The tokenization of real world assets are highly beneficial to users and investors in the blockchain community as it brings about enhanced liquidity, reduced entry barriers, lower risks and better market transparency among others. However, the actual process of digitizing real world assets is often more difficult to achieve than people think. This is due to the different constraints binding the real world assets from being fully realized such as legal issues and smart contracts. Different constraints exists for different kinds of assets. Some assets have much simpler constraints to deal with while others such as real estate have a much higher hurdle to pass through. The issues encountered by real estate are all tightly connected to the status of the property and involves several unique and complex factors such as tax purposes.
Real estate constraints are much more complex compared to other real world assets and often require the assistance of experienced real estate, securities, tax and blockchain attorneys and other professionals to help solve them. Let’s take a look at some of the issues encountered with digitizing real estate below:
Type of Interest
Developers of virtual tokens could choose to tokenize the real estate itself, an equity interest in a legal entity that holds the real estate, a mortgage of the property, a right to share in revenue or profits generated by the property, or any other variation. The nature of the interest being tokenized may impact what regulations apply to the token.
Legal Entity
Securitization of real estate has traditionally relied on the establishment of a special-purpose vehicle (SPV). This will apply to tokenization as well. An SPV is a legal entity that exists for a single business purpose. It can take on many forms such as a trust, limited partnership, corporation, or limited liability company. The SPV’s assets and liabilities can also be considered separate from the developer for accounting, tax and bankruptcy purposes if they are properly structured. This allows the tokens to stand on their own merit as investments, without regard to the creditworthiness of the developer.
Smart Contracts
The smart contracts used to define a token’s characteristics and process sales of the token must be carefully designed before being released since the details and terms cannot be altered once set. The smart contracts’ design must also effectuate the characteristics the issuer desires for its token. Best practices would be to have smart contracts undergo thorough technical security audits to identify and correct any security flaws in the code. Failure to do so may require burning and reissuing tokens to investors, a costly, embarrassing and unnecessary process. Even worse, a faulty smart contract could result in theft of the tokens by hackers.
Securities Regulations
Real-estate tokens will virtually always qualify as securities under state and federal law. As such, they must be registered with the Securities and Exchange Commission (SEC) or satisfy an exemption from registration. Failure to satisfy this requirement can result in substantial civil penalties and give investors a right to rescind their purchases and receive a full refund.
Tax and Reporting Considerations
Although the Internal Revenue Service has provided general guidance regarding the taxation of “virtual currencies” like bitcoin, many aspects of how U.S. tax law treats the purchase, holding, disposition of, or income from virtual tokens remains uncertain. Issuers and investors should consult a tax professional for help in developing a comprehensive tax strategy. Moreover, issuers must be aware of any reporting requirements they may have, tax-related or otherwise.
Even though these constraints are complex and tedious, the tradeoff for its placement on the blockchain is more than worth it since not only does it provide huge benefits for both the users and investors, but it can also effectively solve the illiquidity and high cost for the property. HyperDAO wishes to build an on chain ecosystem for all real world assets and as such has created the NFT Minting System as a means of achieving that.
