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The same peculiarities of real estate investment also require that a sponsor heavily regulate the cash flows into and out of a fund to manage the fund's liquidity and valuation.
A typical real estate fund will raise funds through subscriptions made by investors in one or more closings of limited partnership interests (or limited liability company membership interests) over a limited period, once the sponsor identifies an investment strategy and makes his business case to potential investors through the offering materials (e.g., the "Private Placement Memorandum" or PPM). The PPM is often presented to potential investors at meetings and presentations – called "road shows," subject to the applicable requirements of the securities law (e.g. The first one or two investors often get preferential treatment and are called "seed investors." Investors coming in through later closings typically pay an interest factor to compensate the early birds for footing the bill for the first investments.
The first 3 years will be its investment-reinvestment period, during which it intends to acquire the 30 Dunkin Donuts properties. business entity that acts like a mutual fund with a real estate concentration. When it does, just like a mutual fund, it will be treated as a corporation that does not pay corporate income tax on its distributed income.
The fund will hold the properties for appreciation due to traffic increase in their geographic areas and plans to start their sales in year 8 of the fund's life until all of the investments are sold and the fund is liquidated in year 10. real estate funds are organized as partnerships and, to a lesser extent, as limited liability companies under the laws of a state of the United States. Interposing a corporate blocker may result in increased U. tax cost to foreign investors, depending on the facts and circumstances. real estate fund often invests with a real estate investment trust (REIT) or uses a REIT as a legal vehicle for a joint venture with a tax-exempt investor or a foreign investor. A REIT is generally not suitable as the primary vehicle for a U. real estate investment fund because of the numerous and technically difficult qualification requirements.
This right to carry or promote often is called "carried interest" or "promote interest" or "sweat equity" and, in tax jargon, "profits interest." Often, because of the complexity of tax rules, actual tax liability of an investor for an investment in a U. real estate fund will differ from the investor's actual amount and timing of cash receipts.
Therefore, frequently, a fund will build in the concept of a "tax distribution" to help investors pay their taxes on taxable income allocated to them ahead of the actual receipt of corresponding cash.
He meets privately with potential investors and finally reaches commitments with the following three investors, the "seed investors," for the first closing of his offering: Because of his stellar presentation, Alejandro will not be required to contribute his capital to the Coffee Fund (thus, no "skin in the game") and will receive a 20% promote and a 2% management fee.
The Coffee Fund will have a life of 10 years, with two 1-year extensions at the sponsor's disposal. business entity has to make an election to be taxed as a REIT, and satisfy on an ongoing basis a number of ownership diversification, real estate asset and income concentration, active business prohibition, and distribution requirements, among others.
This article walks the reader through a basic structuring analysis. real estate fund will have a limited life span of not more than 10 years.
Legal structures directly impact investor returns and risk management profile.
In general, tax considerations are foundational to any real estate fund legal structure.
Alejandro is elated, but does not want to pursue further capital through additional capital commitments at this point and wants to begin working right away. Delaware is the default state of choice in which to form a U. legal entity for transacting business and investments within the United States because Delaware has the most sophisticated corporate governance laws (e.g., laws relating to fiduciary duties of directors, officers, and general partners to shareholders and limited partners) and an efficient court system. The choice of partnership form is principally due to its "flow-through" nature for U. federal income tax purposes, which will be discussed later. Earnings distributed from Coffee Fund Blocker to Bellini and Maple Leaf are taxed again as a corporate dividend from a U. In our example, Bellini's effective federal tax rate on ordinary income actually goes down slightly, from 39.6% to 38.25%, while his U. federal tax for long-term capital gain jumps from 23.8% to 38.25%. If the foreign investor qualifies for an exemption from, or reduction of, the withholding tax on the interest, this tax arbitrage can result in even higher savings for foreign investors. For example, the rigid distribution rules applicable to a REIT will be inconsistent with the flexibility required of a typical real estate fund distribution waterfall.
How should the Coffee Fund be structured to make his business case as enticing as it was? While the limited liability companies have gained popularity in recent years, a limited partnership is still widely popular, because of many preferential tax and legal landscapes that have existed at the state and local levels governing real estate investments for many years. tax-exempt investor may use a corporate blocker if the investment strategy is likely to yield income and gain that is taxable as "unrelated business taxable income" (UBTI). Since the Coffee Fund is counting on the economy of scale and better management fetching higher valuations (i.e., capital appreciation), Bellini's U. federal tax cost could increase significantly if he invests through the Coffee Fund Blocker. tax-exempt investors avoid this form because this can easily turn their investment income into UBTI for technical reasons beyond the scope of this article. tax benefit of the interest expense deduction often exceeds the U. However, because of a series of rules enacted and adopted to curb interest stripping, as well as significantly enhanced documentation and reporting requirements, this form of interest stripping is not as popular as it once was. Instead, a REIT is often used to create investment opportunities with tax-exempt investors and foreign investors because, like a corporation generally, it can serve the function of a corporate blocker or reduce the tax cost from investment in significant ways.
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New investors will not be allowed into the fund after the investment-reinvestment period has ended.