Companies interested in real estate tokenization often face various legal nuances. These questions are complex, and getting answers to them is extremely important. However, they are in the competence of lawyers and experts in several areas at once – real estate, securities, taxation, and blockchain. The Stobox company provides legal consulting services for clients around the world, and in this article, its experts will consider the main legal nuances that asset tokenization involves.
Nature of investor interests
You can tokenize different types of real estate – rental properties, hospitality resorts, office centers, and more. Different types of tokens can be issued for each type of real estate – stocks, bonds, convertible bonds, income sharing, etc. The specifics of regulation depend primarily on what type of token you are issuing and the asset to be tokenized. For example, if it is an equity interest in a company, registration under the Securities Act of 1934 may be required in the USA. For this, tokens must be distributed to at least 2000 investors (or 500 non-accredited investors), and the company must have more than $10 million in assets.
If it is planned to provide tokenized loans, such registration is not required. However, this area is governed by special provisions for securities backed by certain assets and paid for from proceeds from specific sources.
One of the recent case studies from Stobox is the tokenization of the 5-star Willows Retreat MDQ in Southwest France. This project provides for the issue of convertible debt for investors, which will further provide an opportunity to receive a guaranteed income. Also, after 3 years, it will be possible to convert the tokens into equity or get the money back.
Form of ownership of a legal entity
Transferring property to another company can trigger taxes and other requirements, so you should consider different formats. It is worth considering the type of company chosen for tokenization. They may differ in the tax burden and investor rights. For tokenization of real estate, a company in the form of ownership of a special-purpose vehicle or SPV is most often used. These are special legal entities that are created for the sole purpose of owning and managing real estate. SPVs can operate as a trust, limited liability company, corporation, etc. The choice, in this case, is individual.
Structuring is carried out so that the assets of the SPV are separated from the assets and liabilities of the issuer. This is necessary to make it more convenient for legal entities to file reports, pay taxes, or carry out bankruptcy proceedings. However, such structuring is a complex process. It is recommended to turn to experts in legal advice and support for tokenization.
Sometimes companies that tokenize real estate can be recognized as investment funds, and then there are additional requirements for them, including licensing not only for the fund itself but for its managers (still, with some exceptions that are not widespread). Also, depending on the jurisdiction, a fund needs regulated service providers, such as a custodian and a regulator.
Important criteria for whether a company is a fund include, in particular, whether it does business with the property and how much investors can influence decision-making.
Smart contracts are a special tool in the blockchain that guarantees the fulfillment of obligations by the parties. Smart contracts are executed automatically after both parties to the transaction fulfill the conditions. However, keep in mind that smart contracts cannot be changed. Therefore, even at the stage of project development, it is necessary to consider their algorithm carefully.
Smart contracts must ensure the implementation of the characteristics of the tokens planned by the issuer. For example, if an investor holds a digital asset, dividends are accrued. Smart contracts developed by Stobox include the following provisions:
- Whitelisting for investors;
- Remote burn of tokens in the case an investor loses access to their private key;
- Limits setting (mostly for AML purposes, controlling the risks of consolidation, and making sure that transactions don’t deplete the liquidity pool);
- Assigning administrators for certain operations with the smart contract;
- Voting functionality;
- Atomic Swap that allows automated settlements for crypto payments, etc.
Before launching the project, it is necessary to conduct a technical review of smart contracts for deficiencies in the conditions or the code’s security. All digital assets may be destroyed and issued anew if this is not done. Also, remember that smart contracts are not, in and of themselves, a substitute for legal documents. Therefore, it is necessary to clearly understand which functions can be performed using smart contracts and which cannot.
Securities regulation principles
In some jurisdictions, real estate tokens may be considered securities. In this case, tokens usually need to be registered in all jurisdictions in which they are sold. However, there are options for designing an offering so that registration with the SEC or other appropriate bodies of the chosen jurisdiction is not required as an exception.
The exception clauses impose different requirements on the token offer. For example, this may limit the number of investments attracted, resale rights, investment rights from unqualified investors, etc. Options are selected individually in each case by Stobox specialists.
Tax payment and reporting
Many countries have already issued digital asset tax guidelines, including the IRS Digital Assets Taxation Guideline. In addition, specific requirements may apply to security tokens. Therefore, investors should consult with experts beforehand to develop a competent tax payment strategy.
Issuers must comply with all reporting requirements relating to taxes and other aspects of doing business. The list is also individual. For example, if the Regulation A+ exemption applies, you must regularly file reports with the SEC after the tokens are placed.
Other legal issues related to real estate tokenization
- Asset type. In this case, it is necessary to determine who will manage the income from the assets. Token holders, members of the board of directors, and trusted managers can receive the corresponding powers. In addition, income management is also possible with the help of smart contracts.
- Property location. This factor is important both from a legal and practical point of view. It makes no sense to purchase an apartment for tokenization in a condominium. Tokenization can be carried out within any jurisdiction; however, it is necessary to take into account the specifics of the legislation of the country or region where you plan to buy real estate.
- Percentage of tokenization. Tokenization can be either full or partial. This issue must be agreed upon between the owners and potential investors.
- Mortgage. If you plan to tokenize a property that is in a mortgage, the mortgagee must agree. Another option is to pay off the mortgage early. However, mortgages can also be subject to tokenization. In this case, it is necessary to consider the peculiarities of local legislation.
- Accounting for token holders. All holders must be accounted for, and the issuer must know their exact number. Moreover, each holder must be identified.
- AML/KYC policy. Compliance with this policy for the sale of digital assets is mandatory. If the sale of tokens is intended only for accredited investors, the issuer must conduct or verify accreditation. Such checks may include both simple confirmation and additional measures.
- Sale of tokens in other countries. Each state has its laws on securities, real estate, digital assets, and AML/KYC policy requirements. It is necessary to consider the requirements of all jurisdictions where it is planned to sell tokens. For example, if tokens are US compliant, they may not be EU compliant.
Real estate tokenization is gradually gaining popularity, but there are still many legal nuances. They relate to the forms of ownership of legal entities, the regulation of smart contracts, user verification, token registration, etc. It is important to know that each jurisdiction has its laws. If you plan to issue tokens in several countries, they must comply with the requirements of each of them. Before tokenization, it is recommended to get full legal advice from a company that deals directly with real estate tokenization and knows all about the pitfalls in this area.