Planning In The Beginning For The End: A Must For JVs
The most successful CRE joint venture partners have a clear exit strategy in mind for their project before inception while providing for the possibility that one partner may want out before the other. This type of planning demonstrates foresight, manages parties’ expectations, and saves time and money, especially when it comes to taxes. We caught up with Berdon LLP Tax Partner Meyer Mintz to learn how seasoned pros conduct their business and structure deals to maximize their payouts and prevent common transactional obstacles.
To Sell Or Not To Sell
One of the most contentious aspects in any negotiation is price, and when partners disagree on their assets’ values, they may choose to split.
“While it may be easier to dissolve a joint venture by putting the building up for sale, situations are typically not that simple,” Mintz said. “It is often the case that one of the stakeholders does not want to sell, either because he believes the property will appreciate, has high-income-generating potential or is unwilling to pay the tax on the gain.”
If one partner is reluctant to sell, that partner can have the property appraised with the intent to buy out the partner who wants to walk away. In simple instances, the appraiser is mutually agreed upon by both parties, yet other times each party will select a different appraiser.
“If it is the latter and they cannot agree, then sometimes the two appraisers pick a third that can confirm one of the two existing appraisals or come up with its own value,” Mintz said.
Common selling costs may be factored into the valuation, impacting the amount to which the selling partner is entitled.
Another common solution is to allow one partner, the "triggering partner," to name a price at which the other partners can buy him out or sell to him.
“While this approach may work well for experienced real estate operators, banks may not allow the partners to buy out the managing member,” Mintz said. "Also, some institutional partners may not want to be put in a position to buy out the JV partner since they may not have the ability to raise the funds or have a limited life and need to wind down.”
Regardless of the approach, it is beneficial to have a partnership agreement clearly define how a potential split will be managed.
Structuring The Deal
When one partner sells to another, the sale will often be for a note and treated as an installment sale.
“Generally, for tax purposes, gains are recognized as the payments come in, and any negative capital will be taxed in the year of the sale,” Mintz said. “If the note exceeds $5M for each ultimate individual owner, there will also be interest on the deferred tax.”
In a redemption, a partner’s share is sold back to the partnership and the seller is typically still considered a partner for tax purposes until all consideration is paid. This type of sale becomes complicated if there are multiple partners unable to agree on a single price.
“In the right circumstances, the partnership may distribute partnership property to redeem a partner,” Mintz said. “A property distribution in redemption can be advantageous because it can defer any tax gain of the partner being redeemed. The deferred gain will carry to the property received, however, and get triggered on a subsequent sale of that property.”
According to Mintz, structuring tax deferred redemption transactions is complex, and requires careful planning to avoid incurring income tax. The transaction may cause transfer tax on the property distributed or even the property retained by the partnership.
When JV agreements are thoughtfully and comprehensively laid out up front, partners have a much better chance at a clean break with no hard feelings.
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