Page 506 - TaxAdviser_2022

TAX CLINIC

With the desire for greater diversi-
The stand-alone real estate partnership fication in real estate holdings, stand-
alone real estate partnerships are moving
entity should avoid giving its partners cash in toward contributing their property, in
addition to a partnership interest in either the exchange for a partnership interest, to
a real estate fund or an UPREIT that
real estate fund or the UPREIT to prevent a holds multiple real estate properties.
disguised sale on the qualified liabilities. Most often, the property contributed is
encumbered by debt. In this case, care-
ful attention is needed to evaluate the
the property to a partnership but partners cash in addition to a partner- liability to determine whether it is con-
that was incurred by the partner ship interest in either the real estate fund sidered qualified or nonqualified. Also,
within the two-year period previously or the UPREIT to prevent a disguised the partnership should avoid providing
mentioned; sale on the qualified liabilities. the contributing partner additional
■ A liability that is allocable under the Moreover, to further help avoid con- consideration on top of a partnership
rules of Temp. Regs. Sec. 1.163-8T sideration of a qualified liability as non- interest in the new partnership entity.
(“tracing rules”) to capital expendi- qualified, the partner can make a capital These measures will help prevent the
tures (as described under Regs. Sec. contribution to the partnership prior partnership restructuring transaction
1.707-4(d)(5)) with respect to the to the restructure partnership transac- from being deemed a disguised sale.
property; tion’s taking effect. This will reduce the From Brenda Graat, CPA, MBA,
■ A liability that was incurred in the amount of consideration the partner is Milwaukee
ordinary course of the trade or busi- deemed to have received.
ness in which property transferred Lastly, four exceptions can alleviate Target capital account
to the partnership was used or held, the impact of a disguised sale when a allocations in 11 easy steps
but only if all the material assets partner receives cash or other consid- The purpose of this item is very simple:
related to the trade or business are eration from the partnership, even if To provide tax practitioners with a step-
transferred to the partnership; and the disguised sale is made within two by-step guide they can use and replicate
■ A liability not incurred in anticipa- years of a transfer by a partner to the in their practice to successfully deal with
tion of the transfer of the property to partnership. These exceptions include the inherent complexities they encounter
a partnership but that was incurred in reasonable guaranteed payments for when working with partnership alloca-
connection with a trade or business capital, reasonable preferred returns, tions under a target capital structured
in which property transferred to operating cash flow distributions, operating agreement. Although this
the partnership was used or held, and reimbursements for preforma- item does not break any new ground
but only if all the material assets tion expenditures. per se, it provides something many tax
related to that trade or business are For real estate partnership restructure practitioners struggle with: a consistent
transferred to the partnership. transactions, most often, the exception process for ensuring correct income/
If any consideration is given to the for preformation capital expenditures loss allocations. In the age of centralized
partner as part of the restructure trans- is used. Such expenditures can include partnership audit regime exam implica-
action, a portion of the qualified liability costs incurred to acquire, construct, or tions and exit transaction due-diligence
can also be regarded as consideration. improve land, buildings, and equipment. examinations, tax practitioners need
This would be calculated only to the What qualifies for this exception is the more than ever to implement procedures
extent of the lesser of: amount incurred during the two-year that avoid allocation process errors.
■ The amount of consideration if the period before the transfer by the partner During the past decade, the target
liability were not a qualified liability; to the partnership, limited to 20% of the capital allocation structure has clearly
or fair market value (FMV) of such prop- become the most prominent structure
■ The amount obtained by multiplying erty at the time of the transfer. The 20% used in the process of drafting a partner-
the amount of the qualified liability limitation does not apply if the FMV ship operating agreement. This structure
by the partner’s net equity percentage does not exceed 120% of the adjusted allows attorneys to more easily draft the
with respect to that property. basis of the property at the time of the agreement and enhances limited liability
As such, the stand-alone real estate transfer. This is applied on a property- company (LLC) owners’ certainty in
partnership entity should avoid giving its by-property basis. their understanding of the ultimate cash

20 October 2022 The Tax Adviser