L/O vs Pac trust

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Posted by Craig (IL) on October 19, 2001 at 13:29:15:

OK; let's go at this some more. Mr. Bronchick's argument on the PAC trust is that Gatten presents it as a Tower of Babel, that Gatten presents it as a sure-fire, neat'n-clean solution to legal and financial problems, that this is misleading, that the PAC trust is a complicated instrument that, in the end, may do the investor no good. I agree that Gatten overstates his case, but that doesn't mean the PAC trust has no advantages over a lease option?

Let's look at what John T Reed says about l/o's. I know many people at this board think none too well of Reed's ideas. But we might do well to take Reed's tough-minded approach into consideration, expecially if tough mindendness forestalls future problems.

Reed says that, even though the chances are low, the courts could recharacterize the l/o as a wraparound-land-contract sale with a balloon payment, that this would have tax and exchange problems that could severely hurt and investor, that such a recharacterization as a sale indeed may be small, but that the consequences if one does get caught may be too severe for the risk. I'm gonna quote for Reed's pamphlet on the l/o. Reed says:

"Let's say for the sake of argument that the probability of getting caught on the wrong end of a recharacterization suit is low. Is it low enough to take the chance? The answer to that question requires consideration of the magnitude of the consequences. To take an extreme example, if the punishment for having a lease option recharacterization as a sale were death, few investors would be much interest in hearing how low the probability was. The penalty is not death, but it can be financial death or bankruptcy in some circumstances. For example, if you exchange a years of depreciation deductions were disallowed because of recharacterization of a lease option--and you suddenly owed a huge tax bill plus interest and penalties. . ." ["Single-family lease options", by John. T. Reed, p. 44.]

Reed adds that the consequences would sometimes be severe and sometimes not, but that few attorneys would draw up paperwork to protect the investor from adverse consequences if they know what the consequences were: "I suspect that few, if any competent attorneys would take that assignment without issuing a disclaimer in which you are told that there is considerable uncertainty as to how the various law would treat your lease option" [p, 45].

He suggests someone run their numbers and see exactly how much of a problem this would be. I haven't studied the PAC trust well enough to know how Gatten handles this. Anyone know? Does the PAC trust offer protections that the l/o doesn't? Is there enough statute or case law for us to know?

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