Like-Kind Exchanges Involving Partnership Property

If you own rental real estate, you probably think you can exchange it for “like-kind” real estate some day, and defer any gain that would otherwise be recognized in that transaction. You would probably be right.
And if you own rental real estate together with others, you probably believe that you could similarly exchange your interest in the underlying real estate for “like-kind” property and similarly defer recognition of any gain on that transaction. You would probably be wrong if you and your other co-owners are partners, and the underlying real estate is owned by the partnership.

Sometimes partners want to separate and apply their share of disposition proceeds independently, with some or all of them wishing to acquire replacement property through separate like-kind exchanges. They face the problem of not directly owning an asset to exchange. Instead, each owns a partnership interest and partnership interests are explicitly excluded from like-kind exchange treatment. The key problem is how to be treated as owning a direct interest in the underlying real estate that qualifies for like-kind exchange treatment.

Three techniques have been used in the past to accomplish this:

1. Drop and Swap.

This involves terminating the partnership and distributing its property to the partners, who acquire direct ownership as tenants-in-common. The partners complete the sale or exchange of their fractional interests.

2. Swap and Drop.

This involves the partnership completing the exchange and distributing replacement property to its partners.

3. Separation without Divorce.

This involves the partnership completing the exchange and using post-exchange transactions to direct the economic benefits to particular partners. The partnership remains in existence.

Each of the above techniques has a number of tax problems and other disadvantages. A recent Treasury Department Revenue Procedure (Rev. Proc. 2002-22) adds to these problems. In particular, property distributed by a partnership to its partners and held directly as co-owners will probably no longer qualify for tax-free exchanges. This may eliminate the first two of the above techniques.

New acquisitions can be structured to avoid these problems. This will require acquiring the property as tenants-in-common, rather than as partners. (Acquiring the property in a limited liability company will not work. Limited liabilitycompanies are considered partnerships for Federal income tax purposes.) A tenants-in-common agreement can provide many of the protections of a partnership agreement, though care must be taken to comply with the requirements of the new Revenue Procedure. In fact, there are certain non-tax advantages of acquiring property as tenants-in-common. For example, the other co-owners are not agents for one another, as partners are, reducing exposure to liability for the acts of others.

Contractor Compliance with Labor Laws

Hiring contractors has always been risky. Effective January 1, 2004, it got riskier. Starting then, if you engage a contractor for construction, farm labor, garment, janitorial or security guard services, you may be liable for damages to that contractor’s employees if you know (or should know) that the contract is not adequate to allow the contractor to comply with all laws governing the labor to be provided. Collective bargaining agreements or contracts for services to be performed on your own residence are excluded from these rules.

The contractor’s injured employees can sue you for the actual damages that the employee incurs if such laws are not complied with, plus attorney’s fees.

There is a way to create a rebuttable statutory presumption in your favor, though it is very difficult to do so. To take advantage of the presumption, there must be a written agreement, consisting of a single document, with extensive provisions including the employer identification number of the contractor, the workers’ compensation insurance policy number, the name, address, and telephone number of that insurance carrier, the vehicle identification numbers of any vehicles owned by the contractor and used for worker transportation together with the vehicle liability insurance policy number, and the name address, and telephone number of the carrier, the address used to house workers, and the total number of independent contractors that will be utilized along with their state contractor license numbers and other identification numbers. Failing to request the information constitutes knowledge of the information for purposes of this labor code provision. You must keep a copy of this agreement on file for four years.

It seems clear that this law could be used against property owners if contractors they hire do not have worker’s compensation insurance and if its employees are injured, or if the contractor doesn’t pay correct wages or overtime to all workers. Certainly, it will become more important to work with financially capable contractors who carry the records of their insurance and meet their other labor obligations. And certainly, all agreements with contractors should include the requisite provisions.

Please do not hesitate to contact me if you have any questions or if I may be of any further service. Thank you for your continuing courtesy. I remain

Very truly yours,

Robert Jay Grossman

Real Estate Brokers

Real estate lawyers and real estate brokers frequently find themselves working together to serve a common client. They also frequently butt heads. Real estate brokers consider lawyers to be deal-killers. Lawyers think that real estate brokers are loose canons, oblivious to the legal duties of themselves and their clients. This will be the first in a series of letters trying to sort out the complex relationship between brokers and their clients, and possibly highlight some reasons for these different points of view.

Let’s assume the typical situation: a seller engages a real estate broker to market the seller’s property. This broker becomes an agent for the seller, whom the law terms the broker’s principal. The law recognizes the very high level of trust the seller reposes in the broker, and imposes a commensurably high level of duty owed to the broker’s principal, the seller. The broker’s duties are similar to those owed by a trustee to the beneficiary of the trust, generally described as a standard of utmost good faith and fair dealing, and include:

1. The duty to disclose. A broker must make a full and complete disclosure to the seller of all facts material to the pending transaction. This means that:

  • The broker must inform the seller of all offers received, regardless of whether they conform to the terms of the listing agreement or whether the broker considers them attractive. Failure to disclose an offer is equivalent to a representation that no offers were received.
  • The broker must disclose all material facts relating to the value of the listed property, including the possibility that a higher price might be obtained.

2. The duty of undivided loyalty. A broker may not act as an agent to more than one party to a transaction without making full disclosure to all parties and obtaining their consent.

3. Confidentiality. A seller’s broker who suggests to a prospective buyer that the seller is willing to accept less than the listing price may be committing a breach of this fiduciary duty.

4. Secret profits. The broker is liable to the principal for any secret profits obtained in the transaction. The broker must disclose all profits regardless of whether the principal suffered any actual damages. A “net listing”, allowing the broker to keep all proceeds above a pre-set price, is illegal. The broker must account for all funds held on the principal’s behalf and cannot commingle the principal’s funds.

The duties above arise out of the relationship between the owner/seller and a broker based on common law principles of principal and agent. They may be enlarged or reduced by contract between the two though, if the contract does not directly address them, they will be independent of the contract. They are also independent of the rules imposed upon brokers by the California Department of Real Estate, the breach of which give rise to disciplinary remedies but not necessarily private remedies.

These rules become far more complicated when:

1. The broker acts through its sales staff;

2. The broker works with subagents or cooperating brokers with whom the commission is split; and

3. The broker, or the brokers’s sales staff, also represents the buyer.

These more complex issues of sorting out the fiduciary duties in the presence of these additional parties, as well as issues of broker compensation, will be left to subsequent newsletters.

Please do not hesitate to contact me if you have any questions or if I may be of any service. I remain

Very truly yours,

Robert Jay Grossman