January 1988
Vol 11 No 3
In the next 12 months we'll experience about as much change as in any previous peace-time year in our history. As an average tax-paying citizen, you'll have little or no influence on those changes even though you supposedly enjoy representative government. You remember that don't you? That's where rules are made with the consent of those who are governed. How long has it been since YOUR elected representatives responded to YOUR wishes at any level from the city dog catcher or school board to the Persian Gulf patrol?
In the euphoria accompanying the Reagan landslide in 1980 I wrote, '. . .we'll still be seeing inflation, inter-party squabbling, several additional layers of red tape, war – or threat of war, and an increasingly higher percentage of our effort confiscated by taxes.' I wasn't being clairvoyant. I was just being realistic about the ability of anyone to do anything effective when the public is more interested in government safety nets than in real economic opportunity accompanied by reasonable risk. Nothing that I've seen has changed in the intervening years. Let's review some of Reagan's accomplishments.
1. War in Granada, American servicemen killed in Lebanon, Germany, Central America, Libya.
2. Deficit spending will push the average debt of each man, woman and child to $10,000 by the end of his term. It's growing at the rate of over $600 per year for each of us.
3. Whipsawing of taxes has left us as the most heavily taxed of any American generation.
4. Government bureaucracy has grown by one third in spite of 'de-regulation'.
5. We've seen the highest number of bank failures in our history during this 'recovery'.
6. Foreigners own some 12% of the American debt which takes 14% of the budget to service.
7. The biggest stock market crash in history occurred when the speculative bubble burst.
8. We've lost control of our borders to dope smugglers, welfare families and criminals.
9. Our space program is going by default to the Russians through lack of leadership. 10 Our Congress can't even begin to agree on any corrective action for run-away spending.
MURPHY WAS AN OPTIMIST . . . Here's what he says:
1. Nothing is as easy as it looks.
2. Everything takes longer than you expect.
3. If there's a possibility of several things going wrong, the one that goes wrong first will be the one that will do the most damage.
4. Left to themselves, all things go from bad to worse.
5. If you work on a thing long enough to improve it, it will break.
6. If you think everything will be OK, you've surely overlooked something.
7. Mother Nature always sides with the hidden flaw. In 1988 it's going to be more critical than ever to try to avoid the repercussions of government mid-management, desperation taxation, regulation and control which produce transfers of wealth from producers to non-producers. You have to begin with a personal point of view – a philosophy based on Entrepreneurial principles.
First, consider that EVERYTHING IN ECONOMIC LIFE HAS A SOURCE, A DESTINATION, and a COST that must be paid. GOVERNMENT IS NEVER A SOURCE, IT IS ONLY A CONDUIT which transfers money through borrowing and taxation/inflation from EARNINGS between recipients. The only true security in our economic life lies in our customers being able to produce a good or service with a market value sufficient to justify their pay – which they choose to spend with us because we can offer the best value for their money. Thus, unless your tenants have a job, you're not going to get paid for your rent. Even then, you're going to have to compete with all the other landlords to attract paying tenants. Anytime anyone is able to command payment without a corresponding contribution of value, your costs will be increased eventually. Thus Section 8 subsidized rent is paid for out of increased property and income taxes that you'll pay sooner or later. Beware of Governments bearing gifts!
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ANOTHER TAX DEADLINE IS HERE!
The 1987 year of transition is a tough nut to crack. Each of us has a completely different tax picture, so general rules must be viewed with suspicion. In general, you've got to do several complete tax work-ups. And the neat part about all of this is that you won't have the forms you need while you're trying to plan your tax strategies. First, take out your 1986 tax return (1040) and look at line 18. For most readers this was a minus/loss figure which was used to offset other income. See what your taxable income on line 32 would have been if that figure were first reduced by $25,000 then multiplied by 65% – then that result added back to the $25,000. For instance, if 18 had been $100,000, you'd end up with $73,750 on that same line in 1987 assuming all the figures had remained the same. In other words, without a dime of additional income, your line 32 income would have increased by $26,350 on which you'd probably be paying 28% tax. Your tax bill would be $7,378 higher!
How do you like 'revenue neutral' so far? Of course, this presupposes that you took a documented active interest in the management of your real estate. Otherwise, you'd see an even more dramatic increase. The same holds true for those with over $150,000 income. Next, re-compute your 1986 income using the new rules for Alternate Minimum Tax. Hopefully, you'll be able to find a form 6251 on which to compute it. Once you've done all the calculations, see whether or not you'll be subject to the AMT. If not, then your best bet would be to adjust all your figures to reflect the anticipated 1987 annual income using the same computations. Generally speaking, it will be better for most people to bring as many deductions into 1987 as possible while holding off as much income as possible until 1988. UNLESS YOU'LL SEE CONSIDERABLY MORE INCOME IN 1988. Confused? So is everyone! There are lots of phase in rules, so as your income approaches the cut-offs for various brackets, you'll need to calculate things very carefully. Remember, there are only 21 shopping days left in 1987 to get all this done. Have a nice holiday season . . .
Here are some things you might do: a. Delay any year-end bonuses or billings. b. Make deferred compensation arrangements. c. Use fiscal year corporations to receive any year-end windfalls and shelter income with pension plans. (Re-read that corporation class workbook from the corporation class.) d. Pay your property taxes. Don't rely on the mortgage companies to meet the 1987 deadlines. Confirm with your tax collector that your taxes have been paid, or pay them yourself. e. Use borrowed money for this and to pay any deferred maintenance that you can expense in this year. Then deduct the interest until January when you can pay back the loans with the income you deferred in a. & b. above. If you have losses, realize them in 1987. For most people they'll be worth more to you. Take a hard look at filing separate returns to see if it will save you anything. And give some serious thought to incorporating if you can see that you'd be able to save more and operate more efficiently because of the inherent corporate advantages for the one-person company.
The IRS publishes myriad booklets you should order along with several sets of the 1987 forms. Xerox the forms and practice filling them out. It really pays off. Here are some: Publications: 920 (TRA 86 for Individuals), 921 (TRA 86 for Small Businesses), 928 (Withholding Taxes), 17 & 334 and 910 (Individual and Business pamphlets for overall law). 523 (Selling Your Home), 915 (Social Security Benefits), 575 (Pension and Annuity Income), 587 (Business Use of Your Home), 526 (Charitable Contributions). To get these, just call 1 (800) 424-3676. You might as well order these, you paid for them!
Some of the areas coming under scrutiny of the tax collectors are limitations on deductions for residential interest, estate and excise taxes, tax free exchanging and some form of value added or national sales tax. We'll see these translated into law right after the next elections in some form or another. Remaining detached and ignorant about tax strategy is a luxury that no investor or entrepreneur will be able to afford in 1988. It will pay you to acquire some rudimentary bookkeeping skills and to take a semester of Tax Accounting at your local night school. Besides being a lot of fun, you'll find that it begins to pay dividends almost immediately. Since the new tax law requires you to keep accounts on a property by property basis, you really don't have much choice either.
I NEVER PROMISED YOU A ROSE GARDEN . . .
The truly happy people in this world are those with no hope of ever acquiring anything. I know. I've been one of them. Do you think they concern themselves with tax matters? Economics? Politics? Balance of Trade? On the other hand, they're going to be the new serfs in what is becoming an almost feudal society. They'll remain employed at the whim of someone else – or the government. They'll be allowed to earn just enough to sustain themselves in the present, but be made totally dependent upon the good will of the government – or employer to provide for future security. The path traveled by the would be entrepreneurs and free people has never been smooth, but the slings and arrows of outrageous fortune have always been worth the price of long hours, risk and enterprise in exchange for fundamental economic and political freedom. 1988 will continue to challenge us.
States are cracking down on Independent Contractor /vs/ Employee status. So is the Federal government. Why? Because they want the employer to be a tax collector. As a Contractor, he doesn't withhold tax. Start to develop a standard contract form to fill out for those who do casual labor for you such as painting, clean-up, general maintenance and specialized repairs on appliances, heating & air systems, plumbing, roofs, etc. This does several things for you. First, it helps absolve you of the responsibility for their withholding, FICA, Workman's Comp. etc. or for their employees. Next, it shelters you from liability caused by injury on the job, mechanic's liens, union problems. Third, it enables you to specify the amount and quality of work that must be done and the price to be paid to reduce the number and severity of complaints and/or negotiation once the job has been done.
Congress is considering federal regulation of real estate appraisers in 1988. The rampant bankruptcies of S&Ls has revealed gross overstatement of real estate assets. They're cracking down. Meanwhile, some real bargains are being offered by those marginal S&Ls which are poised on the brink of disaster. Farm land, Apartments, Industrial sites, building lot subdivisions are all on the block – even some RV parks. Consider sending out a form letter to all troubled lenders in your area soliciting lists of their REO properties. Forget all about the 'market' interest rates and terms. EVERYTHING IS NEGOTIABLE to cash buyers and those with track records which would justify long term non-recourse financing.
There's no point in climbing out of the frying pan into the fire. Unless you can see a way to turn distressed property around, stay clear of it. That also includes a location with poor economic fundamentals – high unemployment, low capital investment, etc. Luxury homes will begin to come on the market as a result of the stock market crash, but be wary around LA, CHICAGO, BOSTON and NYC where a large portion of that market has been wiped out. Houses in the mid-point of your local market should continue to be good bets. Don't buy into condominium projects or apartments unless you're looking at NET CASH-FLOW after taxes which justify the risk and invested cash. I like to start at 10% as a minimum. Continue to avoid origination of new loans with personal recourse. These are risky times.
The South and Midwest continue to have single family homes priced below the median for the rest of the United States. Demographics and income levels will determine where the best long term investments in housing will be available. Among them, Miami/Ft. Lauderdale, Tampa Bay, Atlanta, San Diego, Anaheim, Riverside, Phoenix, Houston, Dallas, Washington DC, and their surrounding areas are going to grow fastest through 2010 in terms of percentages. But there's more to this than meets the eye. Somewhere one has to consider property rights.
For instance, while California will enjoy the largest growth in terms of people, incomes will be dragged down and taxes increased to compensate for the unskilled migrants. Social engineering by landlord and tenant laws, zoning, the courts create higher risks than might be found in Houston or Atlanta where property is much lower priced. We can expect the reduced revenue sharing by the Federal government to cause states and cities to raise property and use taxes. So where there's an indication of a tendency to milk property owners to pay for social programs and to support tenant rights over tax-payer/owners, it might be a wise decision to invest in real estate elsewhere regardless of growth patterns.
THE 'PAPER' BUSINESS IS CHANGING TOO . . .
TRA-86 is wreaking havoc for those who've depended upon 'carry-back' financing to either sell their products or provide depreciable basis in property they are buying. By disallowing a proportion of the deferred gains of the seller RETROACTIVELY TO ALL SALES MADE AFTER AUGUST 16, 1986 for Inventory and sales of $150,000 and over (with a few exceptions), the seller could find himself paying taxes on money he hasn't received, then paying AMT on top of this. Meanwhile, the Buyer wouldn't be able to add the amount financed to his basis because of it's being 'carry-back' financing. One defense is to discount any installment Notes for cash. We're seeing these large notes coming into the market with very attractive discounts – sometimes in the $Millions. But there's still a fly in the ointment: Bankruptcy!
J.W. Durrett was foreclosed for non-payment of a loan. 9 days later he filed for protection under the bankruptcy statutes. The court set aside the foreclosure because the distressed price paid for the property was less than 70% of appraised value. Under the interpretation of that ruling, it's possible for the person being foreclosed to petition the court for access to the property and to re-occupy it even thought the liens remain on it. As you can imagine, yields on discounted mortgages are hard to compute when no one pays and you can't even foreclose the property. Durrett effectively builds in a 12 month danger zone between the date of any foreclosure and the deadline for filing for bankruptcy. This is a landmark Texas case which is being looked at everywhere because of its effect on loan quality.
Too often, people lend money or buy paper with only a single criteria: YIELD. The prudent lender must also look at QUALITY – the character of the collateral AND THE BORROWER – and DURABILITY – the ability of the payor and property to produce an income stream over the life of the loan. Remember, BANKS AND S&Ls ARE MERELY BORROWERS WHO RE-LEND YOUR MONEY! So is the US GOVERNMENT. Now might be a good time to re-evaluate the way you use paper in your overall plan. Pete Fortunato considers it as merely private CURRENCY to be used as a component of a transaction rather than to be held as an investment in these troubled times. And Mike Meeker teaches a course to enable you to re-discount paper to an ultimate buyer before you buy it. These are concepts that are going to be more important than ever before.
DO YOU FEEL YOU KNOW ENOUGH TO MEET TODAY'S CHALLENGES?
I'm beginning to realize that I have an advantage. I've been through it before! I got wiped out in an S&L failure in 1960. I've seen double digit inflation. I experienced the depression of the 1930s. WWII. I've had borrowers file bankruptcy. I've been zoned out of existence, whipsawed by taxes, formed corporations, initiated Pension Plans, lost out due to title flaws, had to deal with due-on-sale and rent controls. I've had foreign bank accounts siezed by foreign governments, managed a slum apartment – yet prospered ultimately. In 1988 I'll try to show you how I've done it so you can avoid the mistakes I made.
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
