Several of 1031 Alternatives Group’s direct investor clients have recently asked questions in regards to the new Worker, Retiree and Employer Recovery Act that was recently passed as it relates to required minimum distributions (“RMDs”) for retirement plans. We thought the following information would be helpful to others as well. Please let us know if you have any questions on this material and/or if we may be of any service to you regarding this subject.

Worker, Retiree and Employer Recovery Act signed into law

On December 23, 2008, President Bush signed the Worker, Retiree and Employer Recovery Act of 2008 into law. The legislation, which Congress passed by unanimous consent, includes provisions to provide much-needed relief for pension plan sponsors as well as individual investors.

Key Details

Among the most significant provisions in the bill are those that address the transition to the new PPA funding rules, the “smoothing” of pension plan assets and the restriction on benefit accruals. Specifically, the legislation:

Suspends a tax rule that requires seniors (age 70½ and older) to take minimum required distributions: The bill suspends the rule requiring RMDs from tax-favored retirement accounts or payment of a 50 percent penalty on the amount they are required to withdraw. The bill suspends the penalty only for 2009, and the Treasury has indicated that it will not issue additional required minimum distribution relief for 2008.

Allows plans to phase-in to PPA funding targets: The bill eases the transition to the new, more restrictive PPA funding rules. PPA phases in full pension funding targets from 90 percent to 100 percent over four years (2008 target – 92 percent; 2009 target – 94 percent; 2010 target – 96 percent; and 2011 target – 100 percent).

Under PPA, if a plan missed its funding target in any phase-in year, the target automatically increased to 100 percent. The new bill adjusts the “phase-in” rule to allow plans that miss their funding target in any year to retain their original target instead of jumping to 100 percent. These provisions apply for 2008, 2009 and 2010 plan years.

Permits 24-month asset smoothing: The bill permits employers to “smooth” the value of their pension plan assets over a period not to exceed 24 months instead of using an “averaging” method. (Smoothing allows plan sponsors to take anticipated earnings into account when calculating asset values; averaging, as interpreted by the IRS, does not.)
This change is intended to soften the impact of investment losses. However, the bill does not expand the asset corridor, so a smoothed asset value would have to fall within 90 to 110 percent of the fair market value of assets as required under PPA. For 2009, the smoothed value of many plans’ assets will fall above the 110 percent mark, negating the benefits of smoothing.

Eases requirements that restrict the accrual of pension benefits: The bill provides a look-back rule to help plans that drop below the 60 percent funding threshold avoid the restriction on benefit accruals. Plans will be able to look back to the previous plan year to determine their funded status as it would apply to workers’ abilities to accrue pension benefits.

While this is a welcome development, it will impact far fewer plans than easing the benefit restrictions that prohibit plans that are less than 80 percent funded from paying full lump sums would – a proposal the business community was urging Congress to adopt.

In order for a DST to qualify for favorable tax treatment, certain restrictions are placed on the trustee regarding its operation of the property. One limitation of the DST is that the trustee cannot enter into new leases or renegotiate the current leases. If the property is subject to a long-term triple net lease with a credit-worthy tenant this may not be a problem. In this situation, the DST could lease the property to the tenant directly and simply provide a property manager.

However, the DST will most likely use a long-term Master Lease to an affiliate of the sponsor if the property has a short-term lease, or other characteristics make it probable that the property may need to be re-leased while it is held by the DST. Under Revenue Ruling 2004-86, the lessee of the property held by the DST can sublease the property and then renegotiate subleases or enter into new subleases. Thus, the Master Lease structure allows the master lessee (sponsor affiliate) to re-lease the property and renegotiate leases. The DST itself would not be able to do that.

According to Rev. Ruling 2004-86 the following are considered the “seven deadly sins” of a DST structure:
1) Sell real estate and use proceeds to acquire new property
2) Renegotiate an existing lease
3) Enter into a new lease
4) Renegotiate an existing loan or borrow additional funds
5) Accept additional capital contributions from existing investors
6) Invest money of the DST in anything other than short-term government obligations
7) Make improvements to the real estate other than minor, non-structural modifications and those required by law

Delaware Statutory Trusts Possess Risks
Delaware Statutory Trusts are not without their risks. As with any type of real estate investment, investors may be subject to high vacancy rates and loan defaults. DSTs are also not sole-ownership investments. A Delaware Statutory Trust is a more passive investment made up of multiple owners and ultimately controlled by the master tenant (the sponsor). Also, the structure has limited usefulness for properties with multiple tenants or large capital improvements needing to be made. It is important for investors who may be considering the Delaware Statutory Trust strategy to consult with an experienced Delaware Statutory Trust professional, and to obtain competent legal and tax advice.
Upon thorough evaluation, the Delaware Statutory Trust structure may be a viable investment alternative for qualified real estate investors. But only your tax adviser and lawyer can tell you if it's right for you.