Loading...
HomeMy WebLinkAboutCOM 0458.003 1996-1998 ~ 1 CONFIDENTIAL MEMORANDUM CIF ' I TO: HOARD OF DIRECTORS HAt~iAICUA HOUSING CORPORATION ~ _ ,,.~5 PROM: A. SCOTT LEZTHEAD ~Y-_ STEVEN L.F. HO DnM ~a _li~:]__.__._. County Counul 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 =ompleted, 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 HousS.ng Corporation ("Hamakua Housing"). Hamakua Housing would immediately transfer each Camp to all Occupants within each 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~.. ,rte - `~~5;~-• d3 EX Ref. Tu: FresP~re,~ ~al,~ c i ~ kte¢. Date ~ 1 7 ~ ANALYSIS 1. Transfer of Camps to the Occupants as Tenants in Common (Alternative 1). The first alternative is for each Camp to be transferred `rom 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 Which he resides until the subdivision of the Property in a particular 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 Management agreement with Hamakua Housing which would allow amakua Housing to manage and subdivide the Camp. E~rh Occu ant ould also rant to Hamakua Housing an irrevocable power of ttprnev wh i c wn„~n,.r~t- ---4-~ n e ~CBC~Z'r}~ ocuments necessary to subdivide and convey the Property. The o~ reas 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 would be-~ landlorr3 and would _ case the Property to t e ccupants un 1 e a P8'-- i ivided. As a an or , ama ua i g wou ave certain - ~ igations 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.11 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 ligatio_ns 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- ~ant 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 >ponsibility 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- III ::pant granting Hamakua Housing a power of attorney to deal the Camps. As a general rule, a power of attorney is ocable 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 particular case the "interest" would be - akua Housing s transfer of the ComDS to the Occupants (i.e., sKUd Housing would not transfer th amnG c he Occu ap nts =ss it receives the irrevocable power of attorney from the ipants b. Disadvantages. (1) Taxi Payments made from an employer to an ogee, 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 ents 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, ier 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 olding, 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 zts. If the Camps are transferred to Hamakua Housing and ire transferred to the Occupants, there is the potential :he Internal Revenue Service ("IR5") may contend that the ~t of the camps constitute severance pay to the Occupants. h event, the fair market value of the Camps would tute taxable income to the Occupants and be subject Federali waif 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 akua Sugar. The IRS's argument would be that the substance ' transaction is the same as if the Camps were transferred .y 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 ere "wages". CX~h~li ~ a . 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 Occupants, the transfer of the by Hamakua Housing may also ~o ar~cize~its tax-exempt. status. Code $501(c.)(3) prohibits any E- an organizaf_ionTS net earnings from inuring to the benefit of }y_ priya~~.indiyidual. Similarly, Reg. g1.501(c)(3)-1(c)(2) :ovides that an organization is not operated exclusively for tiempt 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 iurement or private benefit. - Hamakua Housing's application for tax exempt status, ~wever, has established that the ccupants are a charitable bass and that the prov_ysion o~housing.~_the_O~~upants..furthers smakua Housing's exempt.~u~po~Q. In the context of resident ~uncils operating under _the. of Low Income_Hous.ing Preservation zd Resident Homeownership Act, the 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 Ze 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 zuld be liable for the tax based on the fair market value of the imps or the Property. In addition, Hamakua Housing and_ its. ficers may be secondarily liable for the failure to withhold ich tax. -4- Ct~t-t'1 F111 ~-rlh-~".`ee~t a. Advanta4es. (1) Landlord/Tenant. See discussion above. (2) Control. See discussion above. (3) Consideration. Snce the Property would be conveyed before the subdivision process is complete, Hamakua fio„~,:iag_~gy_still be able to charge a monthly fee to S~*e Cccuoar~ts. This fee could to the same as the monthly rent whict^. is currently being charged, but characterized as payment for the purch~sp.of the Property. The more that payments are characterized as purchase price for the Property, the less likelihood that a severance pay is_.ue will arise. For example, i'f 8100 per. month _is__a1~9ca~gd towards _the_ purchase price of a House and it takes three years until subdivision is completed, a total of S3, 6Q D. will~be paid towards the purchase price. If it is determined that th_e receipt of the Property is severance pay, the additional income to the Occupant will be limited to the. di~~ference between-the fair market value and the X3,600 paid by ~t:ie-Occupant . b. Disadvanta4es. (I) Tax. See discussion above. There may be more of a severance pay issue under L•his alternative since the Property will be immediately conveyed to the Occupants. (2) Conveyance. Under this alternative, the Property ' would be conveyed to the Employees prior to subdivision. This is in violation of the Hawaii County Code which prohibits the sale of ur..subdivided real property. The purchaser ~ unsu=ivided real property will have the right to rind the transaction. - In this case, i*_.is_unli:;ely that the Occupants will rescind the transaction. because they will be receiving the Property for little a~ no consideration. T e `s risk, however, that if chalie_nged, a.ll__of the agreements of sa a may be voided by a court. If this__were to occur, it is possible that a c~y~.t could find_ that the 0 cu~ants are a_ ctual ~ ..~~nts of„ec Hamakua Housing since there i5 -no' bi "'n a ` discussion above regarding Landlor /Tenant issues. Although the agreement of sale will convey a Property to each Occupant, the Cccupar.t will be unable to reconvey, mortga3e cr otherwise transfer or enccmber the Property due to the lack--of a legal description of the Property. This may result in resentment among the Occupants, as thay ma}~ feel entitled to an unrestricted ability to deal with the Property. c::~,ac.~.~r - G- t ~ 3. Transfer of Houses to the Occupants Immediately/Transfer 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 thin 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 Housis nq would enter into sales-agreements with the Occupants to transfer the I.ats to the Occupants upon the subdivision of the Lots. 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/Tenant. The Residential Landlord-Tenant Code applies to the rental of dwelling units, which are defined as structures which are used as a home, residence oz 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 i.ots which will allow it to complete the subdivision grocess. See also discussion above. (3) Cansi.deration. Since the Lots ~+ill still be owned , by Hamakua Housing until the subdivision process is Complete, Hamakua Housing may be able to charge a monthly fee to the Occupants. Instead of rent, thfs 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 .*e conveyance of the Lots wi12 be immediately executed. EjCt~I'16t? ~~1'f~~vu~~ Y L w There may also be same 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 rP a Hamakua Housing's exemption under Code §501(cj(3). If this were to occur, gkua 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 oral~le ruling from the IRS will allow Hamakua Housing to carry _£hs_alternative without the fear of.s~verytax .sequences. The disadv~ A of applying for a private letter .ingis"the time (at least 9 months, unless Congressional ;istance is receivedj'arid.expense (approximately .510,000- i~ OOO• plus filing fees of ;2,500) of..obtaininq such a ruling. addition, there is no.guarantee that a favorable ruling will obtained. If the TRS.doe_s not issue a favorable ruling, nakua Housina'w~ i!~e jj,~o +h; fed from transferring the Property _the__O.c~upants . (2) Title. Since the Occupants will each hold title _ _the Camps, their undivided interest will be subject to the ens of the Occupants' creditors. For example, the IRS or any her credifor could impose a lye o_ n_an Occupant';~.interest_i n e Cam_p.~ Unless the lien .was removed, each Occ_upant'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 cost to obtain title orts for the Camps, since there will be numerou's owners on tle. Transfer of Property to the Occupants on an Acreement of Sale {Alternative 2). The second alternative is for each Camp to be transferred :om Hamakua Sugar to Hamakua Housing. Hamakua Housing would Z~~mmed.iately transfer. the_ Pro~erty...ta._each._Q~cupant on an ~reement. of sale. Hamal~uA ~El~usng would continue to pu'=sue- ibdivision of the Camps pursuant to a manag'eme'nt agreement with Ze Occupants. Once the subdivision_Qrocess_is completed, smakua Housing would convey legal title to the Property to the ~cupants and would convey the common-areas to a nonprofit ~rporation formed for each Camp. -5- A ~ r ECOMMENDATION All three alternatives have significant tax issues dealing ~imariTy-'with 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 ?prying 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 lsadvantage of alternative 2 is the potential for Hamakua ousi_t~g.to be deemed to be the landlord, due to the invalid ~nveYances_.,to.She Occupants. Alternative 3 appears to be the Est preferable because it avoids the foregoing disadvantages of _ternatives 1 and 2. ze.we -8-