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HomeMy WebLinkAboutCOM 0458.003 1998-2000 ~ 1 ~L ~ U v~ CONFIDENTIAL MEMORANDUM CIF ' I T0: BOARD OF DIRECTORS HAt-iAKUA HOUSING CORPORATION w FROM: A. SCOTT LEZTHEAD R7~!, + DnM ~a l_ai~a STEVEN ~.F. HO County Council DATE: JANUARY 9, 1955 RE: TRANSFER OF REAL PROPERTY The purpose of this memorandum is to discuss the various alternatives for the transfer of the camp housing to the former employees of Hamakua Sugar Company (the "Occupants"). The transfer will take place in two steps: (1) the transfer of the camps (the "Camps") once the bulk lot subdivision of each Camp is completed, and (2) the transfer of the housing units (the "Property"), consisting of a dwelling unit (the "House") and the land (the "Lot"), within the Camps. After discussion with Brian Nishimura and Roy Takemoto, we nave analyzed below the following alternatives for transferring .he Property to the Occupants: Alternative 1. The Camps would be transferred from Hamakua Sugar Company ("Hamakua Sugar") to Hamakua Housing Corporation ("Hamakua Housing"). Hamakua Housing would immediately transfer each Camp to all Occupants within each t Camp, as tenants in common. Once the individual lot subdivision within each Camp is completed, the Property would be transferred from all Occupants to each individual Occupant. Alternative 2. The Camps would be transferred from Hamakua Sugar to Hamakua Housing. Hamakua Housing would immediately transfer the Property to each Occupant pursuant to an agreement of sale. Once the individual lot subdivision within each Camp is completed, the actual conveyance of the Property would occur. Alternative 3. The Camps would be transferred from Hamakua Sugar to Hamakua Housing. Hamakua Housing•~would immediately transfer the Houses to the Occupants and enter into an agreement to transfer the Lots upon completion of the subdivision process. o~. y. ~S E l~ n ~ r3 Pres~~re..r ca~~ c i s ~t~*_ DEC 1 7 199T a ANALYSIS 1. Transfer of Camps to the Occupants as Tenants in Common (Alternative 1). The first alternative is for each Camp to be transferred =rpm Hamakua Sugar to Hamakua Housing. Hamakua Housing would :hen immediately retransfer the Camp to all Occupants within such :amp, who would hold a proportionate undivided interest in the :amp, as tenants in common with the other Occupants of such Camp. :ach Occupant would have the right to occupy the Property on ,hich he resides until the subdivision of the Property in a tarticular Camp is completed, at which time the Occupants collectively) would convey the Property to the individual occupants. The Occupants (collectively) would also enter into a ,anagement agreement with Hamakua Housing which would allow amakua Housing to manage and subdivide the Camp. Each Occupant ould also rant to Hamakua Housing an irrevocable power of tYnrnPy WhlC wov a nw ama a 7 e ocuments necessary to subdivide and convey the PropertY• The n areas of each Camp would be conveyed to a new nonprofit orporation formed for each Camp. a. Advantages. (1) Landlord/Tenant. If the Camps are not conveyed to ze Occupants, Hamakua Housin wou be t e landlord-'and would _ case the Property to t e ccupants un i e a P~- i ivided. As a an or , ama ua i q wou av`e certain - ~ igT- ations under the Residential Landlord-Tenant Code, Chapter :1, Hawaii Revised Statutes, including the obligation to comply ~ ' th all building and housing laws affecting health and safety, make a.ll repairs necessary to put and keep the premises in a bitable condition, and to maintain all electrical, plumbing and her facilities in good working order. By law, none of these ligations may be waived by the tenant. ~If the Camps are nveyed to the Occupants, Hamakua Housing would not be subject the obligations of a landlord under the Residential Landlord- zant Code, nor such other obligations imposed by the courts. In addition to avoiding liability as a landlord, this =ernative will help Hamakua Housing to pass on the sponsibility for the repairs and maintenance to Property to the .u pants. The fact that they are the owners of the Camps may ~e the Occupants more incentive to maintain and repair their i Property. (2) Control. The management agreement between Hamakua sing and the Occupants would give Hamakua Housing such control the Camps as may be necessary for it to carry out the division process. This control would be enhanced by each -2- $ I I e ~ "want granting Hamakua Housing a power of attorney to deal :z the Camps. As a genezal rule, a power of attorney is cable at will or upon the death of the principal. A power of ~rney may be made irrevocable, however, if it is "coupled with interest." In this articular case the "interest" would be , 3kua Housing s transfer of the Camos to the Occupants (i.e., s~yy~ Housing would not transfer th amps n rhP n_ r_~ants ;ss it receives the irrevocable power of attorney from the 3pants - b. Disadvantages. (1) Tax.' Payments made from an employer to an oyee, whether in cash or in property, upon the termination of mployee's employment are considered severance pay. Severance is taxable compensation income to the employee under 561 of Internal Revenue Code of 1986, as amended {the "Code"). eth Ramella, TC Memo 1979-77. In Carragan v. Commissioner, F.2d 246 (2nd Cir. 1951), the court found that severance eras made to an employee upon liquidation of the corporation tituted taxable income, even though the employer had no 3ation_to make such payments. Consequently, there is a imption that any payments from an employer to its employees, zer in cash or in property, are paid as compensation for :ces rendered by the employees. In addition to being taxable Compensation, any payments by an employer to an employee on account of an involuntary ~ nation of employment constitutes "wages" subject to oldinq, regardless of whether the employer is legally bound ke such payments. Treasury Regulation ("Reg.") §31.3401(a)- 4). Consequently, the appropriate amount of Federal and i income and payroll"-taxes must be withheld from such nts. If the Camps are transferred to Hamakua Housing and ire transferred to the Occupants, there is the potential :he Internal Revenue Service ("IRS") may contend that the ~t of the camps constitute severance pay to the Occupants. h event, the fair market value of the Camps would Lute taxable income to the Occupants and be subject Federall wait income taxes. In addition, Hamakua Sugar would be ed to withhold the appropriate amount of income and payroll based upon the fair market value of the Camps. The IRS may ontend that Hamakua Housing is acting as an agent on behalf skua Sugar. The IRS's argument would be that the substance ' transaction is the same"as if the Camps were transferred iy from Hamakua Sugar to the Occupants. If the IRS is in this "agency"argument, there is also a possibility ie "responsible" officers of Hamakua Housing would be illy liable for the full amount of any taxes not withheld ese "wages". ~ X~l'h 81 t ~ If the receipt;of the Camps is deemed to constitute verance pay, the net effect to the Occupants and Hamakua using will be dependent on the value of the Camps and the .come of the individual Occupants. At the minimum, the Camps is ;rth what was paid by Bishop Estate or approximately 5700 per :re. It is likely, however, that the Camps is worth gnificantly more than that amount because it will be subdivided :to residential lots and will have an infrastructure in place. the time of the initial conveyance, however, the value of the imps have not been maximized since the Camps have not yet been :bdivided. The other variable is the tax situation of each :cupant. If an Occupant has little or no other income, there :y not be a significant amount of tax due even if the Camps are ~emed to constitute severance pay. Due to the lack of ~mparable properties and the different tax situation of each :cupant, it is difficult to evaluate with any accuracy the <posure to Hamakua Housing. In addition to potential adverse tax consequenc~,s to ze Occupan_ts, the transfer of the by Hamakua Housing may also ~o adze its tax-exempt. status. Code §501(e_)(3) prohibits any _.-T - f an organization s net earnings from inuring to the benefit of zy_ priSta~@.individual. Similarly, Reg. §1.501(c)(3)-1(c)(2) :ovides that an organization is not operated exclusively for Kempt purposes if its net earnings inure to the benefit of =ivate shareholders or individuals. Since members of Hamakua Musing's board of directors will receive Property, there is the ~tential that the transfer of the Property to the board of irector Occupants may constitute an impermissible private zurement or private benefit. Hamakua Housing's application for tax exempt status, ~wever, has established that the ccu ants are a charitable :ass and that the provision o~housi g_~r~he_O~~upants_furthers imakua Housing's exempt_~u~go~e. in the context of resident ~uncils operating u`r the of Low Income.Housinq Preservation ld Resident Homeownership Act, ~,he IRS has_recognized..that there rio_private benefit merely because members of the resident ~uncils receive houses. In summary, there is some risk that the conveyance of le Camps or the Property to the Occupants could be treated as :verance pay and that Hamakua Housing could be viewed as an ~ent_of Hamakua Sugar. ~f._this were to occur_,_each Occupant Auld be liable for the tax based on -the fair market value of the smps or the Property. in addition, Hamakua Housing and its. 'ficers may be secondarily liable for the failure to withhold ich tax. -4- ~Y~t-I1 F111 LOr'~""~ a. Advantages. (1) Landlordi'Tenant. See discussion above. (2) Control. See discussion above. (3) Consideration. S^nce the Property would be conveyed before the subdivision_process is complete, Hamakua Hov„~iag_.nt~~still be able to charge a monthly fee to She Cccupants. This fee could be the same as the nonthly rent which is currently being charged, but characterized as payment for the purc_hgsp.of the Property. The more that payments are characterized as purchase price for the Property, the less li)c_elihood that a severance pay is_.ve will arise. For exanple, if 8100 per. month _is all_q~atgd towards .z~e_ purchase price of a House and it takes three years until subdivision is completed, a total of S3~6QD. will be paid towards the purchase price. If it is determined that the receipt of .he Property is severance pay, the additional income to the Occupant will be limited to the. d'i'fference between--*_he fair market value and the $3,600 paid by ~t:ie- Occupant . b. Disadvantages. (1) Tax. See discussion above. There may be more of a seve=ante pay issue under this alternative since the Property will be immediately conveyed to the Occupants. (2) Conveyance. Under this alternative, the Property would be conveye¢ t,o the Employees prior to subdivision. This is in violation of the Hawaii County Code which prohibits the sale of ur..,ubdivided real prope_ty. The purchaser of unsubdivided real property will have the right to r'~5'Cind tte transaction. In this case, i*_.is_unli:;ely that the Occupants will rescind the transactior. because they will be receiving the Property for little o~ nc consideration. e 's risk, however, that if chalie_nged, all___of the agreements of sa a may be voided by a count. If this__were £o occur, it is possible that a C~~;,~t could find that the 0 currants are actuall_ items cf Ha:na~ua Housing since there is-no-bin~lnq~a ~ -'n a -t. Sec discussion above regarding Landlord/Tenant issues. Although the agreement of sales will convey a Property to each Occupant, the Cccupar.t will be unable t_o reconvey, mortgage cr otherwise transfer or enccmber the Pzcperty due to the lack of a legal description of the Property. This may result in,reser.tment among the Occupants, 3s they may feel entitled to an unrestricted ability to deal with the Property. 3. Transfer of Houses to the Occupants :mmediate).yfTransfer Lots to the Occupants Upon Subdivision (Alternative 3). The third alternative is for each Camp to be transferred from Hamakua Sugar to Hamakua Housing. Hamakua Housing would than immediately transfer the Houses to the Occupants, so that the Occupants would own-the personal property, but not the real property. At the same time, Hamakua Housi__g_would enter into sales-agreements with the Occupants to transfer the I.ats to the Occupants upon the subdivision of the Lats. Once the subdivision process is completed, Hamakua Housing would convey the Lots to the Occupants and would convey the common areas to a nonprofit corporation formed for each Camp. a. Advantages. (1) Landlord/Tenarst. The Residential Landlord-Tenant Code applies to the rental of dwelling units, which are defined as structures which are used as a home, residence Or sleeping, glace. Since the Houses will be conveyed to the Occupants, there will be no rental cf dwelling units involved. Thus, Hamakua Housing will not be subject to the Residential Landlord-Tenant Code. See also discussion above. (2) Control. Hamakua Housing will retain title to the :.ozs which will allow it to complete the subdivision process. See also discussion abo•re. (3) Consideration. Since the Lots .sill still be owned , by Hamakua Housing until the subdivision process is complete, Hama;cua Housing may be able to charge a monthly fae to the Occupants. Instead of rent, this fee could be characterized as payment for the purchase of the Property. See discussion above. b. Disadvantages. (1) Tax. See discussion above. There may be more of a severance pay issue under this alternative since the Houses mill be immediately conveyed to the Occupants and a Contract fcr .he conveyance of the Lots will be immediately executed. C-~C4~'t6t7 ~.a~T~,~ut=o -7- t • There may also be some risk of an impermissible private -ement or private benefit resulting from the transfer of the ~erty. The presence of an impermissible private inurement or gate benefit could cause the IRS to ra a Hamakua Housing's exemption under Code §501(c)(3). If this were to occur, skua Housing would jeopardize its present and future funding n_the Federal and State governments, as well as from private -exempt nonprofit organizations. In order to resolve these issues, we recommend that akua Housing apply for a private letter ruling from the IRS. advantage of applying for a private letter ruling is that a o_rable ruling from the IRS will allow Hamakua Housing to carry this,_alternative without the fear of-~~verse tax .sequences. The d~sad~vantaae of applying for a private letter .i'ngis-the time (at least 9 months, unless Congressional Distance is received)`and,expense (approximately..S10,000- 1.000• plus filing fees of ;2,500) of. .obtaining such a ruling. addition, there is no.guarantee that a favorable ruling will obta;.ned. If the IRS,d_oes not issue a favorable ruling, nakua Housing wi~3 be p nt;. +~ed from transferring the Property _the__O.cGup.ants . (2) Title. Since the Occupants will each hold title _ _the Camps,, their undivided inte~rest_will_be subject to the ens of the Occupants' creditors. For example, the IRS or any her creditor could impose a ~j~l on an Occupant's interest.in e Cam~:~ Unless the lien_was removed, each Occupant's Property uld be subject to the lien upon conveyance of the Property to e Occupants. In addition to potential problems with liens on the mps, it will be time consuming and costl.~ to_obtain title ports for the Camps, since there will be numerous ociners on tle. - - Transfer of Property to the Occupants on an Aareementof Sale (Alternative 2). The second alternative is for each Camp to be transferred =om Hamakua Sugar to Hamakua Housing. Hamakua Housing would 1g~~mmed.iately transfer. the Propezty...ta._eac'h.-Qgcupant on an - 3reement.of sale. Hamal~ua.~ousng would continue to pursue- ibdivision of the .Camps pursuant to a management agreement with ze Occupants. Once the subdivision_~rocess_is completed, 3makua Housing would convey legal title to the Property to the ~cupants and would convey the common areas to a nonprofit ~zporation formed for each Camp. -5- ~~-h1~ 1~ C..6v~wr`-e..pl • ECOMMENDATION All three alternatives have significant tax issues dealing rimariTy""faith severance pay. In addition, there is the ~tential for personal liability for the officers of Hamakua ousing. In order to resolve"these tax"issues, we recommend ~pTying for a private letter ruling from the IRS. The primary disadvantage of alternative 1 is the potential or creditors to place liens on the Camps. The primary isadvantage of alternative 2 is the potential for Hamakua ousing. to be deemed to be the landlord, due to the invalid ~nve~ances_..to. the Occupants. Alternative 3 appears to be the Est preferable because it avoids the foregoing disadvantages of lternatives 1 and 2.