A good friend of mine, Dana Palmer, wrote an article published in this month’s Dallas Bar Association Headnotes. The article, titled “I don’t know what you do and it’s your fault” talks about the “elevator speech” or “magic statement”: that brief statement of your practice answering the question “so, what do you do” in a way that sticks with people.

I’ve been saying for quite some time now that I help entrepreneurs do the deals they want without the taxes they don’t. Dana cites this as a positive example in his article. Not everything I do fits into this statement, but the majority of it does, and that’s what is important. The key is, as Dana’s article’s title embodies, for people I meet to immediately know what I can help them with and what matters to refer to me, in a way that sticks in their mind.

Dana, thank you for not only validating my elevator pitch, but also putting it in front of the Dallas bar as a whole.

For the article, go to: http://www.dallasbar.org/content/i-don’t-know-what-you-do-and-it’s-your-fault

I am excited to announce that I have been accepted to the State Bar of Texas Tax Section inaugural class of the Leadership Academy. This is a great honor for me and I am flattered to have been selected.

More information on the Leadership Academy is available here.

Happy belated Thanksgiving. This time of year I start reminding people that it is time for year-end tax planning. Most small businesses and almost all individuals report on a calendar year basis, so it is important to tie up loose ends and do any proactive tax planning by December 31.

If you have done deals this year without considering the tax implications, you may still be able to correct the tax implications due to the doctrine of rescission. I have written about this before here.

For estate planning, while you do your Black Friday shopping for gifts, consider using your annual gift exclusion. Like your medical flex spending account, if you don’t use it by the end if the year, you loose it. But there are a number of ways to bend gifts to use this year’s exemption for gifts ultimately delivered later.

And don’t forget business personal property taxes, which most states (including Texas) base on the value of business use property on hand in a given state as of January 1.

On December 1, DAYL (the Dallas Association of Young Lawyers) will present its “New Firm Workshop Part One – Before You Open Your Doors.”  I’m excited to have been asked to participate in the panel discussion “Nuts and Bolts of Opening Your Doors (Office Infrastructure).”

If you’re starting your own law firm, curious what is involved in starting a law firm, newly licensed and without a job, or just need 4 hours of CLE including 1.25 hours of ethics credit, please register for the event.

You can find the registration form and more information about the event at http://www.dayl.com/pdf/ssfworkshop.pdf.

This past weekend, the Wall Street Journal published an article “In Real Estate, Simple Wins” by Jason Zweig.  That article convolved tenant-in-common (“TIC”) deals with the 1031 like-kind exchanges on which they are based. I wish to clarify the distinction.  But more importantly, I wish to address the article’s implication that the problem with the investment comes from the tax structure, not from the underlying investment.

Like-Kind Exchanges and TICs, Generally

Like-kind exchanges are a common way to tax structure real estate transactions. Normally, selling one investment or business use property to buy another would be a taxable event. Predominantly, these transactions are taxed at the 15% long-term capital gains rate on the gain over the life of the investment, although higher rates are possible (such as for recapture of excess depreciation). In a like-kind exchange, governed by Section 1031 of the Internal Revenue Code, one property is exchanged for another one similar enough to be considered “like-kind” to the original property. Under Section 1031, the gain on the property sold is not taxed.  Instead it is deferred until a taxable disposition of the replacement property.

By chaining together multiple like-kind exchanges, tax of investment gain can be deferred for decades or beyond. Because the definition of “like-kind” is quite broad in the context of real estate, the nature of the investment can change dramatically without taxes reducing the investment pool.  It is possible to structure a like-kind exchange in which some of the value is extracted through property which is not like-kind, such as other investments or cash.  In addition to moving between different single properties, it is possible to structure like-kind exchanges of multiple properties.  This allows diversification or consolidation of investment without incurring a tax cost. For example, the article discusses a theater exchanged for two separate apartment complexes.  These properties were all considered like-kind despite their difference in use and revenue stream.  Accordingly, the investors discussed in the article were ostensibly able to change both the nature and diversification of their investment without loss of investment pool to taxes.

It is also possible to structure a like-kind exchange so that the disposition of the old property and the acquisition of the new property are parts of separate transactions. These so-called “deferred” or “reverse” like-kind exchanges involve the use of a third-party “qualified intermediary” or an “exchange accommodation titleholder” respectively to handle the mechanics of the exchange in a way that still qualifies for tax deferral. As the article mentions, these indirect like-kind exchanges do involve strict deadlines. But I would argue with the article’s description of them as a “tight” schedule. The two key deadlines are that the property to be acquired must be identified within 45 days of the start of the exchange, and the exchange must be completed within 180 days. The consequence of failing to meet the deadlines is that the gain on the property sold is taxable, just as if the like-kind exchange had not been attempted.

Because like-kind exchanges provide a mechanism for rolling over investment from asset to asset, they do not alone allow the investor access to larger properties than they could otherwise obtain themselves. To do so, the assets of a group of investors are generally pooled to give the group collective access to a larger asset, on the premise that doing so will either be more profitable (such as through acquisition of property with a higher rate of return) or at least more efficient (such as through eliminating redundant overhead expenses such as back-office administration). When a group of investors gather to invest in a single piece of real estate, typically they form a partnership (or some other entity type taxed as a partnership). Investment in these entities is not, for purposes of a tax-deferred like-kind exchange an investment in real property. For example, while the theater discussed in the article was like-kind to an apartment complex, it would not be like-kind to an interest in a partnership holding that apartment complex.

This loss of tax deferral through like-kind exchange can be addressed through other tax deferral techniques, such as non-taxable contributions of real property which the partnership then uses to fund a like-kind exchange at the entity level. But later investors have a hard time participating in such deferral options unless new properties are to be acquired. And what is more, if an investor decides to leave this investment for another piece of real estate, he is similarly barred from a like-kind exchange. For the same reason that partnership interests can’t be acquired in a like-kind exchange, they cannot be disposed of in a like-kind exchange.

This is where tenant-in-common transactions come into play. Separate complete ownership of real property (said to be “held in fee simple” or to be a “fee simple estate in land”) is considered not only like-kind to other real estate held in fee simple, but it is also considered like-kind to real estate held in common with other owners (said to be “tenants-in-common” in the real estate). To be respected as ownership by tenants-in-common for tax purposes, there are certain requirements that must be met. For example, as the article mentions, there cannot be more than 35 investors. So, instead of going from owning one property to owning another, the couple discussed in the article went from owning a single property in fee simple to owning an interest in two separate apartment complexes as one of a series of tenants-in-common in each property. This way, individual investors in a given property preserve their ability to use like-kind exchanges to acquire (whether at the start or later in the life of the investment) and dispose of their interest in the property.  Another structure that similarly preserves like-kind nature of the collective investment but with different restrictions is the use of a specially structured Delaware statutory trust (often called a “DST”).

Like-Kind Exchanges and TICs are Not a Separate Class of Investment

This weekend’s Wall Street Journal article gives the impression that like-kind exchanges or a TIC deals are separate types of investment from the underlying investment asset.  This is not true.  Like-kind exchanges, TIC deals, and DSTs are tools to move between or manage investments in a tax conscious way, not investments themselves.  These techniques could also be used to maintain investment in art, in intellectual property, or in industrial machinery. And real estate investments like the one discussed in the article are, as the headlines from the past few years have reinforced in our minds, inherently risky.

The article comments that the apartments in question have not performed as expected, and have involved significant additional investment and headaches due to lawsuits and an on-site double homicide.But one wonders what would have happened to the former investment property, the theater. Theaters, like apartment complexes, often require infusions of capital if involved in lawsuits and generally suffer when attendance drops or when they are the scene of a violent crime. These are the risks of the underlying real estate investment and not unique to like-kind exchanges, TIC deals, or DSTs.

This is not to say that TIC deals are without complication.  Because the property is owned not by one investor but by many investors, they either must agree unanimously on decisions from the significant (e.g. whether to exchange one property for another) to the minute (e.g. whether to lease to a given tenant on given terms), or they must agree on a property manager to handle these decisions for them. Often it is the property managers that have coordinated the TIC deal in the first place. And yes, the property manager’s diligence and attention may not match up to what an investor would think of his own efforts were he managing the property directly. But again, this is not unique to like-kind exchanges or TIC deals.  This is the case anytime a land owner has a third-party manage his investment properties for him. Were the original investment property, the theater, placed under similar management would it not have similarly suffered?

This afternoon, I upgraded the Christopher Alan Cunningham PLLC website to better provide you with information about my practice, tax law developments, and opportunities for tax conscious transactional structuring.

On February 8, 2011, the IRS announced its 2011 Offshore Voluntary Disclosure Initiative (the “2011 OVDI”) for taxpayers with undisclosed or under-reported offshore accounts.  The terms of the 2011 OVDI are summarized in that announcement and documented in detail in a Frequently Asked Questions document posted to the IRS’s website.  The following is a summary of the 2011 OVDI, its terms, its benefits, and the process taxpayers wishing to participate need to follow.

New social acquaintances, hearing that I am a tax attorney, frequently comment that I must be extremely busy just before tax time.  I find it surprising that the news that the end of the year is actually much more important shocks so many of them.  However, for the majority of taxpayers, on top of everything else to think about at the end of the year, it is an important time for tax planning.  While it may seem like the end of the year is too late for “planning,” in reality there is usually still time to get what you want.