Land Held in Profit Sharing Plan will not sell

[Pixie]

I have a 12 participant profit sharing plan that acquired land as an asset 15 years ago. For the last 7 years, the land has been for sale. The state wanted to purchase the land as part of highway expansion but then backed out a couple of years ago leaving the trustees shocked. They have wanted to terminate the plan for about 7 years as well.

The plan also has an investment fund that is used to cover the administrative expense of holding the land until it sells. The investment fund has dropped to 1/2 it's value. The land is appriased for 2 million and there is $200,000 left in the investment account. We have two retirees and a recent death benefit claim. However the trustees need to conserve the investment account to pay for the $16K to $20K it costs to cover all of the ERISA requirements (annual appriasal, 2 million dollar bond, TPA fees) and local taxes.

So my question is, how do we legally cover the benefit cliams for our two retired people and our beneficiary without using up all of the cash flow needed to maintain the land until it sells? Worst case scenario is that it takes five more years to sell the land and thus at least $100,000 is needed in cash reserves.

Thanks.

[J Simmons]

Pixie, you'll need some 'dust' to handle this one. The plan fiduciaries are between a rock and a hard place.

You could distribute undivided interests in the land. For example, if an employee's share of the land is 1/18th, the Plan Trust could deed an undivided 1/18th interest in the land to the distributee. Then you'd payout 1/18th of the cash as well. Problems: 1-the former employee will be taxable on the value and not have cash with which to pay the tax obligation (ought to make for a happy former employee), and 2-when a sale does come along, you'd have to get that former employee to agree and sign off for it to happen.

The Plan Trust could apply for a loan with nothing due for 5 years when it is all due in one lump repayment, putting the land up as collateral. Then with the cash proceeds you payout the former employees. Problems: 1-the former employee might need to agree, depending on whether the plan document gives him the right to in-kind distribution or not, and 2-the remaining employees are now seeing their benefits decrease due to the interest accruing on the loan to pay the former employees out.

Thirdly, if cooperative the former employees might agree to leave their benefits in the plan for a time, giving the plan time to sell off the land.

Beware that if you sell or lease the property to do so in an arm's length transaction with someone that is a stranger to the plan. You wouldn't want to back into a prohibited transaction while trying to correct the liquidity problem.

There are some PLRs from the IRS that allow for a minimal amount of development activity on property to get it to the point that it will sell so that the plan then has the liquidity to meet the benefit payment obligations. Those PLRs should be carefully examined and a legal opinion obtained before you undertake any development steps on the property. Otherwise, you might incur UBTI (unrelated business taxable income).

Finally, in evaluating what to do, you might want to consider the implications are for the ERISA fiduciaries to this plan of taking any steps--or not taking them.

[Pixie]

Thank you. That is helpful. I like the option where everyone agrees to hold tight for now.

The loan option is a great idea for down the road if the cash account is running low.

Is there anyway that the land could be distributed from the plan into a tax qualified trust or IRA where the owners are the former participants? It would reduce the annual expenses by $10K.

[J Simmons]

Pixie, one thing I should have mentioned earlier about the Plan borrowing money putting the land up as collateral, particularly in the context of the limited development that might be necessary to sell the land. If the borrowed $ is used to improve the property, then you have another UBTI challenge to deal with under IRC section 514©.

As for a tax qualified trust, I don't know of one that you could use.

Each distributee could roll over to an IRA his or her undivided interest in the land assigned to him or her by the Plan. They could not do so on a group basis because IRAs must be owned only by a one person. One problem you will then have is that you would not only need each such former employee to sign off on a potential sale of the property, but also each IRA custodian.

[jpod]

Pixie: Would this accomplish the annual savings you're seeking to achieve? Step 1: Plan contributes the land into an LLC, along with some cash to cover expenses for a period of time; Plan is 100% owner of LLC. Step 2: Plan terminates, and distributes membership interests in the LLC to the participants (along with their respective shares of the liquid assets). Step 3 (Step 3 can differ from one participant to another): Participant pays tax on the value of his membership interest in the LLC. Alternatively, participant rolls over his membership interest to an IRA (assuming participant can find an IRA custodian willing to hold it in an IRA, which might not be too difficult). As long as neither the IRA-holder nor his or her relative is earning fees from managing the LLC or the underlying real estate, there should be no prohibited transaction in connection with this.

Prtnership tax returns for the LLC must be prepared and filed. Therefore, the annual savings may be reduced (although a partnership tax return for an LLC that does basically nothing except hold land should not be too expensive).

[masteff]

Prtnership tax returns for the LLC must be prepared and filed. Therefore, the annual savings may be reduced (although a partnership tax return for an LLC that does basically nothing except hold land should not be too expensive).

Certainly less than the current costs of ERISA compliance.

[J Simmons]

Pixie: Would this accomplish the annual savings you're seeking to achieve? Step 1: Plan contributes the land into an LLC, along with some cash to cover expenses for a period of time; Plan is 100% owner of LLC. Step 2: Plan terminates, and distributes membership interests in the LLC to the participants (along with their respective shares of the liquid assets). Step 3 (Step 3 can differ from one participant to another): Participant pays tax on the value of his membership interest in the LLC. Alternatively, participant rolls over his membership interest to an IRA (assuming participant can find an IRA custodian willing to hold it in an IRA, which might not be too difficult). As long as neither the IRA-holder nor his or her relative is earning fees from managing the LLC or the underlying real estate, there should be no prohibited transaction in connection with this.

Prtnership tax returns for the LLC must be prepared and filed. Therefore, the annual savings may be reduced (although a partnership tax return for an LLC that does basically nothing except hold land should not be too expensive).

In structuring the control of the LLC, what would the ERISA fiduciary duties be on the Plan Administrator/Trustees? Plan beneficiaries would be going from having a right to a benefit under a plan controlled by those under ERISA fiduciary duties, to having a minority interest in an LLC where the majority interests can cause a sale? Would the fact that the minority interest would be worth less than its proportionate share of the entire LLC (due to minority interest discounts) be problematic? Maybe Peter will have some special insight.

[jpod]

JSimmons: Good questions. However, I was suggesting that the LLC be in an ERISA environment only for an instant in time. Also, as a practical matter I don't see how valuation would be an issue because nobody would do anything with their LLC interests until the land is sold, and then the LLC would be dissolved and the proceeds distributed.

[masteff]

Of course the LLC option doesn't completely fix one factor in the OP:

We have two retirees and a recent death benefit claim.

The death benefit is partially solved by the distribution, except for it being non-cash and therefore payment of taxes could be a problem for the beneficiary.

As to the retirees, past discussions on this board make me all the more aware of the problem of MRDs and illiquid IRAs.

We ultimately come back to the need for the land to be sold. I might wonder what asking price they have on the land and whether they have it priced above the appraisal in hope of profiting from a speculator or developer buying it. And then I'd have to wonder if that's actually in the best interest of the plan.

[J Simmons]

I have a 12 participant profit sharing plan that acquired land as an asset 15 years ago. For the last 7 years, the land has been for sale. The state wanted to purchase the land as part of highway expansion but then backed out a couple of years ago leaving the trustees shocked. They have wanted to terminate the plan for about 7 years as well.

The plan also has an investment fund that is used to cover the administrative expense of holding the land until it sells. The investment fund has dropped to 1/2 it's value. The land is appriased for 2 million and there is $200,000 left in the investment account. We have two retirees and a recent death benefit claim. However the trustees need to conserve the investment account to pay for the $16K to $20K it costs to cover all of the ERISA requirements (annual appriasal, 2 million dollar bond, TPA fees) and local taxes.

So my question is, how do we legally cover the benefit cliams for our two retired people and our beneficiary without using up all of the cash flow needed to maintain the land until it sells? Worst case scenario is that it takes five more years to sell the land and thus at least $100,000 is needed in cash reserves.

Thanks.

Who made the decision to put so much of the plan's assets into the land? If it is the trustee rather than the employer, it may behoove the employer to replace the trustee that did not diversify the investments in the plan. Those that made the decision to invest so heavily in a single tract of land might want to get the advice of ERISA counsel about what liabilities they may have.

[Peter Gulia]

Whether to continue or end a retirement plan is the plan sponsor’s creator or “settlor” decision. How to implement the plan termination that was so decided is the plan fiduciary’s decisions. And even if the plan isn’t terminated, a discretionary decision about what to do to make it feasible for the plan to pay or deliver distributions that are due is a fiduciary decision.

If the plan’s circumstances focus attention on the plan’s lack of assets easily redeemable for money, an important step for a fiduciary might be to carefully consider whether he or she must or should recuse himself or herself from decisions about the land and other plan investments. A fiduciary who participated in the original decision to buy the land, one who didn’t act in response to under-diversification, or one who continued the plan’s investment decisions in recent years might have a conflict of interests. A fiduciary should not allow a situation in which his or her duty now to do what’s in the exclusive best interests of the plan and its participants could be compromised or influenced by his or her personal interest in diminishing his or her personal liability, or even by concern about mistaken perceptions.

A better course might be to appoint an independent fiduciary to decide what the plan should do with its land and other assets needed to maintain and manage the land.

John Simmons and others also are right to suggest that, whether it’s interests in land or interests in a trust or limited-liability company that owns land, a plan fiduciary should consider carefully all relationships, including governance and management of all organizations and entities involved. In particular, a fiduciary must consider whether a change in a form of ownership or legal rights advantages or disadvantages each stakeholder, and whether some might be affected differently than others. Beyond finding an absence of a prohibited transaction, a plan fiduciary must do these reviews as a part of his or her evaluation of whether a proposed transaction is or isn’t in the plan’s and its participants’ best interests, and if (as seems likely) there are conflicts among those interests, that the course of action is fair across those different interests.

Some people might wonder whether it’s smart for the plan to incur an expense for an independent plan fiduciary’s services. But if the land really is worth about $2 million or more, paying something to conserve and protect the plan’s assets should be worthwhile. Moreover, such an expense for an orderly wind-up of the plan might be less than the expense of continuing the plan’s administration.

[J Simmons]

JSimmons: Good questions. However, I was suggesting that the LLC be in an ERISA environment only for an instant in time. Also, as a practical matter I don't see how valuation would be an issue because nobody would do anything with their LLC interests until the land is sold, and then the LLC would be dissolved and the proceeds distributed.

Right, but it would be acts by the ERISA fiduciaries in that moment that put the plan participants into those positions with their benefits after the LLC ownership interests are then distributed out of the plan. For example, if I am an EE and receive 10% interest, I'd rather have it as a 10% undivided interest in the land than 10% ownership in an LLC. The reason is that if I think the others are about to sell the land for too little, I can stop the sale with a 10% undivided interest (unless the buyer is willing to buy just the other 90%). However, if I'm then holding 10% LLC units, the other 90% could out vote me and sell the land for what I think is too little. This dynamic would be foisted upon me by reason of steps taken by ERISA fiduciaries.

[Peter Gulia]

It's possible for an owner's interest to be worth less because of how decisions might be made by others. But it's also possible for an undivided interest that's not subject to others' management or control to be worth less because of a difficulty in assembling that interest with others' interests. These and many other considerations about how different kinds of ownership rights can affect value are a part of a fiduciary's evaluation.

[jpod]

We may be going off the deep end here vis a vis fiduciary liability. Although the stated facts are that the land lost half its value, Pixie said that it was acquired 15 years ago. If the land was purchased for five cents (figuratively speaking), the fiduciary who made the decision to purchase it might be a hero rather than someone who should fear for his or her own liability.

[J Simmons]

We may be going off the deep end here vis a vis fiduciary liability. Although the stated facts are that the land lost half its value, Pixie said that it was acquired 15 years ago. If the land was purchased for five cents (figuratively speaking), the fiduciary who made the decision to purchase it might be a hero rather than someone who should fear for his or her own liability.

Even if bought for 5 cents, to be so heavily invested in one asset and not diversified is a problem, as the OP illustrates. Also, the fiduciaries' performance is not tested merely against disposition proceeds versus purchase price, but also whether it was prudent at each given point in time along the way to dispose of it.

[jpod]

How would there be a diversification issue if (a) they've been trying to sell the land for 7 years, and (b) the reason for the lack of diversification is attributable to fantastic appreciation in value of the real estate rather than an investment decision?

Also, to address someone else's comments, I realize that MRDs are a potential problem, but it would be an even worse problem for the ERISA plan fiduciaries if it had to use up all the plan's liquid assets to satisfy one or two participants' MRDs.

[J Simmons]

How would there be a diversification issue if (a) they've been trying to sell the land for 7 years, and (b) the reason for the lack of diversification is attributable to fantastic appreciation in value of the real estate rather than an investment decision?

Also, to address someone else's comments, I realize that MRDs are a potential problem, but it would be an even worse problem for the ERISA plan fiduciaries if it had to use up all the plan's liquid assets to satisfy one or two participants' MRDs.

If they were trying to sell for 7 years and did not, they were likely asking more than the fair market value for the land. Very admirable that they did not want to 'leave money on the table' and under sell it. However, the 'old college try' does not exempt one from liability for fiduciary breach. Only acting prudently under the circumstances at the time does.

It isn't fun being a trustee. Peter's suggestion about now getting an independent fiduciary to manage and find a solution to the current quagmire is a sage one.

[A Shot in the Dark]

Pixie is a collegue of mine. Perhaps a further explanation may shed some light.

The land was purchased for less than $10,000.00. Until 2004, or so the appraised value of the land generally represented less than 10%of the total assets held in the Plan.

The land has been for sale for a number of years at the indepently appraised value. An appraisal has been completed on an annual basis.

As luck (good or bad) would have it, this piece of land is directly in the middle of a public works project.

An offer to buy the land was made in 2004. As the offer was being made, the State came through and froze all sales of real estate with in this public works project area.

Through 2004 or so the appraisal of the land was near or around 300k.

Then the state made a ridiculous offer on the land ($3,000,000 or so) and froze all transactions unitl the project was funded. Natuarally the appraisal came in near the offer price. The written offer of purchae for $3,000,000.00 from the State is still valid subject to the project being funded.

In the meantime, the state has released the area for transactions.

Combine that with a loss of 30% on the other assets held in the Plan (mutual funds and bonds), now you have a map as to how we have arrived at this issue.

[J Simmons]

... Natuarally the appraisal came in near the offer price.

The appraisal didn't factor in the complications you mention of land sale freezes and state project funding contingencies? It just took the clouded offer at its face value?

[A Shot in the Dark]

John:

I don't know about the appraisal that was completed for the year in which the offer was made.

Obviously, the appraisals since then have reflected the issues noted.

[A Shot in the Dark]

I really would like to thank everyone who posted.

As an update to this issue, on Friday May 8, 2009 the Plan Trustees were notified that the public works project received its funding.

This morning, the State Department of Transportation contacted the Plan Trustees and made a revised offer of 2.2 millon dollars. This amount is higher than the last independently appraised value. The Trustees are speaking with ERISA counsel. If all goes well they will sign documents later this week.