Real Estate Distribution

[Guest ERISA?]

A client wants to terminate his Profit Sharing Plan. Only asset is a Real Estate, that has a mortgage on it. Current market value is less than outstanding principal on mortgage.

In this case, it appears that the net distribution is $0, with the client holding the property outside the plan now with $0 cost basis. If and when it is sold, the full sale price would be taxable as capital gains.

Do you see anything wrong with this logic? How do we issue a W2-P for $0?

[Guest Sieve]

Who is the mortgagor? Who is the mortgagee?

[Guest ERISA?]

Who is the mortgagor? Who is the mortgagee?

Mortgagor -- the plan

Mortgagee -- a bank

[Guest Sieve]

I assume this is a 1-participant plan.

How does the plan make a distribution of the real estate (i.e., change the name of the owner from the trustee to the participant) without the bank foreclosing and selling the asset to pay the motgage?

[Guest ERISA?]

I assume this is a 1-participant plan.

How does the plan make a distribution of the real estate (i.e., change the name of the owner from the trustee to the participant) without the bank foreclosing and selling the asset to pay the motgage?

Yes, one-participant plan, and the plan will be terminated. The participant/owner has arranged with bank for the participant to take over the mortgage. (For various reasons external to the plan, it is the best interest of the participant and the bank to stay co-operative on this.) So the name of the owner of the property will go from Joe Smith, Trustee of Joe Smith plan, to Joe Smith.

[Kevin C]

Depending on how the plan got into this condition, you may have other more serious issues.

How does a plan end up with the only asset being mortgaged real estate where the market value is less than the outstanding mortgage? What happened to the rest of the plan assets?

Who did the plan buy the real estate from? Was the purchase price no more than fair market value at the time? Is the participant using or living in the real estate?

[Guest Sieve]

I, too, have concerns along the line of Kevin C's. The fact that you indicate that there are "reasons external to the plan" that cause it to be in "the best interest of the participant and the bank to stay co-operative on this" makes me believe that there may be some PT here--i.e., some considerations that are not arm's length and not limited to a plan/participant transaction, but something more. How were payments on the mortgage made if there's no cash in the plan--or is that the reason the plan is terminating and making the distribution?

If the purpose of the real estate investment was to obtain a piece of property that would remain undeveloped until the participant/owner decided to terminate the plan so that distribution of the property could occur and allow the participant to build his/her retirement home there, then we have a problem, Houston--especially if the real estate was an investment of the plan, but other participants were paid cash and the real estate was left for ultimate distribution to the owner. Or was the real estate always segregated for the owner, but others did not have the opportunity to self-direct?

And, where did the property tax payments come from?

[Guest ERISA?]

It has always been a one participant plan, so there is not an issue re: other participant's assets.

The property was purchased for fair market value at the time -- but as you are well aware, property values have fallen in many locations.

Contributions had been made to the plan in the past which paid the mortgage payments and real estate taxes.

And yes, there have been discussions re: UBTI.

Now the issue is -- with the plan terminating, what is the amount of the distribution -- $0 appears to be the only logical answer. But would appreciate any differing opinions on that piece.

[J Simmons]

Since the plan did not sell the RE, it is logical that the plan has not realized any gain to be UBTI prior to the distribution.

If the RE is transferred as part of a distribution to the participant, subject to the mortgage, the plan is being relieved of an obligation beyond the value of the RE. That could be taxable income to the plan per IRC 108 and thus possibly UBTI under IRC 512-514. I've never run across that situation, but following that logic, would the UBTI liability follow the property out of the plan into the hands of the participant?