The Tax Man: Taxes in Private Equity Real Estate
Teaching Note for HBS No. 218-077. The case discusses the acquisition of a commercial building in San Francisco by a real estate private equity fund KSW Partners LLC (“KSW”), whose limited partners were US institutional investors (Pension Funds (“PFs”)), US high net worth individuals (“HNW”), and a foreign Sovereign Wealth Fund (“SWF”) as a co-investor. The protagonist is a new associate Caelan Langan who has to make a recommendation to his new boss as to what structure(s) to use. All parties involved in the transaction, including the fund’s general partner, are subject to unique tax treatments and exemptions, both on income and capital gains distributions. The general partner faces the challenge of analyzing the economic attractiveness of the opportunity for each party as well as for itself, considering all constraints, tax implications, and risks involved, and deciding on a course of action that reconciles often competing interests. It should become readily apparent there is no optimal solution that maximizes the return for each category of investor on an after-tax basis. It should also become evident that the General Partner faces a series of conflicts between its after-tax interests and those of its investors, as well as potential conflicts among the investors.
The case incorporates the effects of the Tax Cuts and Jobs Act (“TCJA”) signed into law on December 22, 2017. There are references to many different sections of the Internal Revenue Code, some of which were modified by the TCJA, such as the rates on personal and corporate tax rates, and others, such as those on Unrelated Business Taxable Income (“UBTI”).
The case facts have been greatly simplified to allow for a focus on the teaching objectives referenced below. Any potential transaction can be exceedingly complicated from a tax perspective with multiple investor categories. Typical investment structures involve multiple vehicles both on-shore and off-shore. To the extent possible, it would be advisable to have a tax expert as a guest for the case.
The case incorporates the effects of the Tax Cuts and Jobs Act (“TCJA”) signed into law on December 22, 2017. There are references to many different sections of the Internal Revenue Code, some of which were modified by the TCJA, such as the rates on personal and corporate tax rates, and others, such as those on Unrelated Business Taxable Income (“UBTI”).
The case facts have been greatly simplified to allow for a focus on the teaching objectives referenced below. Any potential transaction can be exceedingly complicated from a tax perspective with multiple investor categories. Typical investment structures involve multiple vehicles both on-shore and off-shore. To the extent possible, it would be advisable to have a tax expert as a guest for the case.
Keywords: real estate; Taxation; Private Equity; Property; Acquisition; Conflict of Interests; Governing Rules, Regulations, and Reforms;
Citation:
Lietz, Nori Gerardo, and Sayiddah Fatima McCree. "The Tax Man: Taxes in Private Equity Real Estate." Harvard Business School Teaching Note 219-017, November 2018. View Details