Good Managers Can Carve Out Their Own Opportunities

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Topics: Landlording

     For a high bracket investor, buying expensive houses as investments is a perfectly rational approach, but there's a fly in the ointment. First of all, our well heeled friend probably isn't aware of these possibilities. And he doesn't like the idea of managing real estate. But he hates taxes. That's where you come in.

     If you can persuade such a person to invest in real estate, he's going to like larger, attractive, more expensive houses rather than smaller houses. After all, historically, $300,000 houses have increased in value much more than $100,000 houses. Moreover, because of the inversion between rents and prices, there will be less highly taxed cash flow and each deduction will be worth a lot more when applied in his high income bracket. The $100 per month you extract from the rents in our original premise above will only cost your investor a fraction of this amount.

     Fortunately, a lot more expensive houses are being placed on the market for the first time as homeowners rush to sell their homes so they can take advantage of the tax free gains provided by the new residential tax rules. At the same time, mortgage interest rates haven't been this low or as available for 25 years. This is a marriage made in heaven between homeowners who want sell, and who would probably be amenable to leasing their homes back; and buyers who are willing to share some of the upside gain and cash flow with someone who can buy house investments for them.

     Obviously, it's a cornucopia of opportunity for the entrepreneur who has the ability to find, negotiate a spread in the price and terms, sell to an investor, and lease back with an option which shares cash flow and gain. All of which gets me back to my rent raises.

     Anytime that you can lease a property at a fixed rate for a number of years, then increase the rents, the increases go directly to your bottom line profits. While you may start out with $100 'rental spread' each month, as rents go up, so will your monthly income. Starting with decent houses that will attract decent tenants, if you can contrive to make the tenants responsible for all minor repairs up to $100 or so per repair as a condition of their rental contract, they either stop breaking things, or fix them when they do. That increases your profits while reducing your work load. Then it boils down to watching the value of your Option increase by virtue of the 25% credit toward the purchase price and the 50% share of any increase in value. Best of all, when the house is eventually sold, all the gain that's been built up inside your Option will also be taxed at the low 20% capital gains rate, not your ordinary income rate. But there's more . . .

     Both you and a high-bracket investor can gift a value of $10,000 $20,000 if married) tax free each year in the Option or property to a youngster or retired parent in the family at the inception of the purchase, or in increments afterwards. When it is exercised, an over-14-year-old or parent in the 15% bracket will only pay 10% capital gains taxes. The 90% remaining tax free profit can be used to fund living expenses, college, a new business, or to augment retirement. You'd certainly want to point all these goodies out to a prospective investor to motivate him or her to start getting the benefits that only rental real estate can provide under the new tax Act. If it's so good for the investor, why not start investing yourself?

     Now might be an excellent time to sell, and re-leverage your self into more single family houses. Using your equities in smaller houses, you can negotiate lower prices and interest rates because the seller will be paying lower taxes on the sale. And you'll be able to upgrade your properties and tenants while converting cash flow into lower taxed appreciation and amortization. Ultimately, you may discover that this long term approach to rental management will supplant even the best of the new Roth IRAs as a source of low taxed retirement income once you factor in the expense and regulation of conventional retirement plans.

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