PRIVILEGED & CONFIDENTIAL ATTORNEY-CLIENT COMMUNICATION / ATTORNEY WORK PRODUCT DOCTRINE
CALDERWOOD & HARKNESS LLP TAX DUE DILIGENCE MEMORANDUM
FROM: Sylvia Hartwell, Partner (Tax) Calderwood & Harkness LLP 1700 K Street NW, Suite 900 Washington, DC 20006 Tel: (202) 555-4100 shartwell@calderwoodharkness.com
TO: Douglas Fairchild, Partner (Real Estate) Calderwood & Harkness LLP 450 Park Avenue, 28th Floor New York, NY 10022 Tel: (212) 555-7200 dfairchild@calderwoodharkness.com
CC: Angela Fontaine, Partner (Real Estate) Grace Nakamura, Associate (Real Estate) Rafael Dominguez, Associate (Real Estate)
DATE: April 10, 2024
RE: Tax Due Diligence Memorandum — Fairwater Real Estate Investment Trust Acquisition of 14-Property Sun Belt Logistics & Office Portfolio from Greystone Meridian Partners Fund III, L.P.
MATTER NO.: 1036-00004
This memorandum constitutes a privileged and confidential attorney-client communication and attorney work product prepared by Calderwood & Harkness LLP. This memorandum is intended solely for the use of the addressee and designated recipients and may not be disclosed to, or relied upon by, any third party without the prior written consent of Calderwood & Harkness LLP. This memorandum is protected from disclosure by the attorney-client privilege, the attorney work product doctrine, and any other applicable privileges or protections.
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I. Executive Summary
This memorandum sets forth a comprehensive tax due diligence analysis prepared in connection with Fairwater Real Estate Investment Trust's ("Fairwater" or "FREIT") proposed acquisition (the "Transaction") of 100% of the membership interests in fourteen (14) single-purpose Delaware limited liability companies (each a "Target Entity" and collectively, the "Target Entities") from Greystone Meridian Partners Fund III, L.P. ("GMP Fund III" or "Seller"). The aggregate purchase price for the Transaction is One Billion One Hundred Million Dollars ($1,100,000,000), of which Six Hundred Twelve Million Dollars ($612,000,000) represents existing mortgage indebtedness to be assumed by Fairwater and Four Hundred Eighty-Eight Million Dollars ($488,000,000) represents cash equity payable at closing.
The Transaction is structured as an entity-level purchase of membership interests rather than as a direct asset acquisition. The fourteen Target Entities collectively own a portfolio of ten (10) logistics/industrial properties and four (4) suburban office properties (the "Portfolio") located across five states in the Sun Belt region: Georgia, Texas, Florida, Tennessee, and North Carolina. The Portfolio comprises approximately 5,224,000 rentable square feet across eighty-seven (87) leases, with a weighted-average occupancy of 93.2% as of December 31, 2023.
This memorandum addresses the following key tax workstreams identified at the commencement of the due diligence engagement:
1. REIT Qualification Impact: Analysis of whether the Transaction adversely affects Fairwater's qualification as a real estate investment trust under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the "Code"), including the 75% gross income test, the 75% asset test, the 95% gross income test, distribution requirements, and prohibited transaction considerations.
2. Controlling-Interest Transfer Tax Exposure: Identification and quantification of transfer taxes potentially imposed by the five states in which Portfolio properties are located in connection with the transfer of controlling interests in entities owning real property, with particular attention to Georgia, Florida, Tennessee, and North Carolina (Texas does not impose a state-level transfer tax).
3. Depreciation Recapture and Step-Up Analysis: Evaluation of the federal income tax consequences of the entity-purchase structure on the tax basis of the underlying real property assets, including the absence of an automatic basis step-up, carryover depreciation implications, and the inapplicability of Section 754, Section 338(h)(10), and Section 336(e) elections to disregarded entity structures.
4. Section 1031 Exchange Implications: Assessment of whether the Transaction implicates like-kind exchange provisions under Section 1031 for either Buyer or Seller.
5. State Income and Franchise Tax Filing Obligations: Identification of Fairwater's post-acquisition state income and franchise tax filing obligations in each of the five states where Portfolio properties are situated.
6. FIRPTA Analysis: Determination of whether the Foreign Investment in Real Property Tax Act ("FIRPTA") imposes any withholding obligations on Fairwater in connection with the acquisition.
7. Purchase Price Allocation Under Section 1060: Review of the agreed purchase price allocation methodology and its implications for Fairwater's depreciable basis in the acquired assets.
In conducting this analysis, we have coordinated extensively with Ashford Prewitt LLP, Fairwater's accounting and tax advisors, and specifically with Martin Ashford, CPA, Engagement Partner, and Naomi Ikeda, CPA, Tax Partner. We have also reviewed materials and work papers provided by Seller's accountants, Caldwell Murray & Oakes LLP (William Oakes, CPA), to the extent made available in the electronic data room maintained by Seller.
Overall Conclusion. Based on our review and analysis, we have identified no material tax impediments to the Transaction. Fairwater's qualification as a REIT under the Code will not be adversely affected by the acquisition. The aggregate transfer tax exposure across the five states is estimated at approximately $3,850,000, which is to be split equally between Buyer and Seller pursuant to the terms of the Purchase and Sale Agreement (the "PSA"), dated February 28, 2024. The entity-purchase structure creates certain depreciation considerations — specifically, Fairwater will inherit the Target Entities' existing carryover tax basis of approximately $845,000,000, rather than obtaining a stepped-up basis equal to the $1,100,000,000 purchase price — but this structure is the preferred approach given lender consent mechanics, the avoidance of property tax reassessment triggers in certain jurisdictions, and certain transfer tax mitigation benefits. We recommend that Fairwater engage Ashford Prewitt LLP or a specialist firm to conduct cost segregation studies on all fourteen properties post-closing to optimize depreciation deductions within the existing carryover basis.
II. Transaction Overview
A. Parties
Buyer. Fairwater Real Estate Investment Trust ("Fairwater" or "FREIT") is a Maryland real estate investment trust listed on the New York Stock Exchange under the ticker symbol "FREIT." As of the fourth quarter of 2023, Fairwater had an approximate market capitalization of $4.8 billion. Fairwater is headquartered at 7200 Chesapeake Parkway, Suite 1100, Columbia, Maryland 21044. Its Employer Identification Number is 52-2198437. Fairwater elected REIT status under the Code effective for its initial taxable year ending December 31, 2011, and has maintained continuous REIT qualification since that time. Fairwater's current portfolio, prior to the Transaction, consists of sixty-two (62) logistics, industrial, and suburban office properties across eleven (11) states, aggregating approximately 18.4 million rentable square feet with a weighted-average remaining lease term of 6.2 years.
Seller. Greystone Meridian Partners Fund III, L.P. ("GMP Fund III") is a Delaware limited partnership with Employer Identification Number 83-1647205. GMP Fund III maintains its registered agent at 1209 Orange Street, Wilmington, Delaware 19801, and its principal office at 3300 Peachtree Road NE, Suite 2200, Atlanta, Georgia 30326. GMP Fund III is a 2018-vintage closed-end private equity real estate fund with aggregate capital commitments of approximately $2.4 billion, focused on value-add and opportunistic investments in logistics, industrial, and suburban office properties in the Sun Belt region. The fund is currently in its monetization phase, and the disposition of the Portfolio represents a significant component of the fund's remaining asset liquidation activity.
General Partner of Seller. The general partner of GMP Fund III is Greystone Meridian Capital LLC, a Delaware limited liability company with Employer Identification Number 83-1520984. Greystone Meridian Capital LLC is managed by its Co-Founders and Managing Partners, Victor Lansdell and Elise Rathborne. Mr. Lansdell and Ms. Rathborne serve as the primary decision-makers and "knowledge individuals" for the Seller under the PSA.
Target Entities. The Transaction involves the acquisition of 100% of the membership interests in the following fourteen (14) Delaware limited liability companies, each of which is wholly owned by GMP Fund III and holds title to a single property within the Portfolio:
Each Target Entity was organized as a single-purpose Delaware limited liability company in connection with GMP Fund III's acquisition of the respective property. Each Target Entity has been treated as a disregarded entity for federal income tax purposes since its formation. Based on our review of the organizational documents and federal tax filings provided in the data room, no Target Entity has elected to be classified as a corporation or partnership under the entity classification regulations (the "check-the-box" regulations) of Treasury Regulation Section 301.7701-3. Each Target Entity's sole member is GMP Fund III.
B. Transaction Structure
The Transaction is structured as an entity-level acquisition in which Fairwater (or a wholly owned subsidiary designated by Fairwater prior to closing) will acquire 100% of the membership interests in each of the fourteen Target Entities from GMP Fund III. The Transaction is not structured as a direct purchase of the underlying real property assets. This entity-level structure was selected after careful consideration of several factors, including: (i) the mechanics of obtaining lender consents for the assumption of existing mortgage indebtedness, which are substantially simpler in an entity transfer than in a direct conveyance; (ii) the avoidance of property tax reassessment triggers in certain jurisdictions (notably Georgia) that might be triggered by a direct transfer of real property but not by a transfer of entity interests; and (iii) certain transfer tax considerations. The tax implications of this structural choice are discussed in detail throughout this memorandum, particularly in Section V (Depreciation Recapture and Step-Up Analysis) and Section IX (Purchase Price Allocation).
The aggregate purchase price for the Transaction is $1,100,000,000, consisting of:
• Assumed Mortgage Debt: $612,000,000, comprising the following existing mortgage indebtedness encumbering Portfolio properties:
(a) Pinnacle Federal Bank, N.A.: $421,600,000 at a fixed interest rate of 4.22% per annum, maturing July 1, 2028. This facility is secured by eight (8) of the fourteen Portfolio properties. Lender consent to the transfer of ownership interests in the borrowing entities is required under the loan documents and was the subject of the delayed closing discussed below.
(b) Veltrano Capital Lending Corp.: $142,300,000 at a fixed interest rate of 4.68% per annum, maturing March 1, 2029. This facility is secured by four (4) of the fourteen Portfolio properties. Lender consent was obtained on May 17, 2024.
(c) Sycamore Life Insurance Company: $48,100,000 at a fixed interest rate of 3.95% per annum, maturing December 1, 2030. This facility is secured by two (2) of the fourteen Portfolio properties. Lender consent was obtained on May 10, 2024.
• Cash Equity at Closing: $488,000,000, to be funded from Fairwater's $750,000,000 unsecured revolving credit facility with Aldgate National Bank, N.A. (the "Revolver"), dated August 14, 2022, bearing interest at SOFR plus 130 basis points. As of the date of this memorandum, the available capacity under the Revolver is approximately $530,000,000, which is sufficient to fund the cash equity component of the Transaction.
The PSA is governed by the laws of the State of New York and was executed on February 28, 2024. The Seller's aggregate cost basis in the Portfolio properties, based on information provided by Caldwell Murray & Oakes LLP, is approximately $845,000,000. The properties were assembled by GMP Fund III between 2019 and 2021 through a series of individual acquisitions and development projects.
C. Portfolio Summary
The Portfolio comprises fourteen (14) properties located across five states in the Sun Belt region. The geographic and product-type breakdown is as follows:
By State:
By Property Type:
The Portfolio has a total of eighty-seven (87) leases with a weighted-average occupancy rate of 93.2% as of December 31, 2023. Annual in-place base rent is approximately $74,800,000, yielding an in-place capitalization rate of approximately 6.80% on the $1,100,000,000 purchase price. The tenant roster is diversified across various industries, including third-party logistics, e-commerce fulfillment, consumer products distribution, financial services, healthcare technology, and professional services. No single tenant accounts for more than 8.3% of total in-place base rent.
D. Key Dates
The key dates relevant to the Transaction and this tax due diligence analysis are as follows:
The closing was delayed by six (6) calendar days from the originally scheduled date of May 31, 2024 to June 6, 2024, due to a delay in obtaining the requisite lender consent from Pinnacle Federal Bank, N.A. The PSA permitted a 10-business-day closing extension in the event of lender consent delays, and the extension was exercised by Fairwater on May 28, 2024. The delayed closing did not have any material impact on the tax analysis set forth herein, although certain pro-ration calculations and partial-year filing obligations were adjusted to reflect the June 6, 2024 closing date.
III. REIT Qualification Analysis
A. Overview of Fairwater's REIT Status
Fairwater elected REIT status under Sections 856 through 860 of the Code effective for its initial taxable year ending December 31, 2011. Since that time, Fairwater has continuously qualified and operated as a REIT for federal income tax purposes. A REIT is generally not subject to federal corporate income tax on the portion of its taxable income that is distributed to shareholders, provided the REIT satisfies certain requirements relating to its organizational structure, sources of income, composition of assets, and distributions. Failure to satisfy these requirements could result in loss of REIT status and the imposition of corporate-level taxation on Fairwater's income, which would have materially adverse consequences for Fairwater and its shareholders.
Prior to the Transaction, Fairwater's portfolio consists of sixty-two (62) logistics, industrial, and suburban office properties across eleven (11) states, totaling approximately 18.4 million rentable square feet, with a weighted-average remaining lease term of 6.2 years. Following the consummation of the Transaction, Fairwater's portfolio will expand to seventy-six (76) properties across an expanded state footprint that includes new or augmented presence in Georgia, Texas, Florida, Tennessee, and North Carolina.
The following subsections analyze whether the acquisition of the Portfolio will adversely affect Fairwater's continued qualification as a REIT under the Code.
B. 75% Gross Income Test (Section 856(c)(2))
Section 856(c)(2) of the Code requires that at least 75% of a REIT's gross income for each taxable year be derived from certain specified sources, including, among other items, "rents from real property" as defined in Section 856(d), gain from the sale of real property not held primarily for sale, interest on obligations secured by real property or interests in real property, and certain other qualifying categories.
Rents from Real Property. The term "rents from real property" is defined in Section 856(d) and is subject to several exclusions. Rental income will not qualify as rents from real property if any of the following conditions apply:
(i) The REIT furnishes or renders services to its tenants that are other than "customarily furnished or rendered in connection with the rental of real property" (unless such services are performed through an independent contractor or a taxable REIT subsidiary) (Section 856(d)(2)(C));
(ii) The rent attributable to personal property leased in connection with a lease of real property exceeds 15% of the total rent for the taxable year under the lease (Section 856(d)(1)(C));
(iii) The rental income is based, in whole or in part, on the income or profits of any person (other than amounts based on a fixed percentage of gross receipts) (Section 856(d)(2)(A)); or
(iv) The REIT directly or constructively owns 10% or more of the ownership interests in the tenant (Section 856(d)(2)(B)).
We have reviewed the eighty-seven (87) leases in the Portfolio for compliance with each of the foregoing requirements. Our review was conducted in coordination with Grace Nakamura and Rafael Dominguez, who provided lease abstraction summaries for all Portfolio leases, and with Ashford Prewitt LLP, which conducted an independent review of the lease revenue characterization for REIT income testing purposes. Key findings are as follows:
Impermissible Tenant Services. None of the eighty-seven leases require the Target Entities (or the landlord) to provide services to tenants that would be considered impermissible services under Section 856(d)(2)(C). The services provided in connection with the Portfolio leases are limited to customary services such as common area maintenance, landscaping, security, parking lot maintenance, and HVAC system operation — all of which are services customarily furnished in connection with the rental of real property within the meaning of Treasury Regulation Section 1.856-4(b)(1). None of the leases require the landlord to provide maid service, food service, concierge services, or other personal or non-customary services.
Related-Party Rent. We have confirmed, based on representations from Fairwater's management and a review of Fairwater's existing tenant roster, that no tenant in the Portfolio is a "related party" with respect to Fairwater under the 10% ownership threshold of Section 856(d)(2)(B). No tenant directly or constructively owns 10% or more of the voting securities or value of Fairwater, and Fairwater does not directly or constructively own 10% or more of the ownership interests in any Portfolio tenant.
Personal Property Rent. Certain leases in the office portion of the Portfolio (Buckhead Place Office Tower, Cool Springs Office Park, SouthPark Corporate Center, and Brickell Bay Office Building) include the lease of de minimis items of personal property such as window treatments, certain built-in cabinetry, and common-area furniture and fixtures. Based on our review of the rent allocations and the appraisal of personal property components conducted by Stonebridge Valuation Advisors, LLC, the rent attributable to personal property in each case is well below the 15% threshold of Section 856(d)(1)(C). The highest personal property rent ratio identified in any individual lease is approximately 3.2% (one lease at Cool Springs Office Park). Accordingly, the personal property rent exclusion does not apply.
Percentage Rent Provisions. Three leases in the logistics portion of the Portfolio contain percentage rent provisions based on a fixed percentage of the tenants' gross receipts above stated breakpoints. Rent based on a fixed percentage of gross receipts is permissible under Section 856(d)(2)(A) and does not constitute income based on the "income or profits" of a person within the meaning of that section. Accordingly, the percentage rent received under these leases qualifies as rents from real property.
Conclusion. All rental income from the Portfolio qualifies as "rents from real property" under Section 856(d). No impermissible tenant services, related-party rent issues, excessive personal property rent, or prohibited profit-based rent provisions were identified in our review of the eighty-seven Portfolio leases. Fairwater will continue to satisfy the 75% gross income test under Section 856(c)(2) following the acquisition.
C. 75% Asset Test (Section 856(c)(4))
Section 856(c)(4) of the Code requires that at the close of each quarter of the taxable year, at least 75% of the value of a REIT's total assets consist of real estate assets, cash and cash items (including receivables), and government securities. "Real estate assets" include real property (or interests in real property), interests in mortgages on real property, and shares in other qualifying REITs.
Pre-Acquisition Assets. Ashford Prewitt LLP has provided an analysis of Fairwater's pre-acquisition total asset composition as of the most recent quarter-end (December 31, 2023). Based on that analysis, Fairwater's total assets as of December 31, 2023 were approximately $7.6 billion (book value), with qualifying real estate assets constituting approximately 94.3% of total assets. Fairwater is comfortably in compliance with the 75% asset test on a pre-acquisition basis.
Post-Acquisition Assets. The acquisition of the fourteen Target Entities will add approximately $1,100,000,000 in real estate assets to Fairwater's asset base. Because each Target Entity is a single-member LLC wholly owned by GMP Fund III and, upon Fairwater's acquisition of 100% of the membership interests, will become a single-member LLC wholly owned by Fairwater, each Target Entity will automatically qualify as a "qualified REIT subsidiary" ("QRS") under Section 856(i) of the Code, as discussed in greater detail in Section III.G below. As a QRS, each Target Entity's separate existence is disregarded for federal income tax purposes, and each Target Entity's assets are treated as assets of Fairwater for purposes of all REIT qualification tests, including the 75% asset test.
The assets held by the Target Entities consist overwhelmingly of qualifying real estate assets — namely, the real property comprising the fourteen Portfolio properties. The only non-real-estate assets held by the Target Entities are (i) cash and cash equivalents in operating accounts at Magnolia Commerce Bank, N.A. (which qualify as "cash and cash items" for purposes of the 75% asset test), (ii) tenant security deposits held in bank accounts (similarly qualifying as cash items), (iii) tenant receivables (qualifying as receivables), and (iv) de minimis amounts of personal property associated with the properties (such as furniture, fixtures, and equipment in the office properties). None of these non-real-estate assets creates any concern regarding the 75% asset test.
We have also analyzed whether the assumed mortgage indebtedness ($612,000,000) creates any issues under the asset tests. All three mortgage facilities are secured by qualifying real estate assets (the Portfolio properties). The assumption of this indebtedness does not give rise to any non-qualifying asset or taxable REIT subsidiary ("TRS") concern. The indebtedness will be reflected as liabilities on Fairwater's balance sheet, not as non-qualifying assets.
Conclusion. Fairwater will continue to satisfy the 75% asset test under Section 856(c)(4) following the acquisition. The addition of the Portfolio properties and associated assets to Fairwater's balance sheet will, if anything, increase the proportion of qualifying real estate assets relative to total assets.
D. 95% Gross Income Test (Section 856(c)(3))
Section 856(c)(3) of the Code imposes a second gross income test requiring that at least 95% of a REIT's gross income consist of income that satisfies the 75% gross income test plus certain additional categories of passive income, including dividends, interest (not described in Section 856(c)(2)), and gain from the sale of securities.
The acquisition of the Portfolio does not generate any non-qualifying income under the 95% gross income test. The rental income from the Portfolio qualifies as rents from real property, as discussed in Section III.B above. The interest income earned on security deposits held in Target Entity bank accounts at Magnolia Commerce Bank, N.A. (aggregate tenant security deposits of $4,283,000) constitutes qualifying passive income under Section 856(c)(3). We note that interest income on security deposits and operating account balances is not "rents from real property" and thus does not qualify under the 75% gross income test of Section 856(c)(2), but it does qualify as interest income under the broader 95% gross income test of Section 856(c)(3).
Conclusion. The 95% gross income test is satisfied. The acquisition does not introduce any source of non-qualifying income.
E. Distribution Requirements (Section 857(a))
Under Section 857(a)(1) of the Code, a REIT must distribute to its shareholders at least 90% of its REIT taxable income (computed without regard to the dividends-paid deduction and net capital gain) for each taxable year. Failure to make distributions of at least 90% of REIT taxable income would result in loss of REIT status.
The acquisition of the Portfolio will increase Fairwater's annual rental income by approximately $74,800,000 (based on in-place base rent as of December 31, 2023). After accounting for operating expenses, interest expense on the assumed mortgage debt and any drawn amounts on the Revolver, and depreciation deductions, the net incremental REIT taxable income from the Portfolio will increase Fairwater's minimum distribution requirement. Fairwater's management has confirmed that Fairwater intends to continue distributing at least 100% of its REIT taxable income, consistent with its historical practice, and has adequate liquidity to fund the increased distribution requirement.
We note that there are no "built-in gain" concerns associated with this acquisition. Built-in gain recognition under Section 1374 (as applied to REITs through Section 337(d) regulations) is relevant only when a C corporation converts to REIT status or when a REIT acquires assets from a C corporation in a carryover-basis transaction. None of the Target Entities is or has ever been a C corporation. Each Target Entity is a disregarded entity that has never been separately subject to corporate-level taxation. Accordingly, no built-in gain tax under Section 1374 or its regulatory equivalents will apply.
Conclusion. The distribution requirements of Section 857(a) will continue to be satisfied following the acquisition.
F. Prohibited Transaction Risk (Section 857(b)(6))
Section 857(b)(6) of the Code imposes a 100% excise tax on net income derived from "prohibited transactions," which are defined as sales or other dispositions of property held primarily for sale to customers in the ordinary course of a trade or business (i.e., "dealer" property). This provision is designed to prevent REITs from engaging in active real estate development and sales activities that are more characteristic of a dealer than a passive investor.
With respect to the Transaction, Fairwater is the acquiring party and is acquiring the Portfolio properties as long-term investments to be held for current income (rental income) and potential long-term capital appreciation, consistent with its existing investment strategy. The acquisition itself does not give rise to any prohibited transaction risk. Fairwater is not disposing of property in connection with the Transaction.
From the Seller's perspective, GMP Fund III is the disposing party. GMP Fund III's rationale for the disposition — the monetization of assets as part of the normal fund-life cycle of a 2018-vintage private equity real estate fund — is consistent with investment intent rather than dealer activity. However, the Seller's prohibited transaction analysis is the Seller's responsibility and does not create any liability or exposure for Fairwater as Buyer.
We note that any future disposition by Fairwater of the Portfolio properties (or any portion thereof) would need to be separately analyzed under Section 857(b)(6) at the time of such disposition to confirm that the safe-harbor requirements are satisfied and that no prohibited transaction tax applies.
Conclusion. The acquisition does not create any prohibited transaction risk for Fairwater. Any future disposition of Portfolio properties would require independent analysis.
G. QRS Treatment of Target Entities
Under Section 856(i) of the Code, a "qualified REIT subsidiary" is defined as any corporation which is wholly owned by a REIT. For purposes of this definition, the term "corporation" includes any entity that is treated as a corporation for federal income tax purposes. However, Treasury Regulation Section 301.7701-2(a) provides that a single-member limited liability company that does not elect to be classified as a corporation is treated as a disregarded entity — that is, it is not treated as a separate entity from its owner for federal income tax purposes.
Each of the fourteen Target Entities is a Delaware limited liability company with a single member (currently GMP Fund III). None of the Target Entities has elected to be classified as a corporation under the check-the-box regulations. Accordingly, each Target Entity is currently treated as a disregarded entity for federal income tax purposes. Upon Fairwater's acquisition of 100% of the membership interests in each Target Entity, the sole member of each Target Entity will change from GMP Fund III (a domestic partnership) to Fairwater (a REIT). As a single-member LLC owned by a REIT, each Target Entity will automatically become a QRS under Section 856(i), and its separate existence will continue to be disregarded for federal income tax purposes. No affirmative election or filing is required to achieve QRS status.
The practical significance of QRS treatment is that each Target Entity's assets, liabilities, income, and deductions will be treated as the assets, liabilities, income, and deductions of Fairwater for all REIT qualification testing purposes. This ensures that the Portfolio properties are fully integrated into Fairwater's REIT structure without creating any separate entity-level tax reporting obligations at the federal level.
We note that state law treatment of disregarded entities may vary. Certain states require separate entity-level tax filings even for entities that are disregarded for federal purposes. These state-level considerations are addressed in Section VII below.
Conclusion. Each of the fourteen Target Entities will automatically become a QRS under Section 856(i) upon Fairwater's acquisition of 100% of the membership interests. No election or affirmative filing is required. The QRS treatment ensures seamless integration of the Portfolio into Fairwater's REIT structure for federal income tax purposes.
IV. Transfer Tax Analysis — Five States
A. Overview
One of the most significant tax considerations in an entity-level real estate transaction is the potential application of "controlling-interest transfer taxes" in jurisdictions where the target entities own real property. Many states have enacted statutes that treat the transfer of a controlling interest (typically 50% or more) in an entity that owns real property as a transfer of the underlying real property itself for purposes of imposing real property transfer taxes. This is an area of active legislative and administrative development, and the applicable rules vary considerably from state to state.
The Portfolio properties are located in five states: Georgia, Texas, Florida, Tennessee, and North Carolina. We have analyzed the transfer tax laws of each state with respect to the entity-level transfer contemplated by the Transaction. The aggregate estimated transfer tax exposure across all five states is approximately $3,850,000. Pursuant to Section 14.3 of the PSA, transfer taxes arising from the Transaction are to be borne equally by Buyer and Seller, resulting in a Buyer share of $1,925,000 and a Seller share of $1,925,000.
The analysis below sets forth the transfer tax framework in each state, the applicable tax rates, the estimated transfer tax amount, and the identity of local counsel retained to prepare and file the requisite transfer tax declarations and returns.
B. Georgia (4 Properties)
Properties and Target Entities:
Applicable Law. Georgia imposes a real estate transfer tax under O.C.G.A. § 48-6-1 at a rate of $1.00 per $1,000 of consideration (paid to the state), plus county-specific intangible recording taxes that apply in certain counties. In addition, Georgia has enacted a controlling-interest transfer tax provision under O.C.G.A. § 48-6-2, which treats the transfer of a "controlling interest" (defined as 50% or more of the total combined voting power or value of all classes of ownership interests) in an entity that owns real property located in Georgia as a transfer of that real property for purposes of the state real estate transfer tax. The tax applies to the value of the Georgia real property attributable to the transferred interests.
Because the Transaction involves the transfer of 100% of the membership interests in each of the four Georgia Target Entities, the controlling-interest transfer tax clearly applies to each of the four Georgia properties. The taxable consideration for each property is the allocated purchase price per PSA Exhibit K, which is based on the appraised values determined by Stonebridge Valuation Advisors, LLC.
In addition to the state-level transfer tax, Fulton County (where Buckhead Place Office Tower is located) and Gwinnett County (where Peachtree Corners Logistics Center is located) impose intangible recording taxes on the secured indebtedness associated with the properties. Because the existing mortgage debt is being assumed rather than replaced, no new mortgage recording or intangible recording tax should be due on the assumed debt. However, if any of the assumed mortgage instruments are amended in connection with the lender consent process, additional intangible recording tax may be triggered on the amended amounts.
Estimated Georgia Transfer Taxes: approximately $1,250,000.
Local Counsel. Talmadge Beaumont LLP (Catherine Beaumont, Partner) has been retained as local counsel in Georgia to prepare and file the Georgia transfer tax declarations in connection with the closing. Calderwood & Harkness LLP has provided Talmadge Beaumont LLP with the PSA Exhibit K allocations, and we are coordinating the preparation of the transfer tax returns.
C. Texas (3 Properties)
Properties and Target Entities:
Applicable Law. Texas is one of a small number of states that does not impose a state-level real property transfer tax on the conveyance of real property or on the transfer of controlling interests in entities owning real property. There are no county-level transfer taxes in Texas, although nominal county recording fees apply for the filing of any conveyance documents. Because the Transaction is structured as an entity-level transfer of membership interests and does not involve the recording of new deeds, even the nominal recording fees may be inapplicable for the three Texas properties.
Estimated Texas Transfer Taxes: $0 (nominal local fees only).
Local Counsel. Breckenridge Osgood LLP (James Breckenridge, Partner) has been retained as local counsel in Texas. We have asked Mr. Breckenridge to confirm that there are no applicable local transfer taxes, franchise fees, or recording charges that might be triggered by the entity-level transfer, and to confirm that no deed filings are required in connection with the transfer of membership interests.
D. Florida (3 Properties)
Properties and Target Entities:
Applicable Law. Florida imposes a documentary stamp tax under Fla. Stat. § 201.02 on transfers of real property and on transfers of certificates of title or beneficial interests in entities that hold Florida real property. The standard rate is $0.70 per $100 of consideration. In Miami-Dade County, an additional surtax of $0.45 per $100 of consideration applies (the "Miami-Dade surtax"), for a combined rate of $1.15 per $100 for properties located in Miami-Dade County.
Florida applies the documentary stamp tax to transfers of "controlling interests" in entities owning Florida real property under Fla. Stat. § 201.02(1)(a). A "controlling interest" is defined as more than 50% of the total fair market value of all classes of ownership interests in an entity. The transfer of 100% of the membership interests in each of the three Florida Target Entities clearly constitutes a transfer of a controlling interest for purposes of this statute.
The documentary stamp tax is calculated on the "consideration" for the transfer, which includes both the cash consideration and the amount of any indebtedness assumed or taken subject to. For each Florida property, the deemed consideration for documentary stamp tax purposes is the allocated purchase price per PSA Exhibit K, which includes the proportionate share of assumed mortgage debt attributable to each property.
The Brickell Bay Office Building is located in Miami-Dade County and is therefore subject to the additional $0.45 per $100 surtax. The Lakeland Crossings Industrial property is located in Polk County, and the Southport Logistics Park is located in Duval County, neither of which imposes a surtax.
Estimated Florida Transfer Taxes: approximately $1,680,000 (inclusive of the Miami-Dade surtax on the Brickell Bay property).
Local Counsel. Palmetto Strauss PA (Roberto Strauss, Partner) has been retained as local counsel in Florida to prepare and file the documentary stamp tax returns for each of the three Florida properties. We have provided Mr. Strauss with the PSA Exhibit K allocations and the breakdown of consideration (cash and assumed debt) for each property.
E. Tennessee (3 Properties)
Properties and Target Entities:
Applicable Law. Tennessee imposes a real estate transfer tax under Tenn. Code Ann. § 67-4-409 at a rate of $0.37 per $100 of the actual consideration or value of the property transferred, whichever is greater. Tennessee applies the transfer tax to transfers of controlling interests (50% or more) in entities owning Tennessee real property. The transfer of 100% of the membership interests in each of the three Tennessee Target Entities constitutes a transfer of a controlling interest under Tennessee law.
The taxable consideration for each Tennessee property is the allocated purchase price per PSA Exhibit K. Tennessee law requires the filing of a transfer tax declaration with the Register of Deeds in the county where the real property is located. For controlling-interest transfers, the declaration must be filed within thirty (30) days of the transfer date.
All three Tennessee properties are located in the Nashville metropolitan area — specifically, in Rutherford County (Murfreesboro), Williamson County (Brentwood/Cool Springs), and Wilson County (Mount Juliet). Each county's Register of Deeds will receive a separate transfer tax declaration.
Estimated Tennessee Transfer Taxes: approximately $740,000.
Local Counsel. Ellsworth Ridley LLP (Diane Ellsworth, Partner) has been retained as local counsel in Tennessee to prepare and file the Tennessee transfer tax declarations for each of the three Tennessee properties. We have provided Ms. Ellsworth with the PSA Exhibit K allocations and the relevant transaction details.
F. North Carolina (1 Property)
Property and Target Entity:
Applicable Law. North Carolina imposes an excise tax on conveyances of real property under N.C.G.S. § 105-228.30 at a rate of $1.00 per $500 of consideration (equivalent to $2.00 per $1,000). North Carolina applies controlling-interest transfer provisions to transfers of 90% or more of the ownership interests in an entity that owns North Carolina real property. The transfer of 100% of the membership interests in GMP SouthPark LLC clearly exceeds the 90% threshold and therefore triggers the excise tax.
The excise tax is calculated on the total consideration for the transfer, including the allocated share of assumed mortgage debt attributable to the SouthPark Corporate Center. The excise tax return is filed with the Mecklenburg County Register of Deeds.
Estimated North Carolina Transfer Taxes: approximately $180,000.
Local Counsel. Haversham Cole PLLC (Marshall Haversham, Partner) has been retained as local counsel in North Carolina to prepare and file the North Carolina excise tax return for the SouthPark property. We have provided Mr. Haversham with the PSA Exhibit K allocation for the SouthPark Corporate Center and the relevant transaction details.
G. Transfer Tax Allocation
As noted above, the $1,100,000,000 purchase price is allocated among the fourteen Portfolio properties pursuant to PSA Exhibit K. The allocation is based on the appraised values determined by Stonebridge Valuation Advisors, LLC (Maureen Alcott, MAI, Principal and Engagement Director). The appraisals were conducted in accordance with the Uniform Standards of Professional Appraisal Practice (USPAP) and were delivered to Fairwater on March 22, 2024. The Exhibit K allocation has been agreed to by both Buyer and Seller and forms the basis for the transfer tax calculations in each jurisdiction.
Transfer taxes in each state are calculated on the allocated consideration for the properties located in that state, inclusive of the proportionate share of assumed mortgage debt attributable to those properties. The aggregate transfer tax exposure across all five states is summarized as follows:
Pursuant to Section 14.3 of the PSA, all transfer taxes arising from the Transaction are to be borne equally by Buyer and Seller. Accordingly:
• Buyer's share: $1,925,000
• Seller's share: $1,925,000
The preparation of transfer tax returns is being coordinated by Calderwood & Harkness LLP (Sylvia Hartwell) in conjunction with local counsel in each state and with Ashford Prewitt LLP (Naomi Ikeda), which is assisting with the calculation of taxable consideration based on the PSA Exhibit K allocations and assumed debt schedules. Transfer tax returns will be prepared and filed at or promptly following the closing.
V. Depreciation Recapture and Step-Up Analysis
A. Entity-Level Purchase — Tax Basis Implications
The single most significant tax consequence of the entity-purchase structure selected for this Transaction is that the tax basis in the underlying real property assets held by the Target Entities does not automatically step up to fair market value for federal income tax purposes upon the transfer of the membership interests. Unlike a direct asset purchase — in which the buyer acquires the assets and takes a cost basis equal to the purchase price allocated to each asset under Section 1012 of the Code — an entity-level purchase of membership interests results in a "carryover" of the target entity's existing tax basis in its assets.
Each Target Entity's existing tax basis in its real property and other assets was established at the time GMP Fund III acquired or developed the respective property, during the period from 2019 to 2021. The Seller's aggregate cost basis in the fourteen Portfolio properties, as reported by Caldwell Murray & Oakes LLP (William Oakes, CPA), is approximately $845,000,000. This figure represents the original acquisition cost (or development cost, as applicable), net of depreciation taken by the Target Entities (as disregarded entities of GMP Fund III) during the holding period.
The current aggregate fair market value, as reflected in the Transaction's purchase price, is $1,100,000,000. The difference between the purchase price and the carryover cost basis is approximately $255,000,000. This $255,000,000 difference represents the "premium" that Fairwater is paying above the existing tax basis, for which Fairwater will not receive a corresponding step-up in the depreciable basis of the underlying assets. In practical terms, this means that Fairwater's annual depreciation deductions with respect to the Portfolio properties will be based on the $845,000,000 carryover basis rather than the $1,100,000,000 purchase price.
We note that the decision to structure the Transaction as an entity-level purchase rather than an asset purchase was made after careful consideration of the tax, legal, commercial, and practical implications. While an asset purchase would have provided Fairwater with a full step-up in basis (and correspondingly higher depreciation deductions), the entity-level structure was the preferred approach for the following transaction-critical reasons:
(i) Lender Consent Mechanics. The assumption of the existing $612,000,000 in mortgage indebtedness is substantially more straightforward in an entity-level transfer. In a direct asset purchase, the existing mortgages would need to be repaid and new financing obtained, or formal assumption agreements (with new lender underwriting) would be required. The entity-level transfer requires only a change-of-control consent from each lender, which is a less burdensome process.
(ii) Property Tax Reassessment Avoidance. In certain jurisdictions — notably Georgia — a direct transfer of real property can trigger a property tax reassessment at the property's current fair market value, potentially resulting in significantly higher property tax obligations. An entity-level transfer of membership interests may not trigger reassessment in these jurisdictions, depending on the specific assessment practices of the applicable taxing authorities.
(iii) Transfer Tax Mitigation. Although several states impose controlling-interest transfer taxes on entity-level transfers (as discussed in Section IV), in certain cases the transfer tax calculation on an entity-level transfer may result in a lower tax liability than a direct conveyance, particularly when the consideration includes assumed debt that is excluded from the taxable base in some jurisdictions.
B. Section 754 Election Consideration
Section 754 of the Code permits a partnership, upon the sale or exchange of a partnership interest, to elect to adjust the basis of partnership property to reflect the difference between the transferee partner's outside basis (i.e., the purchase price paid for the partnership interest) and the transferee partner's share of the partnership's inside basis (i.e., the partnership's basis in its underlying assets). This election, commonly known as a "Section 754 election" or a "Section 743(b) adjustment," is a critical mechanism for eliminating the disparity between inside and outside basis in partnership transactions.
However, Section 754 elections are available only to entities that are classified as partnerships for federal income tax purposes. Each of the fourteen Target Entities is a single-member LLC that is treated as a disregarded entity for federal income tax purposes — not as a partnership. Because a disregarded entity has no separate existence for federal tax purposes, it cannot make a Section 754 election. The concept of "inside basis" versus "outside basis" in the partnership context is simply inapplicable to a disregarded entity structure.
Upon Fairwater's acquisition of 100% of the membership interests in each Target Entity, each Target Entity becomes a QRS of Fairwater, and its assets are treated as the assets of Fairwater for federal income tax purposes. Fairwater inherits the existing tax basis in each property as the carryover basis of the Target Entity. There is no mechanism under current law to adjust the inside basis of a disregarded entity's assets to equal the purchase price paid by the acquirer for the membership interests.
Conclusion. Section 754 elections are not available in this transaction structure. Fairwater will inherit the Target Entities' existing carryover basis.
C. Section 338(h)(10) / Section 336(e) Elections
Section 338(h)(10) of the Code permits a buyer and seller in a "qualified stock purchase" of a corporate target to jointly elect to treat the stock purchase as a hypothetical asset purchase for federal income tax purposes, thereby permitting the buyer to obtain a stepped-up basis in the target's assets. Similarly, Section 336(e) permits certain dispositions of stock of a subsidiary corporation to be treated as asset sales, with corresponding basis adjustments.
Both Section 338(h)(10) and Section 336(e) elections are applicable only to entities that are classified as corporations (including S corporations, in certain cases) for federal income tax purposes. They are not available for entities classified as disregarded entities or partnerships. Because each of the fourteen Target Entities is a disregarded entity (single-member LLC) and not a corporation, neither Section 338(h)(10) nor Section 336(e) is available in this Transaction.
Conclusion. No basis step-up election under Section 338(h)(10) or Section 336(e) is available.
D. Depreciation Continuation
As a consequence of the entity-level purchase structure and the carryover basis rules described above, Fairwater will continue to depreciate the real property assets held by the Target Entities using each Target Entity's existing depreciable basis and remaining useful life. The key parameters for depreciation continuation are as follows:
Depreciable Lives. Each of the fourteen Portfolio properties is classified as "nonresidential real property" under Section 168(c) of the Code (ten logistics/industrial properties and four office properties). Nonresidential real property is assigned a recovery period of 39 years under the Modified Accelerated Cost Recovery System (MACRS), using the straight-line depreciation method and the mid-month convention.
Property Vintages and Remaining Lives. The Portfolio properties were built or acquired between 2016 and 2021. The oldest property (Cool Springs Office Park in Brentwood, Tennessee) was placed in service in 2016, with an original 39-year recovery period; as of the anticipated closing date, approximately 31 years of depreciable life remain. The newest properties (Katy Freeway Logistics Park, Southport Logistics Park, and Mount Juliet Commerce Park) were placed in service in 2021, with approximately 36 years of depreciable life remaining. Detailed depreciation schedules for each property are set forth in Appendix C.
Bonus Depreciation. Under Section 168(k) of the Code, as modified by the Tax Cuts and Jobs Act of 2017, 100% bonus depreciation was available for qualified property placed in service after September 27, 2017 and before January 1, 2023 (with phase-down through 2026). However, nonresidential real property (i.e., buildings and structural components) is not eligible for bonus depreciation. Bonus depreciation is available only for property with a recovery period of 20 years or less, certain computer software, water utility property, and qualified improvement property. Accordingly, the building structures and their structural components will continue to be depreciated on a straight-line basis over the remaining 39-year recovery period.
However, certain components within the buildings may qualify for shorter recovery periods and potential bonus depreciation if properly identified through a cost segregation study (see Section V.F below). These components would include, for example, specialized electrical systems, decorative finishes, site improvements, parking lot surfaces, landscaping, and certain tenant improvement buildouts that qualify as personal property or land improvements under the cost segregation methodology.
Impact on Fairwater. The practical impact of the carryover basis is that Fairwater's annual depreciation deductions with respect to the Portfolio properties will be lower than if this had been structured as an asset purchase with a stepped-up basis of $1,100,000,000. Based on the carryover basis of approximately $845,000,000, the annual depreciation on the building components (excluding land, which is non-depreciable) is estimated at approximately $17,500,000 to $19,000,000 per year, depending on the allocation between land and improvements. Had the Transaction been structured as an asset purchase with a stepped-up basis, the annual depreciation (on the building components alone) could have been approximately $22,500,000 to $24,500,000 per year. The difference of approximately $5,000,000 to $5,500,000 per year in depreciation deductions represents the annual tax cost of the carryover basis structure, which translates to an annual federal tax shield loss of approximately $1,050,000 to $1,155,000 (at a 21% corporate rate, although the effective tax rate for a REIT that distributes all taxable income may differ). This cost was weighed against the benefits of the entity-level structure described in Section V.A above.
E. Depreciation Recapture — Seller Side
Upon the disposition of the membership interests by GMP Fund III, the Seller will recognize gain equal to the difference between the amount realized (the allocated purchase price for each Target Entity) and the Seller's adjusted basis in the membership interests (which, for a disregarded entity, is equivalent to the Seller's basis in the underlying assets). Because each Target Entity is a disregarded entity, the transfer of the membership interests is treated as a transfer of the underlying assets for federal income tax purposes, and the Seller's gain is characterized by reference to the nature of the underlying assets.
Section 1250 of the Code provides for the recapture of depreciation on the disposition of depreciable real property. To the extent of prior depreciation deductions taken on the Portfolio properties, the Seller's gain will be subject to the 25% "unrecaptured Section 1250 gain" rate (rather than the preferential long-term capital gains rate). Because GMP Fund III is a partnership, the unrecaptured Section 1250 gain will flow through to the individual partners and be reported on their respective income tax returns.
This depreciation recapture is entirely the Seller's tax obligation. Fairwater, as Buyer, has no exposure to the Seller's depreciation recapture tax liability. We have reviewed the relevant provisions of the PSA and confirmed that there are no indemnification or withholding obligations imposed on the Buyer with respect to the Seller's depreciation recapture liability.
F. Cost Segregation Opportunity
Although the entity-level purchase structure does not permit a step-up in the tax basis of the underlying assets, Fairwater can nonetheless optimize its depreciation deductions within the existing carryover basis by conducting cost segregation studies on the fourteen Portfolio properties post-closing.
A cost segregation study is an engineering-based analysis that identifies and reclassifies building components that may be eligible for shorter depreciable lives than the standard 39-year recovery period applicable to the building structure. Specifically, a cost segregation study seeks to identify:
(i) Personal property components (5-year or 7-year recovery period), such as specialized electrical systems, decorative finishes, certain cabinetry, carpet and floor coverings, and movable partitions;
(ii) Land improvement components (15-year recovery period), such as parking lots and paving, sidewalks, landscaping, fencing, exterior lighting, and drainage systems; and
(iii) Qualified improvement property (15-year recovery period under Section 168(e)(6)), such as certain interior improvements to nonresidential buildings placed in service after the building's initial placement in service.
Components reclassified to shorter recovery periods may also be eligible for bonus depreciation under Section 168(k), to the extent that bonus depreciation remains available during the applicable phase-down period (currently 60% for property placed in service in 2024, declining to 40% in 2025, 20% in 2026, and 0% thereafter). We note that the bonus depreciation percentage applicable to these reclassified components would depend on when the components were originally placed in service, not when Fairwater acquired them, because the basis is a carryover basis and the placed-in-service date carries over with the asset. This is an important nuance that should be confirmed with Ashford Prewitt LLP.
The potential for accelerating depreciation deductions through cost segregation on the existing $845,000,000 of carryover basis is significant. Based on our experience with comparable logistics and office portfolios, a cost segregation study could reclassify 15% to 25% of the building cost basis (approximately $90,000,000 to $150,000,000) from the 39-year building category to shorter-lived categories, resulting in meaningful near-term depreciation acceleration.
Recommendation. We recommend that Fairwater engage Ashford Prewitt LLP or a specialized cost segregation firm to conduct cost segregation studies on all fourteen Portfolio properties promptly following the closing. The cost of such studies is typically modest relative to the tax benefits generated and is deductible as a current business expense.
VI. Section 1031 Exchange Implications
A. Applicability to Buyer (Fairwater)
Fairwater is not utilizing a Section 1031 like-kind exchange structure in connection with the acquisition of the Portfolio. The cash equity component of the Transaction ($488,000,000) is being funded from Fairwater's revolving credit facility with Aldgate National Bank, N.A., and no "relinquished property" has been identified or exchanged in connection with the Transaction. The acquisition is a straight cash purchase with debt assumption, and Section 1031 is therefore inapplicable from Fairwater's perspective.
B. Applicability to Seller (GMP Fund III)
GMP Fund III is a 2018-vintage closed-end private equity real estate fund with aggregate capital commitments of approximately $2.4 billion. The disposition of the Portfolio represents part of GMP Fund III's end-of-fund-life asset monetization strategy. To our knowledge, Seller has not indicated any intent to structure the Transaction (or any portion thereof) as a Section 1031 like-kind exchange.
Even if Seller wished to implement a Section 1031 exchange, the entity-level transfer structure presents a significant obstacle. Section 1031(a)(1) provides that no gain or loss is recognized on the exchange of real property held for productive use in a trade or business or for investment if such property is exchanged solely for property of "like kind" that is to be held for productive use in a trade or business or for investment. However, under Section 1031(a)(2)(D) (prior to the Tax Cuts and Jobs Act of 2017) and current regulations, interests in an entity — even a disregarded entity — present complex analytical issues under Section 1031.
Revenue Ruling 99-6 addressed the tax treatment of transactions involving the purchase of all interests in a disregarded entity. Under Situation 2 of Revenue Ruling 99-6, when a buyer acquires all interests in a multi-member LLC treated as a partnership, the seller is treated as selling its partnership interest (not real property), and the buyer is treated as purchasing the underlying assets. While this ruling supports asset-purchase treatment for the buyer, the analysis from the seller's perspective may differ. For a seller disposing of interests in a single-member LLC (disregarded entity), the IRS has generally treated the transaction as a sale of the underlying assets. However, the interplay between disregarded entity treatment and Section 1031 remains the subject of some uncertainty, particularly in multi-party transactions.
In any event, the Seller's Section 1031 considerations are entirely the Seller's responsibility. The PSA does not include any Section 1031 cooperation provisions requiring Fairwater to accommodate or fa