50% voting interest, the right to some annual management fees and, if financial targets are met, an increase in the percentage of profit-sharing he receives.

Once these contributions have been made, the LLC would buy depreciated property from the homebuilder. This repositioning of the property may translate to increase in tax benefits for the homebuilder if he is able to exploit beneficial business opportunities. 

Tax Refund

The homebuilder is able to deduct his losses on selling their depreciated property to the LLC, leading to a primary tax benefit. These tax losses could mean a tax refund for the homebuilder through repositioning real estate.

If the homebuilder reports taxable income for either of the two preceding tax years, they may become entitled to a refund of some or all taxes paid in those years. There has also been talk of this two-year carry-back period being extended to five years. This may well increase the likelihood and/or the amount of tax refund received.

Risks Involved

No venture is completely risk-free and the same is true for repositioning property. If the homebuilder wants to file for tax loss, they must avoid a number of potential tax pitfalls. For example, there are provisions in the Internal Revenue Code that bar taxpayers from realizing losses on sales to certain parties, including any LLC where the seller has ownership of 50% of investment.

Also, the homebuilder will have to avoid treasury regulations that consider sale transactions as leases. If the sale isn’t characterized as a taxable sale, it cannot be deducted for losses. If the parties involved do not structure the transaction to ensure that it complies with all the rules, it could lead to losses for the homebuilder.

Real Estate Opportunities

Repositioning real estate in this manner allows homebuilders to maintain control over their transferred property. If the market shows an upward trend in the future, the real estate can be repositioned through a LLC, and the homebuilder may be entitled to an increase in profit margins.

This way, the homebuilder can prevent competitors from acquiring and developing their real estate that they transferred to the LLC.

If correct protocols are followed, there are tax benefits as well as future property benefits to be gained from repositioning real estate.

Tax Professionals' Resource