This article and the “tax lease” concept came about after a question by one of our students, who asked: “If a resident beneficiary in a PACTrust™ were to have to forfeit, or leave the property, after the trust term with no further claim to profits, would there have to be an IRS recapture for the tax write-off taken up to that point?  After some thought and some research, the answer that came back was, No.  Such a forfeiture would likely be seen as simply a failure to continue with a mortgage, and be analogous to the departing party's having given a lender back a deed to the property…or a “Deed in Lieu of Foreclosure.” 

So far, since 1984 the concepts promoted by North American Realty Services, Inc. have withstood the test of time in terms of providing full ownership benefits, including the transfer of income tax write-off, to resident co-beneficiaries in multiple beneficiary Land Trust transfers (“Equity Holding Trusts™). 

The Standard NARS PACTrust™ (involving: 1. a settlor and 2. a resident beneficiary); or the  NEHTrust™ (involving a 1. a settlor beneficiary, 2. an investor beneficiary and 3. a resident beneficiary) works this way: 

1) An owner's property is vested in (deeded to) a nominee trustee for a title-holding land trust (i.e., an Illinois Land Trust is created to “own” the property),

2) The trust property is then leased to a would-be buyer on a full-payout (“triple-net”) lease basis, wherein the lessee is contractually obligated to pay all mortgage interest and property tax, and to handle all management and maintenance responsibilities),

3) That same lessee is then appointed to be a co-beneficiary in, and co-director of, the trust, and to serve as the first beneficiary's remainder party in the event of the death of the settlor (the former owner). 

By utilizing the various Equity Holding Trust documents in the proper progression, the property in question needn't be sold, or the title transferred beyond an owner's own inter vivos trust, in order for the would-be buyer to receive the benefits of real property ownership.  Such benefits being: possession, use, appreciation, income tax benefits, gain on mortgage principal reduction, etc.  In either the “PACT” or “NEHT” arrangements, a tenant beneficiary can be given 10%, 25%, 50% or 100% of the future appreciation and mortgage principal reduction, while being entitled to claim 100% of the income tax benefits for mortgage interest and property tax.  (re. IRC§163(h)4(D).

So, now comes the “NARS Tax Lease.” 

In the standard NARS NEHTrust™ or PACTrust™, there is no Option to Purchase, no predetermined buy-out arrangement, and no bargain sale price involved: any of these would (could) constitute either a due on sale violation, creation of an equitable interest in the property by the tenant, or a contract of sale.  Instead, the Equity Holding Trust documentation provides that the property will be sold at the trust's termination for Fair Market Value with no options or bargain pricing.  Should the resident beneficiary opt to be the purchaser, his/her purchase price will be full Fair Market Value the same any anyone else's would.  However, note that any monies due to him/her by the trust from which the property is being purchased will offset that cost. This means that the resident beneficiary has four alternatives at the trust's termination: 1) Refinance and buy the property from the trust, 2) Agree to sell the property to another party and keep the proceeds, 3) Negotiate with the investor or settlor beneficiary for an extension of the term, or…4) Relinquish one's beneficiary interest in the trust, walk away and pay nothing further.

Now, consider this.  Were option #4 above to be a resident beneficiary's choice, that party would be leaving empty-handed: but only after having enjoyed full state and federal income tax benefits over the entire term of the agreement. 

As far as circumstances that would necessitate taking option #4 are concerned, one such circumstances might be the result of the property having lost significant value over the term of the agreement.  Another reason for option #4 might be that if the resident beneficiary held only a small percentage of beneficiary interest and, therefore, a small percentage of the profit at termination, only a minimal amount would be due him/her at termination. 

It is this feature that makes the Equity Holding Trust™ arrangement almost invariably a better option for a lease tenant than would be a straight lease or rental.  The Equity Holding Trust affords an income property owner an opportunity to trade tax benefits for higher monthly rent and an agreement by the tenant to handle all maintenance, repairs and upkeep of the property.

Understand that when an Equity Holding Trust transfer is structured, the parties decide what will be the priority of distributions at the trust's termination (which coincides with the end of the associated Leasehold agreement).  Standard “EHT” documentation provides that at the trust's termination, distribution of proceeds will follow in this order:

1. Pay off the loans
2. Pay all costs of sale
3. Return the settlor's and investor's beginning equities (if any due) along with any other contributions having been made by them that are unanimously agreed to be or become a part of their respective contributions
4. Return the resident beneficiary's initial contribution (i.e., any monies spent at inception relative to contributions to the land trust (e.g., that sum will ordinarily be inclusive of non-recurring closing costs paid at inception, along with any amount considered as an “equity buy-down” in favor of the contributor
5. Divide all remaining proceeds among the beneficiaries with respect to the particular percentage of beneficiary interest held by each.

In the NARS “Tax Lease,” everything works exactly the same as the above scenario, except that the beneficiary interests held by the CO-beneficiaries would be 10% and 90% in favor of the non-resident beneficiaries.

In the above scenario, negotiations might include the inclusion of an addendum containing verbiage to the effect that: “At termination the resident CO-beneficiary hereunder agrees that it shall receive its proportionate share of all net proceeds upon sale of the trust property, which shall not exceed the sum of $--.---, or be less than $--.---.”

SAMPLE MONTHLY PAYMENT GRID BASED UPON A $150,000 PROPERTY

NARS STRAIGHT LEASE	NARS LEASE OPTION	NARS TAX LEASE	NARS TAX LEASE OPTION	NARS LAND TRUST EQUITY SHARE	NARS FULL LAND TRUST SALE
Tenant Benefits
A place to live Owner covers management and Mtce costs Possession guaranteed for specific time period	Monthly Rent credit ($200?) Right to buy at future discount Owner covers mgmt and mtce	Tax write-off for owner's interest and property tax Reduced after-tax housing cost (i.e., cheaper than renting)	Full tax deductions Right to buy at discount Reduced after-tax housing cost (i.e., cheaper than renting)	100% financing No bank qualifying Immediate ownership ½ principal reduction ½ appreciation Full tax write-off Can result in zero rental cost over term	100% financing No bank qualifying Immediate ownership All principal reduction All appreciation Full tax write-off
Investor Benefits
Monthly Income All tax benefits retained All profit potential retained All equity retained Negatives: [Responsibility for costs and mgmt] [Neg. cash-flow] [vacancies] [Landlord woes]	Option Fee Greater cash flow) All Tax benefits retained Return of equity if option is exercised Retention of all funds if option not exercised [Responsibility for mtce,  mgmt]	Up-front payment (via Reserve) Present and future Equity retained Future profits retained Higher than normal “rent” Freedom from costs and mgmt and all landlord woes	Upfront payment (via Option Fee) Existing equity Retained Return of equity if option exercised Higher than normal “rent Retention of all funds if option not exercised	Upfront payment (via Reserve) Positive cash flow ½ of the principal reduction ½  of all future appreciation Return of all beginning equity Guaranteed Profit irrespective of market trends Greater “rent” than normal	Highest sale price Greatest cash upfront potential Highest Positive cash flow Beginning equity Retained & protected [Monthly cash flow, beginning equity, up front moneys can be based upon value greater than FMV- e.g., $160K)*
$1,075.00	$1,275.00	$1,325.00	$1,475.00	$1,500.00	*$1,625.00
After-Tax Housing Expense
$1,615.00	$1,912.00	1,325.00	$1,475.00	$1,500.00	$1,625.00

Now…considering the above grid and the options you can make available to a lease tenant, optionee, resident beneficiary or buyer of the property: what would be the best way to sell the higher payment concept to someone? 

1. Tell them that their rent is going to be $1,500, which is obviously much higher than normal rent: BUT that the payment includes ownership, principal reduction, income tax benefits and a share in future profits (if there are to be any).

1. Show the prospect this grid during the pre-qualification phase (eliminating the options that you may not be interested in offering) and ask them to chose which option they would prefer.

Yeah, “B,” I think so too.

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