April 1993
Vol 16 No 8
Have you had trouble trying to figure out the President’s new economic package? It seems his ‘rich scum’ are going to include those with an income above $30,000, who own and live in their own homes, who buy anything or work at any job, or own a business, or are on Social Security, or are a foreign or domestic corporation making more than about $1 million per year. All of these will be paying more tax in one form or another.
As usual, government by the people, for the people is busy inciting envy between various groups to mask the fact that all these liberal spending programs are going to be paid for by Mr. and Mrs. Lunchbucket. You know them. They’re employed. They support their families. They try to educate their kids and to save a little back for their old age. They’re a doomed breed.
Sooner or later a politician’s going to figure out that the rich, for the most part, got that way because they figured out how the system works. When all those big, rich, powerful corporations are taxed, they raise their prices, or go out of business, or move to another country. Let’s see how that affects us.
Back in the mid 70’s when they passed an energy windfall profits tax, gasoline prices at the pump went up by a dime a gallon. Consumers paid the tax. When a company is driven to the wall by rising costs such as mandated company family leave, rising minimum wage rates, rising taxes, it declares bankruptcy. All its creditors lose. So do all its employees. Often their pensions go down the drain. It creates more unemployment and weakens the family structure.
Government rushes in to help, and we all pick up the tab. Sometimes the help comes in the form of retraining and relocation. Or it may be administered at the corporate level. This happened a dozen years ago when Chrysler’s bankruptcy would have deprived 300,000 employees of their retirement pensions. So they got a $Billion dollar bail out at our expense. Sure they paid it all back later, but in the meantime, we carried the costs. Let’s look at the other alternative.
Major corporations have resources which government can only gasp at. In the age of the FAX, computerized records, international marketing, a corporation can relocate to lower its tax bite. Note how many of our American brand products are really made overseas. In order to remain in business, a corporation must seek the lowest cost of production of goods and services. If the marginal tax rate makes it less profitable to run operations here, it will offset them by exporting its jobs overseas. Small business moves to another state.
What’s the real cause of the loss of manufacturing jobs in America? Corporate taxes at state and national level coupled with excessive regulation have presented companies with a difficult choice. They can either go broke or go off shore. As consumers, the savings they effect by lowering their prices can be seen in the prices we pay.
The same politicians who cry about cheap imports drive business overseas with government imposed marginal costs. As a result, the consumer benefits. Just look around your own house and count the Sony, Honda, Panasonic, Yamaha, Mitsubishi, Volkswagen, BMW, Mercedes, Volvo brand names. Don’t dare look inside anything. Ninety percent of what you’ll see will have been made outside our borders. And the money saved thereby is passed on to us.
American productivity is high. Our factories have been modernized for the most part. But the tax and regulatory burdens are too high, thanks to elected representatives’ practices of purchasing votes with government social programs. Instead, they accuse foreign governments of unfair competition. That simply boils down to foreign governments NOT creating laws which bankrupt their own industries or drive them out of their country. Now, we’re confronting new policies.
HOUSING WILL BENEFIT MORE THAN REAL ESTATE IN GENERAL
Those same social policies that create economic problems in the industrialized areas are focusing on housing. The ‘plight of the homeless’ is something a politician can really sink his/her teeth into. Suppose you were casting around for a solution to this problem. Let’s see, first you’ve got to find money with which to acquire land and create housing.
Taxes? Nah. You’d never get the legislation passed. But wait a moment. There are all those empty apartments currently owned by RTC and various troubled lenders. All you’ve got to do is to sell them at low, low prices to companies that will renovate them in return for tax credits and/or guaranteed rents. Voila. Government housing paid for with lower taxes. This has something for everybody.
You get the people off the street. You get idle housing inventory used more efficiently. You defuse growing anger in cities. You get money moving into the construction industry. You create high paying jobs for marginally skilled people outside of government for a change. You create demand for materials and capital equipment used in renovation. Your rental guarantees create security for investors and financiers in the secondary markets, paving the way for more mortgage backed bonds. You even unlock some of the hoard of dollars in Pension Funds. You’ll have a program you sell at every level, and the cost to the taxpayers will be buried way down in those off-budget guarantees.
Where does that leave the single family house? Employment and regular income enables millions to qualify for housing loans. Alan Greenspan recently stated on national television that, if he could do one thing to get the country moving, it would be to make mortgage money available at low interest rates. And that the FED could do that if government would guarantee the lender’s loans. VA has been doing this for half a century. It seems clear that this is a probability in current thinking on capital hill.
Once new housing starts to move, used housing will move too. Incredible sums of money are released into circulation by housing markets. This creates an inflationary environment which in turn drives prices upward. That’s where housing fortunes are truly made, especially when houses can be bought and sold with low, fixed rate financing loans. That’s where we come in.
FORECASTING HAS TO START WITH A PREMISE . . .
Clinton has reassembled the Carter team. He seems to have about the same comprehension of economic cause and effect as Carter did. Banks are awash with liquidity waiting for qualified borrowers. The Administrationand Congress are committed to economic growth which is the foundation of deficit reduction. And both think a little spurt of inflation to be an acceptable by-product of government spending.
Now, let’s look at real estate’s competitor, the securities markets. Both are at all time highs while home prices in most areas are at inflation adjusted prices of the mid-eighties. It doesn’t take a genius to know one should sell at the top end and buy in at the bottom. Money is even now beginning to move into R.E.I.T.s (Real Estate Investment Trusts). The time is upon us to get busy.
In the recent mini-series, we devoted quite a lot of time to ways in which this emerging market opportunity might be played. For those of you who have fairly long term mortgage paper in your kit bag, now is the time to start using it to fund house purchases. Inflation will rob the notes of value, while adding value to houses, an enviable situation. But you have to be careful. When you use a note that you have carried back on the sale of something, or that you’ve purchased at discount, you’ll trigger the tax on any profit or discount that it represents if you use it to buy property. The IRS sees this as an effective conversion to cash. On the other hand, use of a corporation can mitigate the situation.
Once upon a time, I had a corporation into which I placed various notes that I’d bought. Then I bought a house with a large equity using a corporate note which was secured both by the assets of the corporation (the grab bag of various notes and little else) and by the corporate shares themselves, which were placed into escrow. This accomplished several things which I couldn’t have done personally.
First of all, my notes were of varying quality, yield and desirability. They were secured by property spread out over several states. Their payment records also varied considerably. As a result, their true yields also covered a wide range. In general, the market wouldn’t have placed much value on them, even though income generated by them was reasonably determinable and I was satisfied that they were viable. By placing them into the corporation, I melded their yields and quality into an income stream against which my corporation could create its own notes. Armed with these, I could convert my depleting note portfolio into appreciating house equities.
Secondly, taxes on the income at the corporate level were much lower than at the personal level, since the corporate tax on C corporations lags taxes at the personal level until one reaches an income of approximately $150,000. When this is offset with myriad fringe benefits and deductible tax write-offs, despite what you may have heard, C corporations can pay much lower taxes so long as they’re an active business and not merely holding investments. Added to this was my election to establish a fiscal year that ended in June. This delayed the taxability of corporate income for 6 months over personal taxable income, affording some flexibility on tax liabilities.
Thirdly, the corporate notes carried no personal guarantees, however the corporation was actually at risk. Therefore the debt it carried was added to the depreciable basis of the property. Passive loss rules don’t exist for C corporations. All net operating losses and depreciation could be used to shelter active corporate income.
Finally, the house held by the corporation was largely free and clear. Upon sale, only the first mortgage had to be paid off since the balance of the acquisition debt was secured at the corporate level rather than by the property itself. This enabled me to raise cash without borrowing through institutions and with no personal liability. I’ve made it a hallmark to avoid any kind of institutional financing because of the ups and downs of the credit markets. This is merely one way in which use of a one person C corporation can make a difference in the way you do business, your profitability and taxes.
Now, let’s consider the Clinton programs in the light of both threat and opportunity. The threat: higher inflation, higher taxes, more regulatory risk. The opportunity: housing resurgence, more valuable tax shelter, rising wages and salaries, availability of credit. We can counter the inflation by leveraging additional properties at low cost and risk through the use of below market or zero interest financing. How do we obtain this?
Options and leases control property at very low cost. I was recently approached by an owner of a $78,000 property with a $42,000 loan who was 6 months in arrears in his payments to a private lender. He agreed to sell me an Option on one half interest in his house for $5000. The strike price would equal to half the loan balance in 5 years. This way, I got an equity interest of $18,000 going in (half of $36,000 current equity) plus half of any loan pay down, plus half of all appreciation with no management. By leaving the property in his name, I avoided any liabilities of ownership. He retained all tax benefits of home ownership as well as a stable life style.
Negotiated zero interest seller carry-back financing from distressed owners who are more motivated by saving some of their equity than on making a lender’s profit on the financing is always a possibility. I could have bought his full equity with a $6000 down payment and a zero interest loan for the balance of $30,000. Monthly payments would have been $500 for 60 months.
This would have made my real cost much lower with the value of the financing factored in. Sure, I’d have been able to capture all the benefits of ownership for myself, but (a) that would have required him to move, which he didn’t want to do, (b) required that I manage the property which was out of my area, (d) caused extra expense because of high transfer costs, (e) caused problems with the non-assumable mortgage, and (f) put me to work. I like the Option better.
A lease that encumbers title to a property can work as well as an Option. In one case, a valuable corner was leased as a parking lot for 10 years plus 2 ten year renewal periods. Then a developer wanted the space in which to build a high rise office complex. The lease had to be bought back from the Lessee at a price which divided the profit from the sale of the property in order to clear title. In the meantime, the lessee enjoyed income from the lot ownership.
SMALL BUSINESS IS LIKE THE COCKROACH . . .
Survivability best describes both. A small business is too little for government to spend much time on. It doesn’t affect trade or national credit policy much. It’s not a popular target. Yet small companies provide 85% of all American employment. That’s why business tax breaks are among the last to go and the first to return. Why there are myriad exceptions in the tax law for small businesses. Even more for small one person corporations. I prefer the corporate form of business organization for those reasons, but there’s another reason.
The current Washington Witch Hunt is for contractors the IRS can rule to be employees. If you hire small contractors, they are being importuned to declare that they are actually your employees in return for forgiveness for non-payment of employment taxes. Just about the last safe harbor for the person hiring contractors is for them to become small corporations. A corporation can never be judged your employee. I urge you to discuss this with small maintenance contractors you use and to show them the benefit of becoming incorporated to protect both them and you.
Aside from corporate tax and business considerations, asset protection and privacy are going to become more important than ever before. I’m currently in the midst of acquiring a large property. I’m going to take title in the name of a new corporation. I’ll be a mere shareholder. Nobody will know I own the building. Any attack on the corporation will pass me by so long as I scrupulously observe the corporate formalities and file the records and reports required by the state I choose to incorporate in.
When one considers the flexibility that S, C and Limited Liability Companies offer, not only as operating entities, but also in the area of family and estate planning, I think everyone should be seriously considering the corporate form of business organization I’ve been doing business corporately for over 20 years now, and can think of dozens of incidents in which being a corporate entity served me well. Once you learn the ropes it can offer solutions to a broad range of tax and operational challenges.
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