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Tax advice on a deal I am about to do

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Legend
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Posted: #1
I live on an island in coastal Georgia.  For about three eyars, I have been working on acquiring "some acreage" here on the island which is very difficult to do.  Finally, after all the hard work, my partners and I are set to close on the deal next month.  It involves roughly 16 acres, which we will develop into about 50-55 lots (7000-8500 sq. feet on average).  The lots will list for $185,000-$225,000 initially as some are on the golf course or a small lake.  The average lot on the island currently goes for $180k-$1mm+.  We are serving a nitch for people that want to buy a lot and build a home and still be in under roughly $600k. 
 
In running our numbers, we are figuring a 24-30 month absorption rate.  Our focus is paying down the note (roughly $6mm) first, then we should all be left with 4-5 lots free and clear.
 
That's where I need some feedback.  I assume that since I will be considered a "developer" now rather than an individual real estate investor that my tax ramifications will be quite different than what I am used to buying and flipping a lot, condo or fixer-upper.  So my questions, in no particular order are as follows:
 
-Is a 1031 exchange no longer an option if I am a developer?
-How long and how much can I defer the income from the lot sales?
-Does anyone have experience buying into real estate that has a tax credit associated with it?
-Are there other strrategies out there for minimizing my tax exposure?
 
We should each make $700k-$1mm when all is said and done based on there being five partners and depending on if we build some spec. houses later when the market here picks back up some. 
 
Any and all advice is appreciated.
 
BTW, the tax credit I refer to in one of my questions has to do with about a ten acre lot in a "conservatory" type development where when I buy the ten acre lot, I also get deeded some of the common area, which I then turn around and donate to the state of Georgia.  The ten acre lot is in a spot on the mainland so it's much cheaper than island real estate.  I can buy it for $225k and I would get about $200k in additional tax credit.. Sounds great but I have no experience with something like that!
 
Covers Linesmen
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Posted: #2
ACC,

First thing is you need a good accountant, especially for the state tax credit issue..I dont live in your state and though it makes sense what you say, are you SURE you are turning over the common area to the state and not the HOA? If it is common area to the development, I MIGHT think it is owned by the HOA (if you are using an HOA).

Here are a few of my thoughts to your questions.

First off, these are great questions!

The 1031 issue depends on how you are structuring the deal, are you using an LLC? Are you a direct owner of the said property or just a partner in the venture? Even as a developer I am sure you can use an LLC as your entity..

I found this info and it might help-

If I am an owner of investment property in conjunction with others, may I exchange only my partial interest in the property?

Yes you may. Partial interests qualify for exchanging within the scope of Section 1031 of the Internal Revenue Code. However, if your interest is not in the property but an interest in the partnership which owns the property, your exchange would not qualify. This is because partnership interests are excluded from Section 1031. But don't be confused! If the entire partnership desired to stay together and exchange their property for a replacement, that would qualify.

Another caveat, those individuals or groups owning partnership interests who desire to complete an exchange, and have for tax purposes, made an election under IRC Section 761(a) can qualify for deferred gain treatment under Section 1031. This can be a tricky issue! See elsewhere in this publication for more information. Then, only undertake this election with proper tax counsel and only with the election by all partners!

Depending on your structure again, the tax deferral issue might be different. If you are using an LLC, I imagine since you are dealing with a three year horizon and you will realize revenue along the way, you will probably file quarterly taxes and need to do estimated taxes to avoid penalties and audits. If you are using a partnership I am not positive.

There are MANY strategies to minimize exposure..one would be trying to utlilize a 1031 exchange as you go along..that only passes the gains to your next property of course and doesnt eliminate them..and a good tax accountant will have more ideas.

I would spend the money and get a GREAT real estate tax accountant..someone who deals with property development, you should be easily able to find such a person anywhere in the country.




 
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Posted: #3
developers do 1031 exchanges all the time
 
Banned
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Posted: #4
ACC....I think there is a tenents in common clause in the 1031 exchange. There's a local radio talk show that airs monday thru friday from 11am to noon on local am740, but it's available online. Personally, I think the host, Andy Costa, is a schmuck when it comes to stocks, but lately he's been talking alot about the 1031 exchange as it relates to tenents in common with commercial property. Might be worth a listen. The website is wsbrradio.com and there's a listen live link in the upper right portion of the screen. Good luck.
 
Legend
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Posted: #5
Thanks for the feedback guys.  I am actually involved in 1031 exchanges as an advisor fairly often.  I do have a CPA but as time has gone by, and as I have gotten more involved in real estate ventures, my confidence in his knowledge and crativity has waned.  This will be the largest thing I have ever been involved in by far so I think maybe I need to shop for a new CPA.
 
As for the tax credit Wallstreet, I do know that you are right about these common areas typically being turned over to HOA's.  In fact, we have common areas in my subdivision and that's what was done here.  I also think in this situation, the State of Georgia will accept these "conservation easement" type pieces and then the land is appraised for the tax credit value. 
 
My biggest question really centers around HOW to go from the LLC that will take down the property next month and then develop it......to getting my share of the deal into my name as quickly as possible to start the "long term capital gains clock" so to speak."
 
I still have a small ($20k or so) los carryover from 2000-2001 that can be used to offset some of the gain.
 
I enjoy many aspects of Covers but this is by far the best forum on the site.  Thanks for the feedback guys! 
 
Legend
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Posted: #6
Engineer delivered the preliminary plat yesterday.  It's looking like 52 lots.
 
I'd like to make this sort of an ongoing thread if people have interest as we can all experience the sure-to-come highs and lows of the project once underway.
 
Our next BIG issue is that of the 16 acres, 3.85 of the acreage is being considered a possible isolated wetland.  Our wetlands consultant will be filing what's called a JD (jurisdictional determination) next week with the Corp.  After a major Supreme Court ruling and 5-4 vote last year, the Corp has had to start backing off from "wetlands" that are islolated and not really connected to a naturally occuring waterway, marsh, etc. 
 
It is our consultants opinion that we have a very good chnace of recovering all of the 3.85 acres because our "wetland" was created by years of the property owners selling dirt for fill to help pay their taxes.  As a result over 40 years, the area is lower, water has been held their for long periods of time.  The follage (sp?), frogs, etc. have made it a wetlands like habitat over time but it's technically not a true wetland.  There is a ditch that runs out of it, eventually to the marsh almost a half mile away that is almost always bone dry.
 
When the JD gets to Washington and is reviewed, we have a good shot at getting that land back......which means 8-10 additonal lots that we are not counting on for free!  8-10 lots at $185k-$225k really sweetens the pot.  We will obviously be waiting with baited breath but it's our CONTROLLING government we are talking about here so who the hell knows how it will break.
 
Covers Linesmen
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Posted: #7
I look forward to this "in game" thread..very interesting.

So you have/had a CPA, well that definately helps your ordeal, I have a bach in accounting but never did get the CPA..

As for the long term cap gains, that is a VERY interesting situation since if you are in an LLC now in ownership as a group, the LLC only distributes the overall gains and losses and cannot carryover unless the profit isnt realized in that year. I am sure that makes sense to you, but the "profit books" are wiped every year and unlike a C Corp, there cannot be any holding of gains.

I am guessing here, but if the group is in an LLC than the only thing that is distributed is the overall gains and losses, so you might NOT be able to do a 1031 exchange if the property is held by multiple individuals in the LLC.

Was doing a little reading around today and it is a complex scenario..but most of what I read is the original owner of the property, in this case if it is an LLC has to perform the exchange..

My thoughts is if everyone in this development group are individuals and in one LLC, then 1031s are going to be tough unless certain properties are given to specific individuals in ownership...

As for the long term cap gains, profits from an LLC go at the individuals tax rate..I dont think it matters long or short term, they are netted, at least that is how my LLC has worked over the years..

Just rambling here of course, I hope your wetlands issue works in your favor. After hearing the background I have to think it will work out as you expect..
 
Legend
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Posted: #8
Update:
 
We are down to two bank choices.  One is a local community bank, one is a community bank from the Augusta, ga. area that has been very aggressive trying to break into the coastal Georgia market.  BB&T's beaucracy has virtually elminated them from the running.......I love our local Prez at BB&T but his hands are completely tied on a deal this size so he has to go through MANY layers (and eyes) to get an approval and they are very demanding.  It's their way it appears or no way...so we will thank them for their time and move on.
 
Here is the offer on the table right now, with the other bank's offer to be finalized today/tomorrow.  I think you might be shocked at how aggressive this offer is from "Bank A" if you know much about A & D lending:
 
Rate:  Prime (yes, Prime!)
$6,150,000 (80% of the discounted appraisal value)
80/20 lot release
$400k in additional collateral (paper or cash so we are throwing up some condos we own)
24 months interest-only
quarter point loan fee (good, huh???)
 
More later, gotta run to a meeting.........
 
Covers Linesmen
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Posted: #9
that 1/4 pt fee seems very very steep, plus you are taking a fair ammt of risk off the table with discounted appraisal and the collateral.

Prime isnt BAD, but I guess on a land deal it is probably good.

I wonder if you could get going and then get better terms once you are in production and pay off the higher variable rate.

Thanks for the update.
 
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Posted: #10
wsc... 1/4 pt loan fee for this type of transacation is an absolute home run.  I am completely shocked at that.  the fact that it is even less than a point blows my mind. 
 
with prime at 8.25%, this represents a spread of 245 bps over LIBOR, the usually development/land index for a floating rate transaction of this type.  This is another great deal point for a non-institutional borrower.  Risky land deals are priced at LIBOR + 300 bps and more very frequently
 
I'm also surprised they are doing an 80/20 lot release, especially because you are not an IRR based investor.  Seeing cash from the first sale is very important to a developer that has investor return thresholds to reach before sharing in the profits.  but since you are straight profit driven here (as in $100K today versus $100K in a month makes very little difference to you), i am surprised that the bank didn't ask for all proceeds from lot sales to go to pay down the balance before the investors get a dime. 
 
here are a couple questions i have... how are the debt service payments going to be made?  have you structured an interest shortfall reserve?  if so, where is the money coming from and are you offering credit support specifically for that (the 400k support)?  The other thing you need to be aware of is what happens after 24 months?  do you have extension options?  what if the sales are slower than expected, will you have enough in reserve to make your debt service payments? 
 
Covers Linesmen
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Posted: #11
Gunners,

They might have some high net worth investors and people who are large in the community and a good history with development..maybe ACC can elaborate.

Congrats on the great terms...
 
Legend
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Posted: #12
Great questions guys.
 
The total loan amount is $6,150,000; land acquisition is right at $4mm; infstructure is approximately $800k (2100 linear feet at $325/foot+ clearing, mucking, etc), entrance, landscaping, common areas $75k; closing costs $60k; engineering $60k; the rest is esentially carry built in to the deal.  Yes, it leaves us over $1mm for carry.  We will be able to draw that monthly to service the debt.  That's not an assumption but instead has been clearly discussed.
 
On the lot release, the 80/20 is based on a minimum sales price of $180k retail.  The lots will range form approximately $180k-$225k.  If we sell a builder a few lots for less than the $180k each,  we may have to go to a little higher release but we don't plan on doing that with too many in the beginning. 
 
The $400k we are putting up is in equity in two condos here on St. Simons.  They will release that collateral all together after we have sold 20 lots (also a great deal!).
 
The loan fee was never even countered on by us as we felt it ot be very fair and chose to focus our negotiating on more importnant items.  They originally wanted $500k in additional collateral so we got that down $100k.
 
The rate is very, very competetive in this environement.  The best two other banks came up with was P+.5.  
 
I want to point out that we are doing this deal in an area that is VERY unique.  St. Simons Island has VERY LITTLE raw land left other than what the Sea Island Company owns.  That land they won is being developed into 3-5+ acre lots selling for $1.5-$2mm EACH so that's a totally different ballgame.  To assmeble 16 acres on this island which is roughly 2 miles wide by 16 miles long is VERY unique.  Couple that with the fact that it's zoned R6 (6000 sq ft. minimum lot size) and a price point of $180-$225k and you have a product that is in high demand....even in this market.  The coastal areas of Georgia have held up very well in the slowdown nationally.  Becuase we are holding a commodity that is very rare here, we are not in the same situation as other areas.  Suffice it to say that in Brunswick, Georgia, five miles back on the mainland from St. Simons Island, lots sell for $30k and there are 6000 of them set to come on line in the next five years.  It's night and day.
 
As for our group, there are five of us.  I am 36, the rest of our group is all 50 years old +.  I am the weak link financially though I like to think I have done very well compared to the average 36 year old!  These other guys are all worth $2.5-$3.8mm net each.  A solid group yes but no superstars financially by any stretch.
 
Legend
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Posted: #13
In addition, on our preliminary plat, there are two lots that we are not going to include in the 50 S/D lots at least in the beginning.  The bank has allowed us to "exclude" those form what they will take and sell them off separately......we are talking to a few builders about taking those off our hands at some point at $135k each ( a deal for a builder that can afford to  bank a few lots) and we will put that additional $270k in the bank as an extra cushion.  These two separate lots will come into play if and when we get the wetland answer as we could tie them into a Phase Two.
 
Wetlands update:
 
The JD (jurisdictional determination) has been filed.  We should know within a couple of weeks who it has been assigned to in the Savannah office for the Corps.
 
Legend
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Posted: #14
Gunners-
 
Funny you said that about the loan fee.  I was in the bank yesterday where one of my partner's works.  His boss, the regional manager of that bank came up to me and congratulated me on the deal we had struck with our bank.  My partenr had shown him the commitment letter Friday.
 
His words were " that's a dumb assed deal".  I asked what he meant.  He said "not for you guys but what the hell kind of bank throws those terms out there, then doesn't even charge a point at leats to make ot worht their time????"  Then he commented on them giving the money away on top of that at Prime! 
 
I just smiled and told him that he should only hope that they don't decide they want to get in our market for real!!!!
 
 
 
Legend
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Posted: #15
By the way, we met with " Bank B" today just to get their final offer.  It was not too far off and if given no other options, we would have had to take this deal and move on. P+.5; .5% loan fee; $5,850,000 loan amount; $800k in additional collateral and it had to be mostly cash.......we thanked them for their time and effort and promptly went back to my office to sign the Bank A commitment letter.
 
Legend
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Posted: #16
By the way, we met with " Bank B" today just to get their final offer.  It was not too far off and if given no other options, we would have had to take this deal and move on. P+.5; .5% loan fee; $5,850,000 loan amount; $800k in additional collateral and it had to be mostly cash.......we thanked them for their time and effort and promptly went back to my office to sign the Bank A commitment letter.
 
Legend
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Posted: #17
By the way, we met with " Bank B" today just to get their final offer.  It was not too far off and if given no other options, we would have had to take this deal and move on. P+.5; .5% loan fee; $5,850,000 loan amount; $800k in additional collateral and it had to be mostly cash.......we thanked them for their time and effort and promptly went back to my office to sign the Bank A commitment letter.
 
Legend
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Posted: #18
SORRY for the multiple posts on the same subject!!!
 
My browser locked up and I clicked sumbit multiple times evidently!
 
Sorry.
 
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Posted: #19
Accventures
 
Congrats on your deal. I definitely can not offer you any help in the accounting and financial side like Gunners and WSC, but I do know the area that you are talking about very well. I have spent many summers vacationing at Sea Island with my family growing up and know it is truly a beautiful place. Gl with your investment.
 
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Posted: #20
great work ACC.  now how about keeping one of those lots for "Covers.com Getaways"??
 
let me know when you are working on your next one.  I work for this company and we have offices based in Atlanta and Miami that would be able to serve you well in your area. 
 
Legend
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Posted: #21
Gunners-
 
Is there a way to get in touch with you directly by e-mail?  I cannot remeber what is proper protocal on Covers for that.  I had a question on an unrelated topic that you can probably help with.
 
Legend
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Posted: #22
Gambler711-
 
This land is a few miles form the Sea Island Causeway......down the street that Bennie's Red Barn sits on.
 
 
Covers Linesmen
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Posted: #23
acc,

Email the Covers Team and they can work it out.


 
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Posted: #24
acc... and i'll reply with my personal email.  i use this one for any junk email, but i just don't want to type my work or personal email on here.  so just give me a one word email to that address and post here when you have sent it and i'll check it. 
 
 
Legend
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Posted: #25
thanks guys
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