Ep. 58 | Buying The LLCs vs The Real Estate – Pros and Cons

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On this episode of The Mobile Home Park Lawyer, Ferd talks all things asset purchase agreements. Ferd explains all of the pros and cons of purchasing a property like this and explains that it’s not always the answer but that in certain situations, it might just be worth it.

 

HIGHLIGHTS:

0:00 – Intro
1:43 – In certain instances, you don’t want to buy the real estate in order to hide the sale
1:56 – An asset purchase agreement is when you buy out the membership units
2:29 – There’s a fear the property tax assessor is going to raise the tax because the purchase price is many multiples of the current appraised value
3:09 – You would also use an asset purchase agreement when you’re buying out your partner
4:29 – It may neuter some bank requirements
4:40 – You also might want to do it for grandfathering purposes
5:31 – The first con is that it’s complicated and expensive
6:33 – You’re getting what the seller has
9:20 – There are complications with your books
11:43 – There are some business and liability risks
12:33 – Another con is that it jacks up the 1031 exchange
16:20 – The pros might not work
17:56 – An asset purchase agreement might not be the answer every time, but there are occasions where it’s the right call

 

FULL TRANSCRIPTION:

Welcome back mobile home park nation. Tonight here I am wrapping up my little mini-series here on closing documents and frankly, all legal documents related to, related to the purchase and sale of mobile home parks. Today’s going to be one, that’s a little unique. It’s probably one of the more rarely use sets of documents, but it’s asked about a lot. It’s looked into a lot and it doesn’t work that often, frankly, because there’s a lot of cons to it. But there are some pros, and this is what I call an asset purchase agreement where basically it’s buying the LLC or buying the entity. So most real estate transactions, you know, if I’m the buyer and you’re the seller, if I’ve got an LLC and you got it in your own name or you’re the LLC, I buy it, you transfer it via warranty deed, hopefully, general warranty deed from you to me, it’s pretty much that simple. And there’s certain representations and warranties in there or in the contract that hopefully survive closing if you got a good real estate lawyer. And then there’s, you know, there’s sometimes there’s bank docs and sometimes there is not, but there’s a bunch of other documents we’ve covered that are associated with the sale. But in certain instances, you don’t want to buy the real estate, or you may not want to buy the real estate. Because you know, the key reason is you want to hide the sale.

So what is an asset purchase agreement? It’s when you buy out the membership units, I’m working on one right now, it’s wrapping up tomorrow. So I thought I’d give a little podcast on it here today. This will launch a few weeks after the incident or the example, but it’s still going to be pertinent. And basically in this case, there’s an LLC that the seller owns and my client who’s the buyer intended to and signed a contract to buy the real estate. But there was a fear that the property tax assessor or appraiser was going to Jack up the property taxes because the purchase price is many, many, many, many, many multiples of what the current appraised value as the County courthouse. In large part, because the, frankly not all park because the County appraisal department is incompetent, which is often the case, unfortunately. My client’s not overpaying by many, many multiples as much as the current owner has been getting a sweetheart deal. So that is a key pro to the asset purchase agreement.

Another time you’d use an asset purchase agreement as a sidebar is when you’re like buying out a partner. I mean like my dad and I were 50 50 partners for many years. And at one point in time, it made sense for him to start to look at more estate planning stuff, as opposed to, you know, if he died now, I’ve got more siblings in the business with me and stuff like that. So we did a buyout, something similar, but where I bought the membership units of our LLCs or the stock units, depending on the structure of the company. And, you know, and then we allocated things differently, you know, later dad got back in on equity side of deals, but it was, we had it more buttoned up. You know, I got smarter frankly, and having gone to law school at some point and better understood these things, we realized there were other, I say, poison pills that they’re sometimes called, but there’s, we have a key man insurance buy-sell agreements, and then there’s certain voting and other rights within our agreements. But there are times where, you know, that’s obviously an example where we are related, literally related parties. And that’s not going to be the case when, you know, John Smith’s buy-in from James Doe.

So the pros hide the sale, avoid potentially property tax increases. It also may neuter or another pro may neuter some bank requirements because often these are seller finance deals, right? So you don’t have to go through the hoopla of dealing with appraisals and loan committee and perhaps recourse things like that.

Another reason you might want to and probably you might want to do this is for grandfathering purposes. Like maybe the current owner has a permit or a license or some sort of grandfather status that you frankly can’t get. And there’s like, almost like there’s a transfer fee, like not an impact fee, but a transfer fee or some sort of neutering and the grandfathering. Frankly, I’m not sure that that would hold up. I mean, it’s probably a city-by-city basis, but rarely do those sort of rights run with the owner. They typically run with the land, which would not be a problem in a true real estate sale.

So those are the pros. Those are the pros, right? And that’s why people do these things. Now for the cons. And this is why people don’t do it very much.

The first one is, it’s complicated and complicated means is expensive, frankly. At least relative to a typical sale. I don’t know what the legal fees going to be in this deal here. I haven’t calculated them. But if the norm is 1000 for legal fees to sherpa the transaction, it’s not going to be one. It’s probably going to be two. It might be three. But then when you add in things like the seller finance, promissory notes, real estate mortgage, you know, another lease drafting, ancillary closing documents, it goes up and up, right? And I don’t think it’s going to be 25,000 bucks, but it might be five, instead of one, instead of 1500. So, you know, lawyers ain’t cheap you know, to some degree you get what you pay for. It probably makes sense to hire a lawyer if you’re going to do an asset purchase agreement. I mean, if you’ve got particular skills in this area, maybe not, but that’s one of the cons, complicated and expensive.

Another con is your kind of getting what the seller has, so to speak, meaning it’s a seller, let’s say the company is called one, two, three, LLC. They already own it. If they got a good phase one, if they got good title insurance, when they bought it and did some other degree, things like permits, licenses, surveys, well, then that’s what you’re going to get. And they ain’t got a good phase one. You need to go get one. And at least for your own review. Title insurance is hard to get, frankly, because you, they have some exceptions I’ve found out from different title companies. So they don’t want you to have, you know, they don’t want to insure a currently insured person. So you basically hire an attorney to review the title report or title search. So that’s called an owner and incumbents report to review that there are no new problems with the title since the last time title policy. One of the reasons next that people say don’t ever do this, it’s horrible is for the risk. Meaning like what if the last guy didn’t lease a home to somebody because they were white, black or purple. It’s kind to me is like, the last guy didn’t get a phase one. Well, the phase one, you can update yourself and you want to do that as opposed to just get an indemnification provision. But for the actions, I’m not as worried about that, to be honest, because you can have an indemnification provision that says anything before the date of closing is the last guy’s fault. Anything after it is my fault.

Now that’s true, but there’s a risk to that. Cause let’s say I bought it from John Smith today, but yesterday John Smith did not lease 10 houses in a row because the family was purple. And the purple families might Sue me. I’m going to say point to John, John Smith. Well, they’re just saying we didn’t deal with John Smith. We dealt with one, two, three LLC of which you are the owner. And now I’m in a lawsuit, which means I’ve already kind of lost and didn’t do anything wrong. You know, I’m in the middle of it. And I can point to John Smith and say, look, he notified me. But if John Smith has no money, has no credit, has no collateral, it might not work out that well. Now the seller finance deal, it’s probably safer for me because John Smith is motivated to help me be successful. And there’s probably some case law or some specifics I could get too. If I really got into granular level detail here that look, John Smith, me, he acted in bad faith, blah, blah, blah, blah, blah. Maybe I can get out of that note, especially that notice recourse, but there are indemnification risks, but some of that can be mitigated. There are complications next with your books. I mean, frankly, if it’s today, I’m doing this, it’s January 15th. Now it’s 12.15 in the morning, but it’s January 15th here. And so I am closing today on this deal, and as a result, the seller is going to have to file tax return from January 1, January 15. My client, the buyers have to file a tax return from January 15 to December 31. And there’s going to be, there’s obviously the normal prorations of rant and taxes and things like that. But there’s also, they have to file separate tax returns, a little more complicated. Now, one thing I’ve heard a lot is, Oh, you never want to do this because you’re going to get the old guy’s depreciation schedule.

Frankly, I didn’t do any research before this one here. I just, I’m kind of shooting from the hip and I’m not a CPA. So don’t tell my wife I said this, but I might be wrong. And it’s possible that what I hear is right, that you have to take the old guy depreciation in basis. I don’t think it’s right, frankly, because my CPA who works at a big 10 CPA firm did not make me do that when I bought my dad out. I got to step up in basis because I paid for 50%, let’s say our company is worth a hundred dollars. I previously owned $50. But over time, our company was worth $200. So I bought dad’s half for $100. I now have a cost basis of my original 50 plus his hundred for his half. So I have a step up. I have a $150 basis. Now, dad only had a 50 originally, he sold his half for 100.
So dad has a $50 game. Some of which is depreciation recapture. Some of which is return of principal, return of capital. Some of which is long-term gain short-term gain. So I’m not as worried about that step because I think there’s a step up. Because I’ve done my tax returns. If the IRS is listening blame, that was me. That was me beeping out my CPA’s names, so they don’t get sued, but they signed off on this. That’s legit. And I mean, he’s really sharp. So I think that’s the case. But again, I’m not giving you tax advice or legal advice here. This is for education purposes only.

The next con is general business and liability risks. We talked about indemnification, but I mean, they could, there could be contracts out there, there could be purchased orders, I was dealing with a grocery distribution deal today. Kind of unrelated, was an investor of mine, had a grocery distribution business. And, you know, you could order, I don’t know, a hundred pounds of potatoes. And if you bought the business with the guy that had already made that order, you’re kind of on the hook for delivering that order. Unless you have specifics on you know, receivables, payables, deliverables, things like that. And the real estate business is probably not a lot of that’s being honest. These asset purchase agreements will be considerably more complicated if you’re buying out Coca-Cola or something like that.

Next, another con is that it really jacks with the 1031 exchange. I had a new client today. He owns, he owns a single-family house, and he did a good job, made money, flipped it, but he owned it in his personal name. My ears cringe when I heard that. He wants to do a 1031, buy a mobile home park partner and syndicate with some other buddies. Practically with a 1031, you’re supposed to buy the next property in the exact same title you did the previous property. So it was previous properties in him and his wife’s name, which makes it really hard to joint venture and the next deal. So for back to the example of the asset purchase agreement, if, if I’m buying out the seller, like my deal tomorrow, the seller is took a Forman dollar deal. The sellers out of the picture, the seller did not sell real estate. You now need real property for 1031, which is a like-kind exchange, a starker exchange. Back in the day before the 2017 Trump tax cuts were awesome in 99% ways, in my opinion, especially cost segregation and bonus depreciation, which I’ve got a whole podcast on that. And they also preserved the capital gains. They preserved 1031. They exempted real estate professionals from the 3.8% Obamacare tax, which is one of the worst taxes in the history of taxes, in my opinion. And nobody knows about it where Obama just said, let’s just tack on 3.8% of real estate transactions, but the NAR, National Associate Realtors, they opposed it. There were a massive lobby. It went nowhere, Obama, Biden just shoved it down our throats. Yeah, not a good move in my opinion, unrelated all to healthcare, but snuck it on.

So anyway, back to 1031 exchanges. The problem is during that Trump tax cuts, they cut out 1031 exchanges for personal property. They were like major league baseball teams, trading players and stuff, and trading contracts. People trading a baseball card collection for a stamp collection, personal property. Personal property, goodwill going concern, things like that, which is intangible property. Those are almost by rule or at this point essentially by rule distinct any like my business is different than your business. Even for both in mobile home park business. As a result, you can’t 1031, So the con, if I buy the membership units of your LLC through an asset purchase agreement, you cannot take those net proceeds and go do a 1031, which means you might want not want to do it. And then likewise, if I’m buying your membership units with my net proceeds from a preceding deal, I can’t do a 1031 because my preceding deal wasn’t, it was not called 123 LLC, at least not in the same state in the same genre. So it really jacks up 1031. Which sometimes don’t matter. Cause the deal I’m working tomorrow, the guy’s an old man. He’s owned it for, I think he has owned it for like 70 years. And he’s not going to buy something else. He’s going to ride into the sunset with the bundle of cash.

So those are the key cons. I mean the big cons, the pro might not work. I got a whole podcast on property tax projections and property tax appeals. And I think there are pretty sophisticated techniques to avoid a potential property tax increase, including things like asset purchase agreement. I have one park right now where it didn’t work, because the County appraiser is dumb as a doorknob and the county board legalization is even more dumb and more corrupt. And when I win that tax appeal at the state tax commission, I’ll divulge other names. I’ve already begun to place ads for the billboards to expose them, but I don’t do it right now, because I am vindictive, I’m not stupid. I’m mostly kidding on some of this stuff, but it’s crossed my mind, Let’s be honest. I’m talking out loud here. But my point is that you might not accomplish your goal. The key pro this whole machination of doing the asset purchase agreement is to keep the taxman from knowing via a transfer of a deed to the abstract office that you bought the property.

But it’s possible that the realtor has a big mouth, the closing agent is his sister that his nephew was about to buy the same park and now found out it’s off the market. So there are things that are not your fault, not your attorney’s fault that just make it happen. And that all this brain damage, essentially one of the asset purchase agreement was for not. But in some instances, it’s a pro. I hear it said almost all the time that you’d be crazy to do it. I’m not saying it’s the ideal situation. I’m just saying there are ways to mitigate the risk. And I think there are circumstances where it makes sense to do this. This isn’t just my little humble opinion in here. This happens in retail deals a lot, you know, retail deals, restaurants in particular, they trade or sell all at a multiple that is probably more than the cost basis based on the credit. I mean, to build a Chick-fil-A for example, you could buy a Chick-fil-A for, I don’t know, let’s see, you could build a Chick-fil-A for 2 million bucks, cause that Chick-fil-A, you know, probably trades at a four cap at this point. Maybe even less than that, you could have a $2 million cost basis, but it will trade based on its income in the credit, especially there’s a 15-year ground lease that might trade for 4 or 5 million bucks. Well, an ignorant accessor is going to chase that. Oh my gosh, $5 million real estate value. And now your taxes go up and it just kills and depending on triple net lease or not, that flows through the tenant or it doesn’t, and it’s advantageous to hide that transaction, which is another to have special purpose entities per property for LLCs. But that’s another story for another day. Thanks for listening. Drive home safely, god bless.

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