When negotiating a successful real estate transaction, careful consideration needs to be given to the financial statement and income tax compliance aspects of the deal. Failing to evaluate the financial statement and tax compliance considerations associated with a contemplated real estate transaction in advance of the transaction could result in unexpected additional attest and tax compliance costs, undue strain on the resources of the organization, and even unintended economic consequences.
Financial statement compliance
In negotiating the financial statement compliance requirements contained in relevant agreements with lenders and partners, key considerations include:
- The particular basis of accounting required (GAAP, OCBOA-typically income tax basis or IFRS) and the timing of financial statement deliverables. Use of the income tax basis of accounting typically results in less strain on internal finance resources and lower attest service costs since it is less complex than accounting under GAAP.
- Requirements for externally audited, reviewed, or compiled financial statements. The cost of these services varies significantly.
- Understanding the need for fair value appraisals in connection with the acquisition of real estate. In connection with GAAP financial reporting, third party fair value appraisals may be required to allocate the purchase price among tangible and intangible assets.
- The extent and timing of internal reporting requirements
- Loan agreements may have specific reporting requirements for guarantors and will contain specific requirements for reporting on loans that may be syndicated in the future
- The wording of financial covenant provisions contained in loan agreements should be carefully reviewed, understood and modelled prospectively to ensure that there will be no issues going forward.
There is typically some level of flexibility in the financial reporting requirements of a lender or partner in a real estate deal. Citrin Cooperman’s Real Estate Industry Practice’s professionals can provide valuable advice to assist in negotiating these requirements.
Income tax compliance
Similar to financial statement reporting requirements, there is typically flexibility in negotiating the timing of income tax deliverables (estimates/projections, tax returns and Schedule K-1’s) and careful consideration should be given to the ability to meet the proposed deadlines when negotiating a deal. It is also important to understand the level of complexity associated with the income tax returns post deal completion. Depending on the nature and structure of the real estate transaction, there are many income tax related issues that may arise. These issues should be understood before executing on a transaction to avoid unintended consequences including increased costs down the road.
Some of the more common key considerations include:
- Partnership/operating agreements may contain complex waterfall arrangements regarding the maintenance of capital accounts. The language in agreements related to capital account waterfall arrangements may be unclear or subject to different interpretations. It is critical that deal participants fully understand and agree on the economics of waterfall arrangements prior to executing transactions. In particularly complex instances, it may be helpful to have an illustrative example of waterfall mechanics within the relevant agreement.
- Complications caused by the tax filing status of partners/shareholders should be understood. For example, the inclusion of foreign individuals/entities or REIT’s in the ownership group creates additional considerations and income tax reporting requirements.
- Upon the acquisition of real estate, third party cost segregation studies are often advisable to avail the taxpayer of favorable bonus depreciation rules for tangible personal property. An understanding of the benefits that can be achieved through the use of a cost segregation study should be considered in connection with a transaction including understanding in a partnership structure whether all partners/members will benefit from accelerated depreciation deductions.
- Transfers of interests in real estate may result in step ups in the income tax basis of partnership interests. In a tiered ownership structure, this could impact multiple income tax returns increasing the complexity of those returns and compliance costs.
- Real estate acquired may be eligible for income tax credits including energy credits. The availability of benefits for assets acquired should be understood.
While the aforementioned items are only some of the considerations that may arise in connection with a real estate transaction, there are many others which will be dictated by the form and structure of the transaction. Citrin Cooperman’s Real Estate Industry Practice’s tax professionals can provide valuable advice relating to these matters.
Citrin Cooperman’s dedicated Real Estate Industry Practice focuses on leveraging our deep industry expertise to perform high-quality engagements and customized solutions during your deal negotiations. Our team incorporates specialists from within the firm where needed in areas such as valuation, information technology, audit and attest, and tax. For more information, please contact a member of our team or William Saya at firstname.lastname@example.org.
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