When a land owner sells to a condominium developer, both the land owner and the developer have motivations favoring the developer “paying“ the land owner with finished condominium units instead of cash. Such a transaction reduces the developer’s up-front cash investment while sometimes enabling the developer to use all the land as collateral for senior financing. While more risky than a cash sale, the seller may receive condominium units more valuable than the cash price the seller could realize.
What gets in the way of these transactions? Often, the seller balks because the seller lacks the cash to pay capital gains tax on the value of the condominium units received back. To alleviate that problem, transactions are sometimes structured as partnership “mixing bowl” co-investments and redemptions, or as combination ground lease-Internal Revenue Code Section 1031 exchange transactions. These structures may defer capital gains tax; however, they also are subject to restrictions and frequently sufficiently convoluted so as to interfere with the developer’s business structure or senior financing.
In some circumstances an alternative sale structure offers a better solution. Under the alternative, the seller takes the positon that the receipt of finished condominiums is exempt from capital gains tax under Internal Revenue Code Section 1038. These same rules exempt a seller from tax when the seller forecloses on a delinquent purchaser on traditional seller financing (in tax parlance, an installment note). Unlike the mixing bowl or combination ground lease-Internal Revenue Code Section 1031 exchange structures, the Section 1038 structure more closely resembles traditional seller financing, making it potentially more palatable to senior development lenders and more simple for all the parties to understand and implement.
To learn more—including understanding scenarios involving air rights rather than raw land—follow this link to materials summarizing all these potential structures originally presented in an American Bar Association Section of Taxation webinar.
Please note that we post these materials with permission from and subject to the copyright of a co-presenting firm, Meltzer, Lippe, Goldstein & Breitstone, LLP.