Acquisition Mezzanine Financing Strategy
Copyright © 2012 James B. Wootton
8405 Pulsar Place, Suite 157
Columbus, OH 43240
Fax: (614) 355-0186
Acquisition Mezzanine Financing is an agreement based on my patent number 8,175,951, a financing strategy utilizing an interim step of the seller donating a substantial gift portion of a commercial property, a business or other qualified capital gain asset to a nonprofit organization. The ultimate buyer acquires full ownership of the property, company, or other qualified capital gain asset selected for acquisition, utilizing a minimal cash down payment.
The buyer obtains from its own conventional lender a low loan-to-value (LTV) first mortgage on the business collateral and/or real estate to be acquired. The nonprofit provides long term junior financing under a 30-year amortization with a low fixed interest rate, e.g., 2.9%, for the principal portion of the acquisition equal to the amount that had been gifted to the nonprofit in a bargain sale transaction. If the maturity date is not more than 9 years, then the applicable interest rate would be much lower, e.g., 1.95%, but not less than the then current Applicable Federal Rate as published monthly by the IRS. Once executed, the rate is fixed for the entire term, but with no prepayment penalty.
As an example, consider the case of a nonprofit which would enter into a bargain sale contract to acquire an investment property either via a direct deed of real estate and bill of sale for chattels; or as a direct conveyance of an LLC’s capital interests in the case of a limited liability company. The asset has a fair market value of $5,000,000 including a $1,000,000 tax deductible charitable gift from the current owner to the nonprofit.
The nonprofit would simultaneously deliver possession to its ultimate take-out buyer, which, for the sake of this example, we will call ABC Company, at closing, with a monthly payment equal to the sum of the monthly payment for a low LTV first mortgage loan plus the balance calculated by using a fixed rate of 2.9%, but adjusted once only before closing in accordance with the Applicable Federal Rate for 30-year financing for the ultimate buyer. It would be secured by either a second mortgage on the acquired collateral or if preferable, a chattel mortgage on the LLC members’ interests.
If the property’s fair market value were $5,000,000, as determined by an independent qualified appraiser, a 20% partial gift would amount to a tax deduction for the seller of 1,000,000.
Under the IRS’ Bargain Sale rules, as appreciated real property, assuming the asset has been held as long term capital gains property for more than one year, The Owner may be able to deduct the $1,000,000 against ordinary income for up 30% of their adjusted gross income, and if the owner does not use all of the deduction against their ordinary income in the year of the closing, then the seller could carry forward annually any unused portion of the tax deduction for five more years.
Under this scenario the balance of $4,000,000 would be paid to the current Owner in cash at closing with the proceeds from a new 70% LTV first mortgage of $3,500,000 plus 10%, or $500,000 in cash, supplied by the ultimate buyer. The buyer would also include in its payment to the nonprofit an amount equal to the remaining 20%, or $1,000,000, payable under a fixed rate 2.9%, 30-year amortization schedule.
All concerned would benefit in the following ways:
Foremost, the seller (“Owner”) would have the immeasurable satisfaction that comes from making a positive difference in the lives of people, and making the world a better place through its 20% partial gift to the nonprofit organization. The seller gets to write off $1,000,000 as a charitable deduction, plus the seller receives $4,000,000 in cash at closing.
Under its purchase agreement, ABC Company would pay to the nonprofit $5,000,000 for the property which would be payable 80% at closing (70% loan and 10% cash) and 20% in additional fixed rate 2.9%, 30-year financing carried by the nonprofit, adjustable one time only at closing, in compliance with the Applicable Federal Rate as published by IRS on that date, so as not to incur any imputed interest.
ABC Company would be pursuing a 70% first mortgage loan from their lender based on their purchase price of $5,000,000. By qualifying as borrower for the first mortgage loan, ABC Company automatically qualifies for the secondary amount of $1,000,000. This method makes the whole project far easier to complete, and requires less up front capital by ABC Company, because, in essence, the Owner would be making a tax deductible gift, which is usable now, while the nonprofit would then automatically provide an equal amount of secondary financing to ABC Company, over a period of many years at extremely low rates.
Note that if the Donor-Seller had previously negotiated this sale to the ultimate Buyer, then IRS would consider this to be a step transaction (See the Winston F.C. Guest tax court case 77 T.C. 9) and there would be a capital gain based on the fair market value. However the capital gains tax rate is still much lower that the higher ordinary tax rate which will apply to the gift portion so there can still be a considerable net tax savings. If instead the nonprofit itself finds the ultimate buyer, as was found in the Winston F. C. Guest case cited above, then there is no capital gains tax due on the gift portion, and there is still the ordinary income tax deduction for the full gift portion.
About the Author
As a commercial Realtor doing 1031 exchanges for more than 30 years, James B. Wootton has completed many millions of dollars of tax advantaged partial gift real estate transactions for his nonprofit and church real estate clientele and has developed a particular expertise with it. Mr. Wootton has written a book on that subject, which can be viewed in its entirety, for free, online at www.books.google.com by entering the title which is “Real Estate Gift”. He is the inventor of United States patent number 8,175,951, upon which the above system is based.
Biography: James B. (Jim) Wootton holds a Bachelor of Science degree in Business Administration from the Finance Department of the College of Administrative Sciences at The Ohio State University. Since his graduation he has pursued the study of economics with Harvard University Extension School of Cambridge, Massachusetts. He is a graduate of the Realtors Institute.
Engaged in commercial real estate brokerage since 1973, He has negotiated many major property transactions for churches and other nonprofit organizations, including some of the larger transactions in the State of Ohio.
Prior to Establishing Standard Corporation, Realtors in 1999, Mr. Wootton was an investment specialist for RE/MAX Commercial and the commercial division of Century 21 Joe Walker. In this position, he counseled buyers, sellers, landlords, tenants and investors on how to best realize their long-term real estate goals. He developed an extensive knowledge of the market, inclusive of all product types, such as investment, industrial, retail, office, multi-family and vacant land. He was responsible for managing external professional resources including sales & leasing agents, construction project managers, property managers, attorneys, architects, and engineers during the development, acquisition and disposition of real estate for his clients.
Mr. Wootton is a member of the Ohio Business Brokers Association (OBBA), and for nine years was a registered representative with the N.A.S.D. As a business broker he arranged the sale of Workwell Company NKA Volk Protective Products, a leading manufacturer of gloves, to a company headed by Donald Kelley, former chairman of Beatrice Foods. Mr. Wootton, acting as a finder in cooperation with First Boston Corporation, initiated two American Stock Exchange company mergers, both for Snyder Oil Partners, now a division of Devon Energy Corporation (NYSE:DVN).
Jim has served for more than 20 years as a board member of both The Kiwanis Club of German Village and Teen Challenge of Columbus. Since 1999 he has served as President and member of the Board of Trustees of American Community Fund.
He was president of the Columbus Real Estate Exchangers and rose to become president of the statewide Ohio Commercial Realtors Exchange Association. He is a member of the Columbus, Ohio, and National Associations of Realtors, Columbus Commercial Industrial Investment Realtors, Columbus Real Estate Exchangers, and the Ohio Commercial Realtors Exchange Association.
Jim's areas of expertise are: Arranging major gifts of real property for his nonprofit and church real estate clients, obtaining seller financing for investment property buyers, Site selection, Investment Acquisition/Disposition, 1031 Exchange, and Auction.
Existing and past clients include: First Boston Corporation, Guardian Television Network, Reliance Funding Corporation, Evangelical Lutheran Church in America, General Council of the Assemblies of God, and many other individual and institutional investors.
Jim Wootton provides full consulting services for selected businesses, associations and nonprofit organizations in the continental United States to obtain either the major real estate gift for nonprofit organizations; or commercial financing for its for-profit clientele in acquisitions of commercial property or corporate acquisitions, with a $1 million minimum transaction size.
Copyright © 2012 James B. Wootton
8405 Pulsar Place, Suite 157
Columbus, OH 43240
Fax: (614) 355-0186
Acceleration Clause A clause in a mortgage or note providing the lender with the option to declare the entire outstanding balance immediately due and payable in the event of default
Acceptance of Deed The taking of the deed physically by the grantee
Acceptance of Offer The purchaser’s or seller’s agreement to the terms offered by the other party
Accrued Interest Deferred interest which has been earned, but with payment deferred
Acknowledgement A declaration before a notary public of one’s signing of an instrument
Adjustable Rate Mortgage Loan A loan with an adjustable interest rate as determined by changes in a selected index
Agreement of Sale Contract executed by purchaser and seller containing the terms, conditions and provisions of sale under which a property is to be sold
Amortized Mortgage A mortgage requiring periodic payments which will repay the entire loan by the end of the loan term
Appraisal A written estimate of fair market value prepared by an individual who is unbiased and qualified to make appraisals of the property being valued
Assignment The Assignor’s conveyance of right, title and ownership in property to an Assignee
Assumption A method of acquiring real estate in which the purchaser agrees to become liable for repaying the existing mortgage indebtedness
Balloon Mortgage A mortgage loan with periodic payments for a number of years ending with one large final payment for the unpaid balance, referred to as the balloon payment
Blanket Mortgage A mortgage that covers two or more properties
Broker A person who brings purchasers and sellers together and helps to negotiate the purchase agreement
Capital Finance Nonprofit Lease and Sale An agreement with a nonprofit organization in which the lessee eventually acquires full ownership of a property selected for acquisition
Capital Lease Type of lease classified and accounted for by a lessee as a purchase and by the lessor as a sale or financing, if it meets any one of the following criteria: (a) the lessor transfers ownership to the lessee at the end of the lease term; (b) the lease contains an option to purchase the asset at a bargain price; (c) the lease term is equal to 75 percent or more of the estimated economic life of the property (exceptions for used property leased toward the end of its useful life); or (d) the present value of minimum lease rental payment is equal to 90 percent or more of the fair market value of the leased asset less related investment tax credits retained by the lessor. (Also see finance lease.)
Closing The consummation of a real estate transaction when legal documents are executed and funds are disbursed for the purchase or financing of the property; also referred to as the Settlement
Collateral Assets hypothecated as security for a loan
Commission Compensation paid to a real estate broker for bringing purchaser and seller together and negotiating a real estate transaction
Contingency A condition to be satisfied before the parties are legally bound to consummate an agreement
Contract of Sale The written agreement between the purchaser and seller setting forth the price and terms of sale
Conventional Loan A loan not guaranteed or insured by the government
Creditor The party to a finance agreement who has a security interest to the equipment for the term of the contract, and is entitled to the monthly payments
Debtor The owner and user of the equipment that is being financed and required to make monthly payments
Deed The instrument by which title to real estate is conveyed from grantor to grantee. It contains a legal description of the property. It is signed, witnessed, notarized and delivered to the purchaser at settlement
Default Failure to meet the terms of a contract, including nonpayment
Delinquency Failure to make payments on time as agreed in the note
Discount Points An upfront fee paid by the borrower to the lender at settlement. One point equals 1% of the total loan amount. Interest rates and points or inversely related, i.e. the less points you pay the higher your interest rate
Down Payment The amount of the purchase price paid at the closing by purchaser in cash
Due-on-Sale Clause Mortgage clause permitting the lender, at its option, to demand immediate payment in full in the event property is sold or transferred in any manner
Earnest Money A good-faith deposit paid by the purchaser toward the purchase price at signing of the purchase agreement
Economic Life (Useful Life) The period of time during which an asset will have economic value and be usable
Effective Lease Rate The effective rate (to the lessee) of cash flows resulting from of lease transaction. To compare this rate with a loan interest rate, a company must include in the cash flows any effect the transactions have on federal tax liabilities
Equipment Schedule A document that describes in detail the equipment being leased. It may also state the lease term, vendor, commencement date, repayment schedule and location of the equipment
Fair Market Purchase Option An option to purchase leased property at the end of the lease term at its then fair market value. The lessor does not have the ability to retain title to the asset if the lessee chooses to exercise the purchase option
Finance Lease (See Single Investor Lease) Typically, a finance lease is a full-payout, non-cancelable agreement, in which the lessee is responsible for maintenance, taxes, and insurance
Full Payout Lease A lease in which the lessor recovers, through the lease payments, all costs incurred in the lease plus and acceptable rate of return, without any reliance upon the leased property’s future residual value
General Warranty Deed A deed conveying real estate containing a covenant that the grantor will warrant and defend the title as to all claims
Grace Period A period of time specified in the loan agreement during which a loan payment may be paid after the date due, without incurring a late charge
Grantee Person who receives from the grantor a deed for real estate
Grantor One who transfers real estate by deed
Gross Income Total income before deduction of any expenses
Hazard Insurance Insures the owner and the lender against losses arising from fire and other perils such as rain, explosion, vandalism, snow, hail, aircraft and windstorm. The policy owner pays to the insurance company a premium for the coverage either directly or through an impound account with the lender
Impound Account Escrow account held by the lender into which the borrower pays monthly installments, in addition to the payment for principal and interest, to cover annual expenses such as taxes and insurance
Index A published rate used to determine interest rate changes on the loan
Interest Amount payable for borrowing money expressed as a percentage of the remaining balance
Interest Rate The annual rate of interest on a note, calculated as a percentage
Joint Liability Obligation owed by two or more people, who are each liable for the entire amount
Joint Tenancy A form of group ownership vesting an equal interest in the property to each individual, and with rights of survivorship
Junior Mortgage A mortgage subject to the priority of a senior mortgage or lien. In the event of foreclosure the senior creditor is paid first
Late Charge A fee incurred by a borrower as a penalty when the payment is not paid when due.
Lease A contract in which one part conveys the use of an asset to another party for a specific period of time at a predetermined rate
Lease Rate (Rental Payment) The periodic rental payment to a lessor for the use of assets. Others may define lease rate as the implicit interest rate in minimum lease payments
Lessee The user of the property being leased
Legal Description Written identification of the exact boundaries of the land. The legal description is included in or attached to the deed and or mortgage
Lender The mortgage company, bank or other person providing the loan
Lessor The party to a lease agreement who has legal or tax title to the property for the lease term, and is entitled to the rentals
Leveraged Lease In this type of lease, the lessor provides an equity portion (usually 20 to 40 percent) of the cost and other lenders provide the balance on a debt basis
Loan Application The borrower’s statement of personal and financial information
Loan Application Fee Cost to borrower for loan processing costs, such as the credit report, appraisal fee and other costs incurred
Loan to Value Ratio (LTV) Ratio expressed as a percentage, calculated by dividing the amount borrowed by the lesser of the purchase price or the fair market value determined by an appraisal
Mortgage Document executed by the mortgagor and the delivered to the mortgagee pledging property as security for payment of amounts due under the mortgage note
Mortgage Banker The originator and/or servicer of the mortgage loan
Mortgage Broker A person who facilitates and processes mortgage financing for borrowers
Mortgage Loan A loan collateralized by real property
Mortgage Note Instrument executed by a borrower promising to repay the loan together with interest on certain dates, secured by a mortgage on real estate
Mortgagee The mortgage loan lender
Mortgagor The mortgage loan borrower
Net Lease A lease wherein payments to the lessor do not include taxes, insurance and maintenance, which are paid separately by the lessee
Note Instrument obligating a borrower to repay a loan at a specified interest rate at a certain time
Open-End Lease A conditional sale lease in which the lessee guarantees that the lessor will realize a minimum value from the sale of the asset at the end of the lease
Operating Lease Any lease that is not a capital lease. These are generally used for short term leases. The lessee can acquire the use of the property for normally just a portion of the useful life of the asset. Additional services such as maintenance and insurance may be provided by the lessor
Per Diem Interest Interest calculated on a daily basis
Present Value The current equivalent of payments or a stream of payments to be received at various times in the future. The present value will vary with the discount interest factor applied to future payments
Power of Attorney Written authorization for one person to act on behalf of another person
Pre-Approval Ascertaining how much a perspective borrower may be able to finance, prior to application, with a preliminary review of a borrower’s credit and an analysis of the income and expenses
Prepaid Interest Interest charged to borrower at time of settlement to cover the period until the due date of the first loan payment
Prepayment Full or partial repayment of the principal before the date provided in the note
Residual Value The value of an asset at the conclusion of a lease
Principal The outstanding balance of the debt, not counting interest, remaining due on the note
Purchase Agreement Contract between purchaser and seller setting forth the price, terms and conditions of the sale
Quit Claim Deed A deed operating as a release, conveying the title, interest or claim, if any, which the grantor may have in the real estate, without warranty of the title’s validity
Real Estate The land and anything permanently attached to the land. Also sometimes referred to as real property
Real Property See Real Estate
Recording The act of filing a legal instrument such as a deed or mortgage with the appropriate government registry
Refinancing The process of paying off an existing mortgage note with the proceeds obtained from a new mortgage secured by the same real estate
Sale-Leaseback An arrangement whereby property is purchased by a lessor from the company owning and using it. The lessor then becomes the owner and leases it back to the original owner, who continues to use the equipment
Second Mortgage A subsequent mortgage placed on a property that ranks in priority junior to the existing first mortgage
Settlement See Closing
Settlement Statement A statement detailing the disbursements at closing of the purchase or refinancing real estate
Specific Performance Requiring a party to perform exactly as agreed under the precise terms of an agreement
Term The period of time between commencement of the loan and when the loan is due at maturity
Title Written evidence of rights of ownership and possession of real estate
Title Company A company that issues a policy insuring the title to the real estate
Title Insurance An insurance policy insuring against loss arising from claims over ownership
Title Search Examination of the public records to determine if the seller is the legal owner of the real estate and whether there are defects in the title
Transfer Tax The tax imposed when title passes to a new owner
Variable Rate Interest rate that may be adjusted upward or downward in response to money market fluctuations
Variance Government permission to improve or develop a property in a way not authorized by the existing zoning ordinance, due to a unique hardship
Verification of Deposit (VOD) Written verification by the borrower’s financial institution as to the applicant’s account balance and history
Waiver Intentional relinquishment or surrender of some right, privilege or contingency
Copyright © 2011 James B. Wootton
8405 Pulsar Place, Suite 157
Columbus, OH 43240
Fax: (614) 355-0186