December 1981
Vol 4 No 3

 

THE GOVERNMENT’S CHANGING THE RULES – AND THE BENEFITS

Taxes loom large at this time of the year, and the recent Economic Recovery Tax Act of 1981 (ERTA) is going to have an impact on our NET incomes and those of our clients. First, let^‘s look at appropriate year-end strategies for 1981 starting with the top brackets and working down. 70%-ers only have 1 month left to reap the full benefits of depreciation and tax investment credits. After January 1st, you^‘ll only be in the 50% bracket, and the value of tax shelter will fall accordingly. You should huddle with your tax specialist to see how you can wrest the final benefits out of acquisitions you could make in 1981.

Although YOU may not be affected by the maximum tax, you’ll want to consider carefully the effect of buying personal property used in your trade or business. If you buy it this year, you^‘ll get a tax credit of 10%, but you won^‘t be able to take the 20% bonus depreciation. If you delay until 1982, you’ll be allowed to deduct up to a maximum of $5,000 directly under the mass asset provisions of Section 179. Just to make it more complicated, you could buy a business vehicle in December and take a 25% expense deduction for depreciation in 1981. You could also take a 6% tax investment credit as a direct reduction of your tax bill, and write the vehicle all the way off in 3 years. In addition, you^‘d be allowed to deduct actual costs of operating the vehicle.

After 1981 everyone who pays taxes can deduct 100% of their earnings up to $2000 as a contribution to Individual Retirement Accounts (IRA). It might pay for you to hire your adult dependents, spouse, etc. and pay him/her $2000 each in commissions, fees which they could contribute toward their own plan. Spouses filing jointly on the same form can show $4,000 expenses. Each reports $2000 income with a $2,000 deduction to the IRA. The net effect is $2,000 less taxable income for each plan member. A working couple could have a company pension plan, a Keogh plan, and separate IRA^‘s to reduce their taxes.

Every tax year, the need for competent tax planning counsel grows more urgent. Estate planning is just one area in which massive changes are being implemented. Under current law, everything goes to the spouse tax-free even without him/her proving any contribution to the estate. For those who can manage to remain alive until 1987 it will be possible for $600,000 to be exempted from the estate before taxes are levied.

Rental houses bought in 1981 can be depreciated over 15 years under the new ACRS (Accelerated Cost Recovery System). The bad news is that component depreciation is out. The good news is that major improvements comprising 25% of the value of the premises can be separately depreciated under the new schedules even if the old schedules must apply on the original portion of the structure. Where property is exchanged under tax free provisions of the IRC, basis carried forward retains the old depreciation schedules, but additional cost basis picked up can carry the new ACRS schedules.

Many tax changes are being contemplated by the Administration and Congress. These include elimination of all or a portion of home mortgage interest for owner occupants; elimination of interest deductions for landlords on single family houses, 6 month period for holding property in order to obtain capital gains, classifying all property that fails to yield “market” returns as inventory – thereby making it ineligible for depreciation or capital gains treatment – and even tax free exchanging under Section 1031. It will pay to keep a weather eye cocked on Washington for the next few months to protect your profits.

 

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Quotation not permitted.  Material may not be reproduced in whole or part in any form whatsoever.

 

DUE-ON-SALE BATTLES ARE HEATING UP!

Round 1: in Florida, just after the State Legislature had declared that no new law would be passed giving lenders’ the right to accelerate loans upon conveyance of an interest in property, a U.S. District Court Judge ruled that federal law preempted all state law pertaining to due-on-sale clauses. This was in contradiction to Florida’s Lockwood vs First Federal S&L of Englewood where the Second District Court of Appeal in so many words said that tie Lender must prove its security had been impaired to foreclose.

Round 2: Meanwhile in California on September 23rd the 9th Circuit told lenders that state law controls enforcement of Federal S&Ls’ due-on-sale clauses and the 1978 Wellenkamp ruling is currently controlling. There are a few other cases still being considered, but legal precedent seems to have been achieved to protect investors.

Round 3: On September 24th (please note the timing vis a vis the California decision above), Johnny Johnson^‘s Daily News Digest (P.O. Box 39027, Phoenix, AZ 85069) reported that the Treasury issued a bulletin to all financial institutions issuing mortgage loans giving them instructions to advance all mortgage assumptions to current market rates irrespective of the individual contracts, assumability clauses or state laws.

Round 4: We^‘ve heard that a new bill has been introduced to prevent home owners from permitting buyers to benefit from taking title subject to their old low interest rate loans. If this bill becomes law, both home owners and investors will have been delivered bound and gagged into the hands of the money lenders by their own representatives.

Round 5: It^‘s time to consider strategic moves when one observes Congress using its power to subvert private property rights of investors to curry favor with lenders. Here^‘s what^‘s happening around the country on this issue: TENNESSEE, NORTH CAROLINA, WISCONSIN, OHIO, NEW YORK, VIRGINIA, COLORADO, ILLINOIS, MARYLAND, NEVADA, TEXAS, UTAH, WASHINGTON, NEBRASKA are tough on those trying to acquire low interest rate loans from original borrowers. GEORGIA, IOWA, MINNESOTA, ARIZONA, FLORIDA, CALIFORNIA, MICHIGAN, MISSISSIPPI, ALABAMA, OKLAHOMA, NEW MEXICO are easier on those who assume older loans. But the picture is changing with each court case, and powerful lobbies are involved.

We^‘ve covered some strategies to be used in avoiding Due-On-Sale problems before in these pages. In general, it doesn^‘t really pay to fight them unless there is a gross profit involved. Overall, your investment yield will be higher if you stick to assumable loans in areas where they may be located, and FHA or VA loans offer the best source. If you insist on challenging the lenders, then be willing to take it all the way to the courthouse steps – and try to buy the property at a low liquidation price using investor’s money with some form of equity sharing. Who knows, someone else may overbid you, giving you a fast profit with little expense.

There^‘s still time, before the federal government steps in with a new law, or the Supreme Court rules against private property rights to secure future profits. You can act now to place your property into a Trust, Corporation, or Partnership before any legal prohibition is enacted. Suppose you placed 10 houses with FHA and VA, or Conventional or Private mortgages into Trust, then they passed a federal law requiring escalation of interest rates upon transfer of any interest in title. You could continue to buy and sell your beneficial interests (or corporate shares, or partnership interests) without affecting title. Imagine how attractive your low interest rate loans would be to buyers, and how much more you could charge if you^‘d had the foresight to take action in time.

And now more than ever, Options and Lease-Options hold the key to being able to lock in future profits. Where can you find the money in this tight market? Last February we devoted most of the issue showing how to use EQUITY financing rather than DEBT financing. SYNDICATION IS RAPIDLY COMING INTO ITS OWN AS A FAST, SAFE, EFFECTIVE WAY TO CONTROL HOUSES. This is particularly true in the light of the changes in the tax laws we mentioned earlier. Under ERTA Investors are restricted as to the Gold, Silver, Art, Gems they can place into pension plans. At the same time, they^‘re being assaulted with incredible benefits of ownership of real estate – and leased houses offer a broader range of benefits than any other type of real estate, all things being considered. At the opposite end of the spectrum are those speculators, trapped in management intensive portfolios who desperately need competent, productive managers. Both of these situations offer rich rewards for those with the talent to meet new challenges.

MANAGEMENT PERFORMANCE IS THE KEY TO SYNDICATION

In the past year I^‘ve been approached on three separate occasions for help by members of syndicates whose properties were out of control. These weren^‘t isolated instances by any means. Almost everyone has had ^“management problems^“ at one time or another. In fact, the specter of management hassle keeps most of the investors out of the real estate income property field. With the addition of another fact, an exciting opportunity becomes apparent: TODAY THERE IS IN EXCESS OF $341,000,000,000.00 in 5.5% SAVINGS ACCOUNTS IN THE UNITED STATES! Offering these savers a better, safer way to invest with inflation hedged yields is the key to unlocking this capital hoard.

Education is the first step. For years I^‘ve offered my services as a free luncheon/dinner speaker to various local service groups. I wrote a column in my local paper for a couple of years. I appeared on panels – most recently at the National Committee on Monetary Reform in New Orleans in November – to educate the investing public on the financial rewards of real estate investment. You should be doing the same! At the risk of advancing my own career, this newsletter isn^‘t a bad tool for introducing people in your own sphere of influence to the world of single family house investment. Our recent seminars in Nashville and New Orleans were aimed directly at investors too.

The next step is to find and control IDE’J houses for investor syndicates. You can use both short and long term Options and Lease/Options, delayed closing purchase contracts, Contracts for Deed, Listings, etc. to tie up the houses with small amounts of cash. Obviously, if you are already renting the property profitably, that enhances your qualifications and credibility with the investor market. Let^‘s face it, none of us would risk our money with someone who had never bought or managed property, You^‘ve got to get your own feet wet prior to asking investors to jump into a major investment.

Rental Agencies such as Rentex, Homex, Homes-R-Us, Home Finders, etc. can usually be found in the Yellow Pages in all medium to larger cities. By cooperating with them, it is sometimes possible to master lease several houses and to sub-lease them to others at a small cash-flow profit per house. Often, Agency houses are listed offering Options to Lessees. With a relative few of these houses, even the person with minimum cash is in a position to attract investors. Of course, the same technique works even if you must approach individual house owners and offer to rent their properties with an Option to buy. You^‘ll find that even the most reluctant owner will give you an Option, or a credit on the purchase price for rental payments, if you offer a high purchase price.

Your strategy and negotiation should focus on the holding period for the Option. 7 years is about right, since this will span any financial ^“tight money^“ period that the current wave of 5 year balloon notes might bring about in 1986. It also permits you to offer a substantially higher-than-market price in order to get good terms on the Option. For example, I recently obtained 8%, interest-only financing for 10 years on an Option which I don^‘t have to exercise for 4 years by giving the owner 15% more for the house than it is worth today. A few moments with a calculator will show my benefits.

Here are some numbers. SFH Value: $50,000. Loans: $18,000 VA @ 6% with payments of $237 per month. Rents: $375. Leased to give the owner $100 per month positive. Option to be exercised in 4 years at $59,000. with $9,000 down and the $32,000 second mortgage at $213,33 or total payment of S450.33 per month. Average rent increase of 12% estimated will bring rents to $590 in 4 years, or about $140 per month positive cash-flow. That^‘s about 20% cash flow return on my down payment. In 4 years the house should be worth about $84,500 with 14% per year compound appreciation. All I have to do to get that profit is to manage it competently for 4 years AND I WILL HAVE HAD POSITIVE CASH FLOW FROM THE START!

What^‘s the point of this war story? How would YOU like to ^“buy in^“ on this deal? Would you put up $4500 TODAY for ½ the cash-flow and 1/2 the profit in 14 years (estimated at $300,000 +) without any active involvement? So would I. SO WOULD ANY INVESTOR! For the syndicator there would be $4500 going in, 1/2 the cash-flow and profit without any cost to himself. For the investor, cash-flow , gain plus whatever tax benefits are available.

Where are these miracle investors: At the Orland CommonWealth Convention just completed, over half the attendees were cash investors actively seeking people with whom to work. The true shortages are of aggressive, sharp entrepreneurs who can put together attractive property packages with solid returns.

LET’S PUT THIS MONTH’S LETTER INTO PERSPECTIVE

Under proposed changes leverage could become hazardous as we^‘ve warned for the past 10 months. Due-on-sale decisions could be made at levels beyond the reach of even favorable courts which would terminate or at least severely limit our opportunities to buy with creative leverage. On the other hand, these same new laws will drive thousands of investors into our markets seeking a hedge position against ever increasing inflation. Continuing high interest rates will keep real estate construction at low levels, giving us opportunities to increase rents dramatically. By using creative leases we can gain control over properties to generate both cash flow and Options on future growth. Once we^‘ve demonstrated our ability to pyramid without using high cost loans, we^‘ll be able to sell interests in our positions to investors for cash, income and future gross profit.

There^‘s more to this than meets the eye! With Equity financing, we give up huge profits. But we also gain immense safety. Not only do we OWE less, but we have built in financial backing if we should experience high vacancy rates in an economic down turn. If the tax laws are amended to eliminate interest deductions, our equity financing will be the perfect remedy. If strict interpretations are made by the IRS as to what constitutes inventory based upon return, Equity financing will enable us to generate positive cash flow when others cannot, insulating us from that hazard. And our cash reserves, saved out of positive cash flow, will provide us with opportunities in distress sales and in taking even larger positions in leveraged syndicates who will need our expertise in management.

LATE BREAKING ITEMS FOR NEXT MONTH^‘S LETTER:

Private towns: the next significant trend in housing? Government revamping of the CPI threatens leases and indexed contracts. Inflation and Printing Press Dollars are on the rise. Structuring Options and Rent for Optimum Taxes. Cashing in on the Coming Distress Sale Bonanza. Florida^‘s Tax-Cap Amendment Gains Ground. Money Market Fund Ratings and Strategies. New rules for Brokers from the Federal Reserve System.

 

Copyright © Sunjon Trust All Rights Reserved, www.CashFlowDepot.com.  (888) 282-1882 

Quotation not permitted.  Material may not be reproduced in whole or part in any form whatsoever.