Two major concerns of any buyer or seller of real estate are financing and taxes. Creativity can help buyers obtain more favorable financing terms and being aware of like-kind exchange opportunities can help sellers with tax consequences.
Financing: Be Creative
Lenders carefully review borrowers' financial reports and credit history before offering loans with competitive interest rates and terms. Real estate purchasers who lack sufficient assets or whose financials are not as strong as commercial underwriters like may obtain competitive financing rates and terms by enhancing their credit rating.
For example, a company wants to purchase real estate to construct a factory but has operating loans or other debts that affect its cash flow and reduce its ability to borrow. The company should first have an accounting firm audit the company's financial records. Once the audit is complete, the company can obtain its credit rating from a credit rating agency. If the credit rating is not strong enough, the company should contact a seller of credit enhancement products, such as a surety bond or letter of credit, which can elevate the company's credit rating. Once the credit rating is elevated, lenders or an investment broker/banker dealing in private debt placement may be willing to loan to the company with more favorable rates and terms.
Financing based on an enhanced credit rating could save a borrower money by reducing interest payments and allowing a borrower to finance debt over a longer period of time. However, the prospective borrower should be cautious. Credit enhancements may not be available to every borrower and the fees for closing a loan through such a process may be higher than with more conventional loans. The borrower should engage legal counsel and an accountant to analyze whether the benefits of reduced interest and extended payment terms outweigh the costs.
Tax Liability: Be aware of tax-free exchange options
There are significant tax benefits to selling real estate as part of a like-kind exchange. The exchange typically is either a simultaneous exchange where a Seller sells real estate and simultaneously invests the proceeds in other real estate, or a deferred exchange in which real estate is sold (the "relinquished property"), the sale proceeds placed in escrow with a qualified intermediary, and the proceeds then used to purchase replacement real estate within the time period prescribed by the Internal Revenue Code.
If the Seller desires to purchase new property prior to selling the relinquished property, he can do a reverse exchange by acquiring the replacement property (new property) before the relinquished property (old property) is sold. The preferred method of performing a reverse exchange is to have a third party (the "accommodator") acquire and hold title to the replacement property until the sale of the relinquished property is completed.
For example, Seller has contracted to sell an apartment complex. Due to the Seller's equity in the complex, Seller will incur significant tax liability from the sale. Prior to closing the sale of the complex, Seller finds a new complex to purchase. Seller can arrange for an accommodator to acquire the new complex and hold it until the old complex is sold. The accommodator would purchase the new complex with loan funds or cash provided by the Seller. When the closing on the old complex occurs, Seller does a simultaneous exchange with the accommodator and takes title to the new complex.
A reverse exchange is an important alternative for the Seller who locates replacement property before the relinquished property can be sold. This situation could arise if there is construction to be completed or an environmental issue on the relinquished property. Seller, like the Buyer seeking financing, should be cautious. Advice of tax counsel is crucial in insuring that the steps required by the tax laws are followed. A deviation from these required steps can defeat the exchange. Finally, tax counsel and real estate counsel can assist in identifying an accommodator (often a bank, title insurance company, or unrelated law firm), conducting due diligence on the replacement property, and wading through the exchange process. Once completed, the exchange can result in significant tax benefits for the Seller.