The Corporate Transparency Act and its Impact on Commercial Real Estate
The Corporate Transparency Act (CTA) went into effect on January 1, 2024. The CTA allows government entities to combat terrorism, money laundering, and tax abuse by requiring foreign and domestic reporting companies to disclose their beneficial ownership to the Financial Crimes Enforcement Network (FinCEN) of the U.S. Treasury Department. According to some estimates, there are at least 30 million state-chartered entities in existence and prior to the adoption of the CTA, governmental entities did not have a systematic way to obtain information of the beneficial owners of these entities.
Typically, the CTA requires any entity created by filing a document with a state agency (or files to qualify to do business with a state agency) to report its beneficial owners to FinCEN via a secure online registry. There are 23 exceptions to the filing requirement. Generally, these exceptions exclude several highly regulated entities such as banks, credit unions, insurance companies, and certain security related businesses. The broadest exception is for so-called “large operating companies” that employ more than 20 full time employees and more than $5,000,000 in gross receipts or sales as demonstrated by filed federal income tax returns.
Since real estate developers and investors often own properties in single purpose entities, these entities do not fall within CTA reporting exceptions. Even if a property owned by a single purpose entity generates more than $5,000,000 in revenue, the management and operation of the property is usually performed by a third-party property manager. The large company reporting exception requires meeting both the revenue and full-time employee thresholds.
An entity that does not fall within an exception is deemed to be a “reporting company” under the CTA and is required to register with FinCen and disclose the “beneficial owners” of that entity. A beneficial owner is either a person who directly or indirectly (i) owns at least 25% percent of the beneficial ownership of the entity, or (ii) exercises substantial control over important decisions made by the entity. Additionally, if the equity holders or entities holding substantial rights of control in a reporting company are also entities, these entities are also likely to be reporting companies. The purpose of the CTA is to require each reporting company to trace the ultimate ownership/control of the reporting company through the various levels of entities to the people (as opposed to entities) who indirectly hold ownership interests and rights of control. Since real estate developers and investors often establish a complex network of entities dividing up ownership between multiple investor classes and varying rights of management and approval rights, the CTA often imposes (sometimes duplicative) reporting requirements for the multiple entities involved in the ownership/management of a single property.
The broad coverage of the Act and the criminal penalties for non-compliance requires real estate developers and investors to pay close attention to the CTA with existing entities and entities formed in the future. Due to the prevalent use of multiple entities involved in the ownership and management of properties, the CTA creates some complications and issues that need to be addressed:
Determination of Equity Ownership
Given the multiple layers that accompany real estate ventures, indirect ownership will need to be factored into the analysis of who the ultimate owners are. If two different limited liability companies (LLCs) each have a 50% ownership of entity in questions, the owners of those LLCs will need to be determined. If all or a portion of the respective 50% interests are owned by entities, the analysis must continue until individual owners are identified. This could lead to disparate determinations of ownership among affiliated entities as it is possible that an individual could own more than 25% of an entity but less than 25% of the entity owned by the first entity. Additionally, a person could own equity interests in various entities within the ownership structure, which when aggregated total 25% or more despite not owning 25% of all the entities.
Substantial Control
While day-to-day management of a property would satisfy this standard and would classify the person holding such management authority as a beneficial owner, would a limited partner with approval rights over major decisions such as financing and sale of the property be deemed to have substantial control and thereby deemed a beneficial owner? By all accounts, the answer to that is yes. As such, a careful analysis of these significant rights needs to be undertaken.
Loan Covenants
While the CTA reporting requirements overlap with standard Know Your Customer (KYC) requirements governing banks, lenders will likely impose CTA compliance upon their borrowers. Although the CTA gives reporting companies a full year to register any reporting companies existing as of December 31, 2023 and three months from the date of formation for companies formed after January 1, 2024, banks may impose shorter deadlines. Accordingly, developers will need to start gathering the necessary information to comply with the CTA.
Impact on Governing Documents
When multiple parties own real estate through a network of real estate reporting companies, one of the parties needs to take responsibility for filing reports disclosing beneficial owners who constitute outside investors. For example, if Developer A owns 50% and Investor B owns 50% of an LLC though one or more LLCs, either the developer or investor would be required to report the identity of individuals who may not be known to the reporting person but who would constitute a beneficial owner. Accordingly, it would be prudent to include strong language in the LLC operating agreement requiring each member to fully disclose its ownership structure, the persons within that ownership structure, and to indemnify the other members for failing to provide accurate information necessary to comply with the CTA.
Responsibility for Reporting Changes
In addition to the initial disclosure of beneficial owners, disclosures must be updated periodically to reflect changes. The death of an individual beneficial owner or the transfer of that individual’s interest for estate planning purposes could impose an obligation to update the disclosure. Updated requirements must be tracked for future reference.
The Problem with Trusts
While most trusts are not created by the initial filing of a document with a state agency (e.g., a typical grantor trust) and would not constitute a reporting company under the CTA, the CTA could still require the disclosure of beneficiaries of the trust if that trust and the beneficial owners of that trust are deemed to own at least 25% of the underlying reporting company.
While determining the obligation of owners of real estate to report their interests in the entities through which the real estate is owned and managed might not be burdensome in the case of a simple ownership structure, the organizational complexity of many commercial real estate projects requires thoughtful analysis.
For more information regarding commercial real estate and or assistance evaluating the impact of the CTA on real estate projects, please contact Levin Ginsburg Attorney Jeffrey Galkin.
