February 7, 2012
By Salvatore J. Armao, CPA/PFS, CFP, CFE
Lately, we have come across several situations involving improper formation of real estate holding companies that hold real property occupied by a union local and/or its related benefit funds.
Real estate holding companies (REHC) are specifically formed to hold title for and control real property.
Union locals generally own 100 percent of an REHC as a wholly-owned subsidiary. However, if a C corporation is formed to hold the real property, there are certain application forms that must be filed with the Internal Revenue Service to qualify the entity as a not-for-profit REHC.
All too often, we see instances where C corporations were formed and used to hold the real property on behalf of the union local without obtaining the not-for-profit status. By using this form of organization, the union local often unknowingly creates numerous tax problems that could have easily been avoided. Once the property is in a C corporation, a “built in gain,” subject to tax at the corporate level, is created. Additionally, income from the C corporation to the union local could be treated as Unrelated Business Taxable Income (UBTI), with the potential to create a tax liability for the union local.
Forming corporations under not-for-profit corporation laws
If the decision is made to use a corporation:
• It must be formed under the not-for-profit corporation laws of the state in which it is incorporated; and
• Form 1024 must be filed with the IRS to obtain a tax exempt status determination; and
• The corporation must operate under the Internal Revenue Code Section 501(c)(2) rules and regulations.
IRC Section 501(c)(2) provides for recognition of exemption of title holding companies which are organized for the exclusive purpose of holding title to property, collecting income from the property, and turning over the entire amount less expenses to a parent organization which is exempt under IRC section 501(a). An organization cannot be exempt under IRC Section 501(c)(2) if it:
• Engages in any business other than holding title to property and collecting income there-from and;
• Accumulates income rather than turning it over to the parent organization.
Consequently the wholly-owned subsidiary (the REHC), must distribute any excess of revenues collected over expenses paid during the year to the parent (the union local).
The LLC Alternative
Another alternative that has gained popularity recently is the use of a Limited Liability Company (LLC) to hold the real property, making the union local the single member of the LLC, as well as the managing member.
Other advantages to this form of organization are:
• There is no requirement to distribute the excess of revenues collected over expenses paid during the year to the union local; and
• Single member LLCs are not required to file any government reports separate from the union local. Activity in the LLC would be consolidated with the union local for financial statement and government filing purposes.
A final word of caution
In any event, one point is crucial: Be careful when deciding to form an entity to hold real property. Professionals should always be consulted before considering the choices. A prudent course of action will avoid creating tax problems that may be impossible to unravel.
For over 25 years, Armao, Costa & Ricciardi, CPAs, P.C., has been committed to providing accounting, auditing, tax, financial and wealth management and advisory services to labor unions and employee benefit funds. Visit us at www.acrcpa.com or call (516) 256-3200.