Month: February 2016

Advantages of the Tenant in Common Arrangement

Tenant-in-common ownership, sometimes called tenancy-in-common, is a method of holding title to property involving multiple owners. When a tenancy-in-common arrangement is created, each individual owner, called a “co-tenant” or “co-owner,” owns an undivided interest in the property.

Typical Tenant-in-Common Interest

tenant in common investment
Typical tenant-in-common agreements involve many individuals who each own a fractional interest in a property.

A typical tenant-in-common (“TIC”) interest involves a number of parties, generally unknown to each other, who each own an undivided tenancy-in-common interest in real property.

There can be any number of co-owners. Ownership of a TIC allows the investor to own a fractional interest in a property that is typically investment-grade and professionally managed.

Why Tenant-in-Common?

One advantage of TIC investment is the potential for tax-free exchange treatment. In 2002, the IRS issued Revenue Procedure 2002-22, which states that a taxpayer can use a TIC investment, if properly structured, as either relinquished property or replacement property in a qualifying like-kind exchange.
(I covered like-kind exchanges in my previous post, “Understanding IRC Code Section 1031 and Why You Should Care.”)

The relationship among TIC owners is generally controlled by a tenancy-in-common agreement (“TIC Agreement”). Decisions to sell, borrow, or lease a property, or hire property management, are typically controlled by the TIC Agreement.

Additional Advantages

There are other benefits to TIC ownership, including professional property management, diversification, appreciation, and predictable cash flow.  Investors may counter that they can receive these benefits in a partnership structure; however, a partnership interest is considered personal property and cannot be exchanged. (The Internal Revenue Code specifically prohibits the exchange of partnership interests.) However, an LLC or partnership can do a 1031 exchange on the entity level.  This means the partnership relinquishes the property and the partnership purchases a replacement property.

If you are buying a property with another person or persons, KRS CPAs can help you set up a tenancy in common. Give us a call at 201-655-7411 or email [email protected].

Goodwill and Your Business

 

What is goodwill?  How is it measured?  Why is it important?  Goodwill is often misunderstood by owners of closely-held businesses.

An Intangible Asset

According to the American Institute of Certified Public Accountants’ Statement on Standards for Valuation Services, goodwill is “that intangible asset arising as a result of name, reputation, customer loyalty, location, products, and similar factors not separately identified.”

business goodwill
Goodwill includes intangible assets such as customer relationships, trade secrets, reputation and brand.

The Internal Revenue Service defines it as “The value of a trade or business attributable to the expectancy of continued customer patronage.  This expectancy may be due to the name or reputation of a trade or business or any other factor, and in the final analysis, goodwill is based upon earning capacity.  The presence of goodwill and its value, therefore, rests upon the excess of net earnings over and above a fair return on the net tangible assets.”

What does this mean in English?  Goodwill is the value of a business, over and above the value of its identifiable tangible assets.  It is the expectancy of future earnings.  As a simple example, assume a distribution business’s only asset is inventory with a value of $100, but someone is willing to purchase that business for $500. The $400 paid over and above the value of the inventory is payment for goodwill.

The Value of Goodwill

Why would someone pay more for a business than the value of the tangible assets?  Because they expect to use those assets to earn a profit.  In the distribution business or any business, goodwill may include customer relationships, supplier relationships, reputation, location, trade secrets, or any other factor that causes the business to earn income above and beyond a fair return on tangible assets.

How can you create or increase the value of goodwill in your business?

  1. By earning consistent (and hopefully increasing) net income, which is supported by good accounting records.
  2. By establishing consistent and well-documented procedures, which will hopefully support continued future profitability. After all, someone who buys a business is not doing so because of what happened last year, he or she is buying it with the expectation of what will happen next year.

Who Owns Goodwill?

If goodwill is based on customer relationships, is the goodwill owned by the business or the employees who maintain the relationships?  This is an area of controversy because it has significant tax ramifications in the sale of some businesses, but the courts have generally held that goodwill is owned by the employee unless he or she has executed a restrictive covenant or employment agreement with the company.  If no such agreement exists, and the employee is free to work for a competitor and bring the relationship there, then the company does not own the goodwill.  However, if you are considering selling your business and do not have restricted covenants or employment agreements, consider very carefully whether or not they are necessary.

For more information on this subject, please see my article, Business Sales and Personal Goodwill.

For help in valuing your business, give us a call at 201-655-7411, or email [email protected]

 

Understanding IRC Code Section 1031 and Why You Should Care

Hint: it’s about deferring capital gain taxes

1031 exchange
1031 exchanges,also called like-kind exchanges, offer tax benefits when structured properly.

If you think this is one of those dry topics about taxes, think again. It’s important information for anyone selling a commercial real estate property who cares about being protected from capital gains taxes and growing their portfolio.

Continue reading “Understanding IRC Code Section 1031 and Why You Should Care”