August 1986
Vol 9 No 10
I think Calvin Cooledge came up with that expression. If he didn't, he should have. In this mid-summer of 1986 our world is being changed. We'll need to change with it! This month's letter will try to point the way. First, let's take a look at the investment landscape to see what confronts us. The Senate and House may argue over some of the ways to raise our tax burden, but it seems clear to me that tax shelter promoters and investors are going to take a bath. So will those who hold long term to get favorable long term capital gains. And those who bought with high leverage in anticipation of a lot of appreciation. And those who 'pulled equity out' with resultant negative cash flows.
Even prudent investors are going to see some short term evaporation of their benefits of ownership of good real estate if there's any panic selling. And I don't think cur leaders have even considered the effects on our mortgage lending institutions once the syndicators and General Partners are driven into bankruptcy leaving millions of loans in default. Might as well get all the bad news out in one paragraph. Latin American loans, deficits, balance of payments, manufacturing and capital intensive industries, space programs are all in trouble. So are the institutions who depend on their cash flows. So are the employees of these institutions. And in this election year, our politicians and the citizens who elect them are going to be faced with momentous decisions which will have long lasting effects on all of us.
Anytime things change, it's a natural reaction to resist, to list disadvantages, to lament the passage of the good times. To the extent that you can modify the changes to your benefit, that's a sound course of action. On the other hand, every alteration in the status quo creates opportunity for others. An easy example in real estate can be found in Zoning applications which permit a change in use of property. Invariably, those who are already established in a neighborhood resist the change. Those seeking opportunity are for it. I think those mental attitudes apply to the nation today. On the one hand, I've been inundated with writers urging letter writing campaigns to ward off the new tax law changes. On the other hand, many of my more entrepreneurial peers, those seeking opportunity, see new horizons in which to ply their respective trades. This letter's for them.
GOLD IS WHERE YOU FIND IT . . .
That was a slogan of California's gold rush community. It's equally true today. Where should we look first? I'd like to divide things up into DEFENSE and OFFENSE. For the rest of 1986 we should nail down the gains we've already got. If you've been taking my advice and begun culling the 'losers' out of your portfolio, keep on doing it. Whenever possible, sell for CASH. You'll pay taxes on 40% of your gains plus the Alternate Minimum Tax on 60% that exceeds $40,000 per family. But that could be cheaper than selling next year under the new rates. Depends on how the law comes out. Regardless of its eventual form, it always pays to get rid of marginal properties for cash. Do it! I am!
If you have a corporation, set up a Pension Plan right away. So far, these are emerging unscathed, but changes are scheduled which will reduce their advantages later on. If you don't have a corporation, give serious consideration to forming one. Despite all the talk, corporations offer many advantages over individual forms of ownership. One-person corporations are my favorite kind. If your state allows it, you be the Stockholders,
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
Employees, Directors and Officers. The more you learn about this, the more you'll like it. Don't be greedy. Your spouse and adult kids can have their own one-person corporations too. When you calculate all the corporate deductions and benefits available, this will still be a viable business organization in spite of the new tax bill.
Run up as many deductible expenses as you can while you can still use them to offset income outside your investments. I'm fixing up rental properties as never before. I'm making all major purchases involving sales tax. I'm paying off consumer and high interest rate credit. I'll be sure to pay all property taxes in 1986 and to make maximum IRA contributions. Set up Trusts for your children too, if your tax counselor approves. Get all those medical expenses in in 1986 – physical exams, medicines, dental work, surgery. Surely, you'll want to attend every investment seminar you can while you're still able to deduct them.
Anticipate that Adam Smith's 'Invisible Hand' is going to be felt throughout the stock and Bond markets as millions of investors cash in prior to the end of the year. If you're waiting until the last minute, you may be all dressed up with no place to go. I'd rather be 3 months too early than one day too late! Strive for balance. Good solid income properties that you're willing to keep forever. Enough cash to enable you to go through a period of recession with low rents. Inflation hedges such as Options and Zero interest loans on good houses. Clean up any credit problems and get rid of bad financing. Use the lower interest rates to eliminate balloon payments and callable loans. The Defense rests.
PT BOATS CAN SINK BATTLESHIPS . . .
It's not how big you are that counts. It's not necessarily your fire power. In the final analysis, the winner is the guy who can maneuver surely and quickly, who can plan and anticipate problems, who can adapt to swiftly changing circumstances adroitly, who knows in advance what's needed and is able to provide it. That more or less describes your basic off-the-shelf entrepreneur. That's who's going to come out on top for the remainder of this century. Why? Because by his very nature, he's creative, innovative. He's accustomed to the short end of the stick. He's almost always under-financed. He doesn't settle for half a loaf. And he's wary of gifts from the government that come wrapped in regulations.
Here are some things you can do right away. HEDGED DELAYED EXCHANGE: Under both the current and new law you can still sell for cash, put the proceeds into escrow, identify a replacement like-kind property within 45 days, close the purchase within 180 days tax free. Sure, there are special rules to be observed and you'll need professional help, BUT YOU CAN STILL DO IT. Now for the hedge: Suppose the tax bill comes out so that you'd be better off to take the money and run, paying the taxes or offsetting them against deductible expenses. Fine, just don't close on the replacement property. You can identify it and buy an Option on it for that period. 6 months from today will be February of 1987, yet the effective sale date and applicable tax law will be 1986. Now you can sit back and await the final version then make your decision as to what's best. If tax deferral works out better, go ahead and close your purchase on schedule. That way you can have the best of two worlds. Where can you get such an Option? What are friends for? Remember, the seller gets the Option money TAX FREE in this year. His sale will be in 1987. And he can repeat the process to defer his own tax bite. And so can the person he buys from, Ad Nauseum . . .
Recognize that the new tax bill treats people differently. If you and your spouse have an adjusted gross income of $185,320. you'll pay 27% of that in taxes. If it's below $29,300, you'll still be in the 15% bracket if you file jointly, $17,600 for singles. One thought that immediately crosses my mind is to use multiple tax payers to hold down the adjusted gross income on any single return. Who are these multiple tax payers? Kids over 14, Spouses, Corporations (his, hers, ours, theirs), Family partnerships, certain Trusts that are tax paying entities. Of course, when you can use FISCAL YEARS, this also splits income. The IRS tries to plug a lot of these holes, so you're going to need good advice.
WHY NOT JOIN THE PRIVILEGED CLASS?
No, I'm not referring to bureaucrats who will be the ultimate beneficiaries of all revenue raising laws. I'm talking about small businessmen – those PT Boats who can move quickly to seize opportunity while staying out of harm's way. When it comes to real estate investment, things are going to be much rougher. But when it comes to Real Estate Businesses, things could turn bright indeed. So become an active participant in a Real Estate Business. Look at all the things you could be doing:
1. Appraisals – every lender will need your services before making loans. Every Trustee of Referee in Bankruptcy (even lender's bankruptcies) will hire your services. Those who make tax free Exchanges too. Those receiving gifts. Even the IRS. The courts.
2. Surveyors – they're the folks who physically identify what's being sold, seized, or used to collateralize loans. Developers, zoning officials, minimum housing standards enforcers all use them. When bureaucrats need you, how could you ever go broke?
3. Abstractors – they verify condition of the chain of title. Nobody will buy something unless a specialist researches every transaction and prior owner, legal claim, loan, payment of property taxes and assessments against or involving a property.
4. Attorneys – they examine all of the above for all participants to a transaction. In some instances they make the final determination of the marketability of title, and in other instances they contract with title and escrow companies to do it.
5. Closing/Title/Escrow/Foreclosure companies – all perform specialized services on a contractual basis with consumers, lenders, courts, entrepreneurs, etc.
6. Brokerage firms – everything in this world was sold at one time or another to someone else. And someone made that sale for a fee or for a profit. Real estate and Mortgage brokers are involved in almost every real estate transaction in some way. Fees earned can be astronomical when measured against investment by the Broker or NET sale proceeds to the seller.
7. Management firms – almost all large portfolios of real estate are managed professionally at a cost of from 10% to 15% of GROSS rents. This figure continues to grow with each additional service provided which might include Tenant Screening, Rent Up, Collections, Bookkeeping and Accounting, Evictions and Legal Services, Maintenance and Repairs, Appliance Sales and Services, etc. Or the company might just NET LEASE the property.
8. Mortgage and Installment Lenders – they round up money for loans; buy and sell 'paper' for profit, service loans for those who employ them. They're the grease which makes the system work, finding sources of funds and buyers of loans in the secondary markets.
9. Builders and Developers – they create real estate product for the consumer and the investors. They locate and tie up property, get financing commitments, take care of all legal and regulatory problems, create value in the form of attractive lots and buildings. They've created most of the truly great real estate fortunes ever made.
10. Real Estate 'Business' Operators – hold property, leases, mortgages, management contracts and listings for business profits from rents, interest, sales, rehabs, management and marketing fees. They USE their assets for the production of income combining all of the above functions as needed to produce a profit, getting optimum tax advantages to offset cash flow earnings prior to paying taxes. This is where the future lies for most of the people who think of themselves as INVESTORS. This is the entrepreneur's territory.
Think about it for a moment. You can either START UP or BUY INTO any of the above businesses. You can place your present assets into such a business, or co-venture with someone who's already the owner of one. They're all synergistic, helping each other.
HOW DO YOU SPELL RELIEF? C-A-S-H – F-L-O-W B-U-S-I-N-E-S-S!
It's time to do a little mind bending. 34 years ago I built my first house by hand. The profit came from buying scrap and used materials, then using cheap labor (mine) to create a house. There were no mortgage, no payments, no problems. Not much house either, but it was free and clear to the owner. A few years later, I had a house built for me again at low cost because I supervised the sub-contractors and paid cash. I made my profit by putting together all the factors of production: land, labor, materials, money, time to create value both as a USER (my residence) and as an INVESTOR (I captured my profit when I sold). Next, I created profit by buying properties from people who were willing to trade off price for speed. I bought fast, sold slow and made a profit from market knowledge. The property had little to do with the amount of profit. That depended more on my knowledge and skills as a negotiator and as a financier. The next plateau was as a broker who earned cash fees from marketing and management. This led to the real estate business which I've been operating for the past 13 years.
Suppose you recast your position from being an investor to being a businessman? That means you engage in activities specifically for the production of income. The assets you have – single family houses, notes and mortgages/trust deeds, leases – are contributed to the business. The business enjoys business income. It pays business expenses. It not only performs for you the owner on your former investment property, it also expands to offer services to the other property owners. It might elect to employ a licensed Broker to deal with matters requiring such a license. At the end of the year, out of its income, it first pays expenses. These include interest, depreciation, taxes, insurance, operating expenses, travel and transportation, education and training, pension plan expenses, etc. While some of these might not be allowable to a passive investor, they will be allowable to an active business owner engaged in pursuit of profit.
Of course, as a new businessman there's lots to learn. You're going to have to decide whether to start your own business or buy someone else's – or both. You'll need to know which form of business organization would be better for you and your family. If you buy into another business you're going to have to learn how to find it, evaluate it, price it, finance it and structure the transaction to assure profits. It's complex. It's very rewarding. It has many built in features you probably haven't thought of – especially in terms of estate planning and family involvement. And it offers a profitable response to the new tax bill. We've offered you a Corporation seminar. There's more to come.
ART HAMEL'S DESIGNING A NEW BUSINESS SEMINAR JUST FOR REAL ESTATE INVESTORS . . .
I went to Art's course over 10 years ago. I bought a business at the course. He has the only course I know of on the subject of Business Opportunities, so I asked him to write a course for us at THE COMMONWEALTH CONVENTION in ORLANDO in OCTOBER. One of the most important things he's agreed to deal with is using dead/passive real estate equities to buy into businesses. This isn't a tax free move necessarily, but it's a way to transition into an existing business out of your current real estate position. This is the only class he's scheduled on this subject. It's still a deductible event in 1986 as of today.
Art's had lots of experience in hundreds of companies both as a buyer and as an entrepreneur starting up his own. He's been involved in franchising and knows the traps. He understands when it pays to buy and liquidate to make a profit. He's been a broker as well as an entrepreneur in his own account. He's the best I can find to address our needs. As someone who's made the transition into several businesses, I can tell you that a little knowledge goes a long way – so does a little ignorance.
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
