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stock marketAuthor: Staff

California real estate investors have many options when deciding where to put their money. This includes a real estate syndicate, in which investors contribute money to a real estate project under the management of a syndicator or sponsor. Since a real estate syndicate investment often involves buying ownership equity in a business entity, such as a limited partnership or limited liability company, state and federal securities laws may be a factor. In order to avoid inadvertent securities law violations, syndicators and investors alike should be aware of the general requirements and exemptions in laws like the federal Securities Act of 1933.

Securities Law Enforcement

Both federal and state laws define “securities” very broadly. In addition to stocks and bonds, the term also includes a variety of “investment contracts.” An investor in a real estate syndicate often entrusts their money to a syndicator, who will handle the actual operations of the syndicate. This type of investment is likely, in many cases, to be an “investment contract” within the meaning of state and federal laws.

At the state level, the California Department of Corporations (DOC) is responsible for enforcing securities laws. The Securities and Exchange Commission (SEC) handles federal securities enforcement. Anyone seeking to sell a security, possibly including an interest in a real estate syndicate, to the public must register with securities regulators. This can be a time-consuming and expensive process, as demonstrated by the overall rarity of companies “going public” by making an initial public offering (IPO) of stock to the public. State and federal laws provide exemptions to these rules, however.

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Stock ExchangeAuthor: Staff

Real estate syndicates in California offer investors a way to invest in real estate projects under the management of a syndicator, also known as a sponsor. The syndicate itself may use one of several different business forms under California law, such as a corporation or a limited partnership.

The individual investors own a portion of the syndicate. This raises an important question about state and federal securities laws:  do investments in a real estate syndicate constitute “securities,” which might place them under the jurisdiction of state and federal securities regulators?

The rather complicated answer is that it depends on various factors, including how the syndicate was formed and the role of the investors in its ongoing operations. Determining the answer requires a careful and thorough review.

What is a “security?”

At the federal level, the Securities Act of 1933 regulates the offer, issuance, and sale of securities to the public. It defines “security” to include not only stocks, bonds, futures, and options, but also a wide range of “investment contracts” and other financial transactions.

California’s Corporate Securities Law of 1968 defines “security” in much the same way. It also adds provisions that exempt certain membership interests in limited liability companies (LLC) when the investors are “are actively engaged in the management of the limited liability company.”
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Minnesota-Amicus-Brief

Author: Luke Wake

Luke Wake is an attorney for the National Federation of Independent Business Small Business Legal Center—a Bona Law client. Luke and Jarod Bona have also published two law review articles together, on both takings and antitrust law. Luke is one of this nation’s leading experts on takings law. You can read some of his academic articles here.

Last week Bona PC filed an amicus brief, on behalf of the National Federation of Independent Business Small Business Legal Center, challenging the Minnesota Uniform Disposition of Unclaimed Property Act (“MUPA”).

In this case, a Minnesota resident discovered that she had lost a substantial inheritance because she had invested it in a savings account and left the money untouched—without any interaction with her bank—for a three-year period. At that time, Minnesota deemed her account presumptively “abandoned” under MUPA and the Act required the bank to transfer her money to the State’s general fund.

Under Minnesota law this could happen to anyone holding assets in a Minnesota bank account. This is, of course, highly concerning, especially since the State offers no actual notice to affected owners. For that matter, the only way that a Minnesota resident may learn that he or she has lost assets under MUPA is by searching a website.

Minnesota is willing to return the amount it seized when an owner discovers that the State has taken possession, but MUPA assigns the interest on the money to the State rather than the owner during the time the State holds his or her assets. So whereas one fully expects to earn interest on money deposited in a savings account, MUPA purports to extinguish that right at the time the State forcibly transfers the money to the State’s control.

But can a state law simply abrogate private property rights in this manner?

This is the essential question that the Minnesota Supreme Court will soon decide in Hall v. State. Affected owners argue that MUPA effects an unconstitutional taking of their property in withholding accrued interest, while the State defends its regime on the view that nothing is taken because MUPA defines the scope of one’s continued rights in property deemed presumptively abandoned. That is, the state tries to define away your property rights to the money in your savings account.

In the proceedings below, the Court of Appeals sided with the State—holding that there could be no valid takings claim where an owner has lost rights as a result of his or her own “neglect” under the statute.

We argue in our amicus brief that the State cannot simply avoid a takings claim by virtue of the fact that an enacted statute purports to impose restrictions on one’s common law property rights. If that were the case then regulatory authorities could enact legislation to take private property without paying just compensation by putting an expiration date on one’s right to retain title, or by simply declaring that once protected private property rights are no longer recognized under state law. But, of course, the U.S. Supreme Court had already made clear—in numerous cases—that the government cannot abrogate private property rights in this manner.

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San DiegoAuthor: Staff

In a recent unpublished California appellate decision, the plaintiff appealed after a bench trial was conducted on his complaint for breach of contract and breach of fiduciary duty. The case arose when one of the defendants, who’d worked as a real estate developer in Illinois for 21 years before moving to San Diego, needed seed money for a potential development. He contacted his childhood friend to see whether he’d be interested in creating a partnership to invest money to follow the opportunity.

The childhood friend agreed and formed Gimbel Corporation with another friend. Meanwhile, the defendant formed Kriozere Corporation, in which he was the sole shareholder. The two corporations formed a general partnership. Gimbel invested $250,000 in a development in downtown San Diego, and both partners enjoyed profits from this first project.

In 1993, the initial partnership agreement was changed to reallocate profits between the partners. Gimbel invested in some properties with Kriozere under the second agreement. In 2006, the partners restructured their partnership so that Gimbel was a limited partner, while Kriozere was a general partner. The childhood friend’s other friend replaced the childhood friend as director of Gimbel.

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highriseAuthor: Staff

In a recent California appellate decision titled Ito v. Ito, the appellate court considered how to value two brothers’ respective interests in real estate they’d bought and sold. One of the brothers, a programmer, had gone into business with the other, a real estate investor, and then they fell out. The programmer sued the investor to wind things up. Ultimately, the real-estate investor appealed.

The main issues in the lawsuit were how to value each brother’s interest in real estate they’d bought and sold and how to treat their interests in a corporation they’d formed to make arrangements. The programmer testified that when they formed the corporation, he was making more than $300,000 a year as an independent contractor. His brother had no money, and the programmer agreed to do his business through a corporation and give his brother a 50% share of the business to take advantage of the brother’s tax losses. The brother got a salary under an employment contract with the corporation, but according to the programmer, he didn’t do anything for the corporation. In 2002, the brother forfeited his share of the business.

At trial, the court labeled the corporation an illegal scheme by the programmer to avoid paying income taxes and decided the brother had no interest from the beginning. The brothers had jointly bought about 39 properties and continued to own six of them through partnerships and limited liability companies at the time of trial. The investor argued that their interests should be determined by their capital accounts in the property, with the amount of the accounts fluctuating based on their contributions. He argued that the programmer’s capital accounts for the properties were zero because whatever he’d put in, he got back in the form of payments he’d received from the investor.

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1031-apartment-building

Author: Matthew Riley

Matthew Riley is an attorney with Bona Law, primarily focused on antitrust, commercial litigation, real-estate, and federal administrative law.

Does property that started off as non-qualifying (i.e. primary residence), but over time has changed its character to fit a qualifying purpose fit within the requirements of Section 1031?

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Does property used concurrently for both non-qualifying and qualifying purposes, for example a primary residence, a part of which functions as an office space, qualify as Section 1031 property?

Over time the purposes a property serves can change or multiply.  When this occurs, the applicable tax rules may change as well.  For example, a primary residence may later become rental property and convert to a business or investment purpose.  Or, perhaps the property owner devotes part of their residence for use in a business.

The frequency of questions raised in relation to primary residences and whether or not such properties qualify for a Section 1031 Exchange has spurred the IRS to compose many well-developed tax rules pertaining to these circumstances.

These tax rules, though involving the disposition of Section 1031 property, primarily center upon two other issues:

The first concerns Section 121’s applicability to a Section 1031 Exchange; and the second instructs how to allocate and treat gains recognized in that Exchange.

We will take up the second part, categorizing and calculating taxable gains, later. Here we focus on the initial requirements that must be met before a primary residence can be included in a Section 1031 Like-Kind Exchange.

Section 121 applies when a taxpayer’s primary residence is sold [exchanged] and treats taxable gains from that exchange differently than Section 1031.   That is, Section 121 excludes taxable gains from a sale, up to $250,000 for a single taxpayer ($500,000 for those filing taxes jointly), from taxation.  This tax-free treatment of gains under Section 121 for primary residences differs from the tax-deferral treatment for business/investment properties under Section 1031.  Under certain circumstances, a taxpayer may be able to enjoy the tax advantages of both rules for the same property.

Generally, Revenue Ruling 59-229 disqualifies primary residences from a Section 1031 Like-Kind Exchange.  Revenue Procedure 2005-14, however, allows the Exchanger to use such property in an exchange when the property’s use as a primary residence is either concurrent or consecutive to its use for a qualifying business/investment purpose under Section 1031.

To qualify for tax-free and tax-deferral treatments under Section 121 and Section 1031, respectively, two conditions must be met.  First, the property must be held as the Exchanger’s primary residence for at least 2 years during a 5 year period ending on the date of the sale or exchange.  And, secondly, at the time of the sale or exchange, the Exchanger must have held the property long enough to establish and demonstrate an intention to use the relinquished property for a qualifying business or investment purpose.

For many, the second condition raises the question, How long does it take to establish a demonstrable intention to use a property for a qualifying business or investment purpose?  Unlike the first condition, which outlines a specific time requirement, the IRS does not provide the same bright-line holding period for the second condition.  Rather, whether the Exchanger has held the property long enough to establish the proper intention is determined on a case-by-case basis.  Case-law, legislative history, and heuristics provide guidance to determine whether the required holding period to establish business or investment intention has passed. You should consider the following:

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windowsAuthor: Staff

Sometimes investors in California are interested in having the flexibility of a partnership structure but are worried about personal liability. In a limited partnership, there are one or more general partners and one or more limited partners. There always needs to be at least one general partner, and the general partner or general partners will have unlimited liability for the partnership’s debts and liabilities. Under California Corporations Code § 15611, the limited partners contribute capital but don’t get to manage or have other responsibilities and aren’t held liable for partnership obligations that go over their capital contributions. Often, however, an Limited Liability Corporation (LLC) is considered a more favorable vehicle for real estate than a limited partnership in California. For example, all of the owners of an LLC can manage it.

To form a limited partnership in California, investors file a certificate of limited partnership. Limited partners do not need to disclose their names or legal information. There is no legal requirement that a partnership agreement be in writing, but it is important to have one. The agreement will set forth why the partnership is being created, how business is going to be conducted, the rights and liabilities of each partner, and other contingencies. Negotiating and creating a written agreement about how a limited real estate partnership will be conducted can eliminate litigation down the road.

In most cases, a limited partnership is a good way for passive investors in real estate to become involved. A limited partner gets to invest in real estate and share in profits when the project is successful, but they aren’t held responsible for liability when it exceeds their initial capital contribution. The general partners are liable beyond this amount and are considered jointly and severally liable to third parties when a lawsuit arises from their actions on behalf of or in the course of the partnership.

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mallAuthor: Staff

Real estate syndication involves multiple investors pooling funds and putting them into real estate projects, either to acquire a property completely or as an equity contribution to fund the cost of a project. But there is a great deal of variety in which types of projects are considered real estate syndication, and certain private placements may be heavily regulated.

Sometimes disputes involving real estate syndicate projects are arbitrated before the Financial Industry Regulatory Authority (FINRA), which regulates all securities firms by regulating brokers and brokerage firms and monitoring stock market trade.

In an unpublished 2015 case in a California state appellate court called Stark v. Beaton, a defendant appealed after the court denied his petition to vacate an arbitration award associated with a real estate syndication project. The case arose when the parties submitted the defendants’ claims to expedited arbitration under the FINRA rules.

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Red Rock CanyonAuthor: Staff

Real estate syndication allows you to put your private savings into real estate investments when other financing isn’t available for them. The syndicator’s responsibilities and obligations to an investment group and the investors’ responsibilities to each other are determined by how the syndication is organized.

Choosing the form of organization requires the syndicator to look at the advantages and disadvantages of each. Many people prefer a limited partnership. When there is a corporate form, you can have central management, but most syndicates do not use this form because of negative tax consequences. General partnerships allow you to avoid double taxation but incur unlimited liability, and in addition, there is no central management. A limited partnership allows you to have centralized management but also keep certain tax advantages.

Some syndicates are organized as limited liability companies. This form allows members to actively participate in managing the syndicate and provides for limited liability with specific exceptions. It can incur taxes like a partnership, while avoiding certain double taxation problems that happen when the form of the syndicate is a corporation. But an LLC cannot hold a real estate license in California.

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houseAuthor: Staff

In a recent California appellate case, a plaintiff sued multiple parties after the nonjudicial foreclosure of his home. The court sustained the defendants’ demurrer without providing leave to amend.

The plaintiff challenged the judgment against the bank that instituted the foreclosure sale and one of the entities that serviced the plaintiff’s secured loan. He argued that it was a mistake for the court to determine he hadn’t stated a cause of action against these two defendants and couldn’t amend his complaint to state a cause of action. The court affirmed the judgement.

The case arose in 2007, when the plaintiff borrowed $528 to refinance the loan on his home. The loan was reflected in a note that both parties signed, and it was secured by a deed of trust on his home. The deed of trust identified him as the borrower and also identified the lender, trustee, and beneficiary. It stated that the borrower understood the beneficiary held legal title to the interests specified in the deed of trust but had the right to foreclose and sell the property and take any action required of the lender, if necessary to comply with law or custom. It also allowed the note to be sold multiple times without giving the plaintiff notice.

The beneficiary entity assigned the note to Mellon Bank, which was a trustee for a securitized investment trust and one of the defendants. The assignment was signed by an assistant secretary and recorded. The trust was organized under New York laws and was governed by a servicing agreement that required a servicer to make certain advances on delinquent loans. One day after the assignment was executed, another entity recorded a notice of default, stating an owed amount of $35,254.26.

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