June 1987
Vol 10 No 8
At about this time every year, with the income tax calculations all tucked into the mail, it's not a bad idea to take a long look at where you are and where you're going. Rockefeller is purported to have said that the difference between rich and poor people was not so much their intellect as their ability to see and plan in longer segments of time. For instance, it's not uncommon to be able to hire general laborers by the hour and to pay them at the end of the day. For working hard all day, they might earn between $50 and $100 dollars most places. On the other hand, the truly rich people have been known to work for average salaries, but to have stock options accrue worth millions of dollars at a point in the distant future. There's a reason why this is a topic in this month's letter.
Over the past decade since I've been writing this letter the economy has endured several major changes in direction. We went from feast to famine and back in the house business. Interest rates went from 9% to 21% and back too. Loans went from being fully assumable to being non-assumable. Tax rates fell from 70% to 40% on capital gains before capital gains became taxed as if they were ordinary income. With each of these changes, specific strategies were presented to either mitigate their damage to you, or to enable you to capitalize on them and use them to your advantage. Sometimes we offered both. In some instances we were able to give you a couple of years advance warnings. In others, you only had a few months in which to react. But overall, for those who took the long view, houses have been an outstanding estate building tool.
Things are beginning to change even more swiftly in 1987. It's time to take a long look at the rest of this century – 12½ years – to see what direction you should take. First, look at your age. How old will you be in 2000 AD? How healthy? How extreme will the AIDS epidemic be? What will the trend be in State and Local taxes? Federal taxes? Estate taxes? What will your family composition be? Kids in college? Grandchildren? How will you foot the bills you can predict then? What about your career? Will you be earning a high salary? Retired? Will you have enough cash to pay for your desired life style in case of either depression or inflation? Or will either one wipe you out if it occurs?
You say you don't want to look so far ahead? Then try 1990. How will you feel about your savings and portfolio under President Gary Hart? Bush? How would you like Tom Hayden as Secretary of HUD or Treasury? Will we be in the midst of a full fledged trade war with Japan? How might they retaliate? Stop buying T-Bills? Start buying American corporations and farms? Dump dollars into our economy or the world's? Our economy is dependent on the actions of people all over the world, so we can't ignore what's happening even though it doesn't directly affect our rents. It can still drastically affect the costs of financing and the liquidity of real estate – and the value of what we own.
If you hope to make the correct decisions and to forecast events with any degree of accuracy, you have to keep abreast of much more than real estate and finance. You must learn enough about other political and economic forces that influence it. So once a year the CommonWealth Letters try to take the long view. It can be a sobering experience to play 'what if'. What if that big bank failure finally occurs? The S&L industry and the FSLIC are only being propped up by a Federal policy of ignoring negative net worth when there are no funds with which to pay depositors. Freedom Mortgage company in Tampa has enjoyed that position for some time. And let's not even discuss Brazilian debt default. Another what if must necessarily include war – even a small war which disrupts families' lives and justifies implementation of government bureaucratic control of everything.
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I'LL RESPECT YOU IN THE MORNING . . .
That's one of the all-time great lies. Another one is: 'I'm from the Government and I'm here to help you.' Still another is: 'Rent Controls help to provide decent, low cost housing for the poor.' While housing prices have increased a lot more slowly in the 80's compared to the 70's, rents have leap frogged upward at a remarkable rate. In the past year, rental prices have begun to come to the attention of rent control advocates who've already decided that landlords are making too much money.
Let's debunk some of the rent control myths. For some reason landlords are supposed to invest under a different set of rules than other investors, but they don't. They seek a yield on their invested dollar that is comparable to the yield they would be able to get in any other non-real estate investment. Prior to the 1986 Tax Act, real estate tax shelter enhanced otherwise so-so cash flows to produce a competitive yield. But with the new Passive loss rules, that benefit has been reduced. Only by collecting more gross rent will an investor be able to offset the shelter losses. In some areas this means increases of as much as 30%. But there's more to this story.
Real estate has lost some of its allure for investors because of the actions of tenant advocacy groups, state laws regarding exposure to liability claims, uncertainty in the markets regarding interest rates, property taxes, increased licenses and fees. So to attract buyers at prices which will recover their investment, properties must produce even higher cash flows after expenses and higher taxes. And, they have to compete with the stock market, which has been stunning. So, rents have to go higher where the market will permit it. Coincidentally, economic market factors in many areas are creating conditions in which rents can be increased. Here's what's happened.
The new tax act has scared off investors in new housing projects. Property and use taxes are on the rise in many areas. Tenant rights groups and tax supported legal services have increased the risk as well as the costs of operating rental housing. Many apartments are being converted to condominiums. Demand is exceeding supply. Now, the specter of RENT CONTROL has virtually shut down any new construction, increasing the competition for housing. In areas where there isn't any rent control, landlords have found it more profitable to rehabilitate their units and to convert them into higher-rent accommodations. The older, poorer former residents now can't find housing. You see this phenomenon everywhere there are rent controls – New York, Washington DC, Berkeley, Santa Monica, West Hollywood, etc. The very people the government has tried to help have been hurt the worst. There are some unforeseen beneficiaries of rent controls who aren't poor.
Once Government interferes in the markets, things become distorted. People who occupy rent controlled apartments can command fees running into the thousands of dollars just for agreeing to relocate or to buy a new condominium when their apartments are converted to condos by a developer. They can sub-let at black market rates to others who don't get the benefit of their locked in rents. They can take the money they've saved from their rents and speculate in real estate – or the market – in more favorable areas. When Donald Trump tried to break some of these leases he discovered a broad array of people from the middle class posing as poor tenants in a rent controlled building. Now, New York is even considering making rent controlled leases something that can be left to heirs.
If you own property in an area in which rent controls are being broached or where tenant militancy is evident, beware. It can have a devastating effect on income and net worth. You'll want to re-read the June 1979 issue to plot your counter strategy. In the meantime, you can take comfort in the news that your government has allocated $500 Million to the homeless poor – who probably wouldn't have been homeless if normal supply and demand had been allowed to rule the prices of property and rents. You'll note that the new tax act retains favorable treatment for those who invest in low income housing. Low income means as much as $21,000 in Washington where your taxes are collected – and spent!
TAX PAYERS TO GET BILL OF RIGHTS . . .
By the time you get this letter, you will have completed your tax return for the past year, filled out your W4 to get the proper withholding for 87, or, filed for extension until August 15th, or made one estimated tax payment and are readying yourself for the one due June 15th. In short, you've been a good, law abiding citizen. Why is it that you'll officially be considered a crook in the event an IRS representative decides he doesn't believe the facts you've presented on your return? Why is it that all constitutional guarantees of due process, trial by your peers, presumption of innocence, etc. all go out the window when federal income taxes are concerned? Shouldn't you deserve a better shake?
Senator Harry Reid, United States Senator from Nevada is trying to do something about it. He's the sponsor of the OMNIBUS TAXPAYERS' BILL OF RIGHTS ACT which was introduced February 26, 1987. In a letter to Harley Laughlin dated March 19, 1987, he stated that this bill . . 'applies a legislative remedy to the abusive, discourteous, and possibly illegal behavior taxpayers are often subjected to by the Internal Revenue Service (IRS). S. 604 includes provisions requiring the IRS to disclose taxpayers' rights and obligations; establishing new procedures for IRS interviews of taxpayers; establishing a statutory office of the Inspector General in the Department of the Treasury; prohibiting the evaluation of IRS employees based on amounts collected from taxpayers; and by placing the burden of proof with the IRS in administrative and judicial proceedings.'
Here are some interesting provisions of the proposed Bill of Rights: Section 4 requires that the taxpayer be given a MIRANDA type warning prior to any interview and gives the taxpayer the right to make recordings of any interview as well as allowing him to be represented by another party with a Power of Attorney. Section 7 precludes the IRS from conducting any investigation or surveillance over taxpayers regarding their beliefs and/or any membership in any organization or associations except for organized crime activities. Section 8 requires the IRS to disclose levy procedures and alternative options to the taxpayer and precludes any levy on any day that the taxpayer responds to a summons issued by the IRS. Increases personal property exemptions from $1500 to $10,000 and exempts all animals plus property of an UNINCORPORATED business up to another Ten Thousand dollars. Increases wages exempt from levy up to $150 per week, plus $50 for each dependent.
Section 9 creates a judicial and administrative appeals process for jeopardy levies. Section 10 authorizes installment payment of tax liability and requires IRS to propose such where the tax liability doesn't exceed $20,000, binding on the IRS. Section 11 prevents the IRS from collecting deficiency interest and penalties which result from its incorrect written advice. Section 14 sets a minimum sale price on levied property. Section. 15 limits audits on a particular trade, business or profession. Section 16 makes the IRS carry the burden of proof in court proceedings if the taxpayer provides minimal information necessary to support his position. Finally, Section 17 requires that all rules and regulations be analyzed for their impact on small businesses prior to enactment.
In a representative government your elected representatives need to know what you want them to do. This act is a major move in the right direction to maintain rights you should already have guaranteed under the constitution. Sit down right now and write to both your Congressman/woman and Senator and express your support for this act as well as your wish that they support it. Send copies to Senator Harry Reid, Senate Office Bldg., Washington, DC 20510.
WHILE WE'RE TALKING TAXES . . .
IRS regulations issued April 1 has changed reporting requirements on homes sold after January 1, 1987. 1099 information returns are not required on sales closed before May 4, 1987, nor on any sales of larger buildings with more than 5 units, nor on sales by corporations or governmental agencies. Every little bit helps when it comes to reducing paperwork.
Copyright Sunjon Trust All Rights Reserved
Quotation not permitted. Material may not be reproduced in whole or in part in any form whatsoever.
1-888-282-1882 www.CashFlowDepot.com
