1031 Exchanges can be used to defer losses? Huh?

This post is another guest post from my friend Jeff Brown.  Jeff’s a common sense investment Realtor who has done more Straight Talk in his career than many people I know.   Check out more of his writings at Bawld Guy Talking or at Brown & Brown Inc.  

Real Estate Investors — 1031 Exchanges Can

Be Used To Defer Losses

Posted @ 6:53 pm – Filed under 1031 Exchanges

What? Huh? What would possess anyone to defer a loss for Heaven’s sake? There are situations in which a tax deferred exchange deferring a loss would make excellent tax planning sense. Sometimes, believe it or not, investors have executed exchanges without knowing ’till the end they’re in fact not deferring a gain, but, horror of horrors, a loss. No really, I’m not kiddin’.

First of all it’s crucial the taxpayer understand a 1031 basic truth. Once you’ve done what it takes to qualify for tax deferral, it doesn’t matter whether it was taxes to be paid by you, or tax savings to be enjoyed. Crazy, no? Once you’ve filed a tax return with a transaction structured as a qualified 1031 — there’s no changing your mind. It is what it is. The gain, or in this case, the loss is deferred.

Now you know why I’m always banging away at folks to ‘call the guy’, which would of course include your tax pro when contemplating a strategy of tax deferral. Sure, I know the law and regs, even a large part of the minutia of which I talk much about here, and about which most folks don’t know to ask. Yet I still insist clients speak to their tax people or have them speak to me to ensure we’re all on the same page. My experience is chock-full of examples where clients’ tax pros bring ‘new’ facts to the table that saves the shared client from a self destructive strategy.

Oh, you wanna hear one? OK…

How ’bout the client who ‘computed’ his capital gain without the understanding of ‘adjusted basis’ and it’s impact? “Well, I paid X and sold for Y, therefore my gain is Z.” Wrong 6-figure tax bill breath. His adjusted basis effectively lowered his ‘what I paid’ number by almost a half million bucks! Uh, seems the calculations neglected to include the factoid he’d twice used 1031’s — ultimately ending up with the property in question. Not only that, but since he’d acquired the initial property in 1985 his depreciation was off the charts huge, and relatively short lived compared to today’s law. If I remember correctly, he’d barely gotten under the line, qualifying for a 15 year life. Then he traded again in 2001. Then traded into the subject property in early 2003. He came to me around Jan-Feb of 2005.

His actual gain would’ve cost him, according to his CPA, who was a real firecracker, and a funny lady, easily over $100,000. Our client wasn’t amused. His figures showed a tax bill literally in the ‘chump change range’. Go figure — pun intended.

But why would one defer a loss on Purpose?

This is where it gets way simple.

You might be protecting some other ‘loss carry forwards’ which make more sense to use time wise. It’s also common to defer a loss when you’re fairly sure you’ll be in a higher tax bracket or at least making a bunch more income down the road. Maybe you’re planning to take a good size capital gain in a couple years on another property, and plan to take the loss at that point. There are several reasons a taxpayer might choose to defer a loss.

My experience has taught me it normally makes sense to simply take the loss by selling, not implementing a deferral strategy. An example is what we’ve talked about here recently. You own real estate with significant capital gains, and also some with similar capital losses. Don’t fall into the trap of thinking all circumstances with the same facts will work best using the same solutions — it just ain’t so. Sometimes a choice made years earlier can come home to impact today’s decision.

BawldGuy Takeaway: Don’t get lost in the minutia of what to do, when to do it, or how it’s done. For those things, ‘call the guy’. The primary takeaway here is to do whatever you do on Purpose and with a well thought out Plan. The rest will generally take care of itself.

Call me with any questions you may have about your current situation. I can be reached at 619-889-7100 or via email. Have a good one.

BawldGuy

Mark to Market Discussions

You know I must not have a life or something if I’m reading about mark to market at 11:30 on a Friday night, but I just finished reading one of my favorite bawldguy’s writings and since he was talking about me, I thought I’d take the liberty that he’s given me many times and guest post the entire discussion.  So, here goes:

Some Thoughts As We Enter The Weekend

The first quarter isn’t over yet, and banks lending to each other and/or to business is trending slightly up. I make a distinction between ‘trending’ and calling it a definite trend. It’s not a trend yet, just encouraging.

Our portfolio lender in Texas is coming through, closing loans Fannie Mae wouldn’t give a sniff to. That’s great news for you too, as it shows they’ve assessed the risk and decided the interest charged (low 6’s) is appropriate. This means pressure will now begin to build on Fannie/Freddie from lenders who will be losing more and more loans to portfolio lenders — and guys like me who advise investors. I have a client now able to purchase 3 duplexes, who’d be limited to 2 if he were to use a Fannie Mae lender. This is due to what I call the ’successful investor penalty’ inflicted via down payment on those owning more than 4 properties. In this client’s case, it’s empirically impossible to acquire that 3rd property without using the portfolio lender exclusively. That’s five figures of income the Fannie Mae lender will never see — times how many investors nationwide one wonders.

Over the next 25 years that extra property will mean at least an extra $2-4,000 in monthly retirement income. See? It is such a big deal.

Had an interesting discussion with my good friend Tom Vanderwell today. He’s among the very small group of lenders for whom I hold the ultimate respect. He lives in Grand Rapids, which these days is spelled H-E-L-L as far as micro-economics goes. He’s also a fellow BloodhoundBlog contributor, one of the best moves that blog’s owner, Greg Swann ever made.

Anywho, we were having a spur of the moment give and take on the ‘Mark to Market’ accounting rule. You learn early on not to run willy nilly when debating with him, ‘cuz you’ll find out quickly your apparent gains are really a prelude to becoming outflanked by your own impetuosity. Bottom line, he’s for keeping it the way it is, and I’m with the crowd wanting at least a meaningful modification.

For those still tryin’ to figure out exactly what it is, I used an analogy with Tom that I thought was illustrative of the fiction perpetuated by MM’s accounting. In real estate, depreciation is a phantom loss which acts as an offset to income from both property investments, and in the case of those earning $100,000 or less from their job, paycheck income. Imagine going to the bank for a loan, any kinda loan. You make $76,000 a year, saving over $10,000 annually after taxes. Your credit score exceeds 750.

Using the concept of MM, i.e. a loss never incurred, your banker says you only make $51,000 on your job ‘cuz of the $25,000 ‘loss’ shown on your tax return via depreciation from your real estate investments. You both realize you didn’t lose a dime. In fact, due directly to the depreciation you were able to avoid paying almost $10,000 in state/fed income taxes. Still, you’re denied the loan — you don’t make enough money to qualify. Now, how silly does that sound to you?

Yeah, me too.

Tom made some great points, one for which I simply don’t have an answer, but surely on which will affect any compromise reached by the SEC’s efforts next month. Though the loss inflicted by the practice never happened, the value of the asset in question is more or less correctly identified. In other words, if the house indeed has a current vlaue of $XX when it used to be worth $XXX, it is what it is. And if the bank needs to liquidate assets today, there very well could be a loss, depending upon the loan’s balance.

Though Tom disagreed with me, I think I can safely predict he’d like living in a world free of Mark to Market. Both real estate and Wall Street would be positively impacted almost immediately. The psychological influence will more likely than not be very positive, no doubt reflected in the very next day’s DOW/S&P numbers.

OK, that’s enough for a Friday. Enjoy your weekend.

By the way, this site will be undergoing an upgrade shortly after midnight PST. My web guy says I’m ready to eat at WordPresses cool table. So if you come here and I’m not here, you now know why. It’s only supposed to take 10 minutes or so, but we all know how it can go sometimes.

Mark to Market, Bawldguy

Some Straight Talk About Rents

This is another post by my friend Jeff Brown of Brown and Brown Inc. He writes at Bawld Guy Talking and almost everything I read of his is rock solid advice for those who are investing in real estate.    I hope you’ll enjoy this one too….

I won’t quote here, something I recently came across, so as not to embarrass the author, who was surely well meaning. Seriously, some of the things I’ve read this year about establishing rents and vacancy rates are amateur at best, and hopelessly misleading at worst. Some of the advice has been off the wall.

Here’s something ya don’t wanna do in your attempt to find out neighborhood rents.

The #1 mistake would be asking your neighborhood real estate agent. That’s not in any way a slam on house agents. But knowing rents isn’t in their job description. Chances your kid’s teacher, who owns a duplex down the street is a far better source than the agent who sold you your home.

So how do you, as a real estate investor, find out what the rents are on that property you have your eye on? Since yer investing mucho dinero I suggest you, or somebody you trust, do the following. (Of course, this in addition to getting estoppel agreements from the tenants when you buy. Always get those.)

1. Grab a clipboard/pen/paper.

2. Head out to the neighborhood of interest and park yer car.

3. Spend as much time as possible talkin’ to tenants, on site managers, and others you see, in person, belly to belly.

4. Make note of ‘For Rent’ signs and their phone numbers, then call them while standing there. Ask the pertinent questions.

5. Make extensive notes about the interiors/exteriors of everything you see. I bring a camera when I do rent surveys. I make a note of the order of what I see, and describe the picture I took, in order to make it easier to match pics with market info.

Here are some of the questions I typically ask:

What’s the rent? The deposit? How thorough is their background check? Do they take Section 8? In their opinion, are they under rented for the neighborhood? Silly question? Hardly. Many landlords, for various reasons, mostly subjective in nature, keep their rents lower than everyone else’s. Sure, you’ll figure that out while doing this ‘boots on the ground’ rental survey. But how much better to hear it from the landlord straight up? What’s the square footage. (take the answer to that one with a grain or two of salt)

On site managers as a breed, generally love to help out those who don’t try to BS them. I tell them exactly who I am, and what I’m doin’. They appreciate the honesty and the opportunity to strut their stuff. It’s similar, only much, much better when you run into the occasional owner occupant of multi-family income property. Think they pay attention to what the rents are? You bet. They’re almost always pure gold.

5. Visit, in person, all the local professional management companies in the narrowly defined area. They want your business, and will offer any help they can. The caveat I’d add, is they sometimes tend to understate their vacancy rates. Duh They realize they can’t fabricate their rents though, as they can so easily be verified.

Try to talk with several tenant’s in a building if possible. See a maintenance guy around? They’re solid gold info machines. Take him around the corner to the coffee shop and pump ‘em ’till the well’s drained. It’s more likely than not some of the other owners in the area use him too.

The highest quality source are other income property owners. You’re thinkin’, well duh, of course. Yeah, me too. But after having read some of the articles, posts, real estate forums, and emails on the subject, not one said to query income property owners themselves. Go figure. They can also tell you things only long term locals would know. Who maintains their property better or worse than others for instance. Or, who’s been experiencing an outa whack string of vacancies lately. Drugs?

And yes, you can look at Craig’s List. But a word to the wise — use it as your secondary data source. Asking prices for rents are roughly equivalent to pending sales — not worth all that much. Tellin’ a buyer for yer units that the guy down the street is ‘askin’ $1,200 for his new vacancy’ usually doesn’t cut it, know what I mean, Verne? Again — amateur night.

In the end, the more time spent with your own boots on the ground, the more hard, reliable data you’ll accumulate. Can’t tell ya how many times, whether I was workin’ for the seller or the buyer, that my first hand knowledge, based upon my own shoe leather, made the difference. It’s called income property for many reasons, not the least of which is — the value is based upon the property’s income stream, quantitatively and qualitatively. If you don’t know the facts, you could either miss out on a good deal, buy a pig in a poke, or find yourself out of a sale you thought you had.

Over the years, I’ve saved clients literally millions of dollars in both acquisitions and sales ‘cuz I was able to undress the other side’s claims for rent. If I’ve said rents should be higher, I always had empirical, documented evidence awaiting any skepticism. It works almost every time. Real is real.

The best result for a buyer of income property is when you or your advisor does what I’ve recommended here, happily discovering the rents are easily 20% below market. Talk about some pretty quick equity gain.

There’s more, but you get the picture, right? Driving the neighborhood, or Heaven forbid, askin’ the local real estate agent, is the surest way to stay woefully ignorant about what might be the most important data required for the sale/exchange/purchase of income property.

So, you haven’t called, you haven’t written — what’s the deal? Get a hold of me and we’ll figure things out.

The Verdict is in – a Guest Post

I’m taking the liberty of reposting in it’s entirety a post that my friend, Jeff Brown from Brown and Brown Inc. in San Diego wrote.   Jeff does most of his writing at BawldGuy but he’s also a co-writer with me at Bloodhound Blog.

If you are planning on retiring some time in the next 40 years, I’d strongly urge you to read the entire post (below) and also go to Bloodhound and read the comments.   Then, if you want to talk about it more, get in touch with Jeff or talk to David Shafer.

Enjoy!

Last year on these pages I wrote posts extolling the benefits of EIUL’s. Back then I called them FIUL’s. The common usage for awhile has been the former, which we’ll stick to here. What’s an EIUL? It’s permanent insurance, designed, in essence, to deliver tax free retirement income. Some have called it investment grade insurance. It also has many other benefits, including the ability to pass the entire value of the policy tax free to heirs upon the insured’s death.

My point in the previous posts was that if folks would just be objective, they’d realize 401k’s are a trap, baited by government with paltry annual tax savings to lure us in. What folks don’t know, I wrote, is that upon retirement, a disciplined saver finds out that in 4-6 years they’ve already paid back 30 years of ‘tax savings’. Such a deal.

Why would anyone do that on purpose?

It created a barrage of comments, some seemingly personal, but most disbelieving the information imparted. What’s so ironic, is whenever we guide our clients into these vehicles, it’s at a loss to us. We make not a penny on anything done by the EIUL experts to which we refer our people.

Then why do we advise many of them to separate some of the real estate investment capital from their pile in order to acquire an EIUL? Simple — it’s the right thing to do. Yesterday I posted what happened to those who refused to believe me last year.

Those who manage their company’s qualified retirement plans? Please, pretty please, at least check into this? If you’d at least done your own objective research, you would’ve discovered I was simply tellin’ you the way it was, and was gonna be. And now, the way it is.

Those who saw the information for what it was, did not get hurt in the stock market crash of the last couple weeks. It’s been significantly hurtful to most, and absolutely devastating to a majority of American taxpayers heavily invested in mutual funds through their 401k’s.

Those who chose EIUL’s? They not only didn’t lose a penny, they’ll have made about 2% this year. For those who belittled the info I put out last year, some of whom were in a position to make a difference for employees — how is your approach workin’ for ya now?

This recent downturn hasn’t just caused severe financial losses to hard working Americans. What brings insult to injury is that it didn’t have to be that way. Toward that end, I’m on my knees begging you, no, BEGGING YOU — please talk to this expert in EIUL’s. What’s the worst that could happen? Garnering new information?

If folks took the advice offered on last year’s posts, their retirement nest eggs would now be 15-30% larger. Not only that, but when they retire, their income will be tax free. When they die, their heirs will receive the EIUL’s complete value untouched by the death tax.

I’ll stop here, as I’m about to get wound up. I’m sick to death of those for whom change is anathema, and to be besmirched at any cost, merely because it’s not what they’ve been doing. That cost in the last year has been devastating to thousands of American families who never knew they had another choice.

What’s worse than that? Many of them were advised by those who knew about EIUL’s, but decided to keep it to themselves. Shame on them.

What do you now say to a family who this month alone lost upwards of 30% of their retirement nest egg? It will take that family years to simply catch up to where they were. Some will be forced to postpone their planned retirements. Think about that. What’s worse than retiring with less income than should’ve been there?

How about not being able to retire as scheduled?

Had a call the other day from a client who’d started their EIUL last year. He and his wife aren’t 40 yet. You could hear his smile as he talked. Wonder what kind of phone calls some of the in house ‘advisors’ have been getting this month?

Please, click the link and at least hear what an expert has to say. Yeah, I’m begging one more time. Imagine if this happens again, and you’re ambushed again. Working into your 80’s isn’t all it’s cracked up to be.

To those who dismissed what I had to say, out of hand last year?

Read my mind.

Jeff “Bawld Guy” Brown