How do I enter the appreciation of value after a refi & cash out?

Question

We are finally getting our business computerized and are running into a glitch.

Scenario -

Purchase a building for $70,000

Initial improvements $25,000

New value $145,000

Refinance at 75% of $145,000 = $108,750 mortgage

The problem that I am running into is that I am showing an long term asset value of $70,000 + $25,000 = $95,000 but an offsetting long term liability value of $108,750.

Each time that I do this it makes me look more and more risky.  The properties also appreciate normally over time, so this property 10 years from now will show 10 years of depreciation on it lowering the value even more when in reality the value will most likely have appreciated greatly.

I understand that the book value of the property is already entered and is standard, but it is failing miserably to give a true and accurate snapshot of the company's health.

How can I incorporate a proper value - say the latest real estate appraisal- into the balance sheet for each property?

If this has already been covered, please forgive me and send me to the right area.

Thank you!

Mike

Simon W. · Answer

@Mike Carstens - Is your accountant an outside accountant i.e. CPA?

Here's the thing - adding an additional line to show an appreciation would not make it more accurate since the value of a property fluctuates.

My assumption is that you want to see how well this property is doing.

You basically need to do a project income statement and get the cap rate.

Purchase:

$70,000

Improvement:

$25,000

Total Spent:

$95,000

Annual Rent Income ($1000x12)

$12,000

Total Expenses (50% rule of thumb)

-$6,000

Net Income:

$6,000

Cap Rate:

6.32%

New Appraisal Value:

$145,000

Adjusted Cap Rate:

4.13%

To be honest, the information is too little to give a full picture.

Once you make the spreadsheet with all the information to produce a realistic cap rate and when you update it that will be your best snapshot of your overall Property's health.

When it is time to sell- the lower the cap rate, the better.

I hope this makes sense.

Basit Siddiqi · Answer

Are you trying to depict a balance sheet or income statement?Net Worth Statement                                                     Fair Market ValueCash                                                                                       $10,000Investments                                                                          $20,000Real Estate(original purchase of 95,000)                         $145,000Total Assets                                                                          $175,000Liabilities  Mortgage                                                                                $108,750Equity Equity                                                                                         $66,250if you are trying to do an income statementStatement of income & expendituresGross rent(A)                                                                               $10,000Expenses(B)                                                                                 $5,000Taxable income (A-B)                                                                 $5000Unrealized gain on assets(C)                                                    $5,000Book Income A-B+C                                                                    $10,000

looks simple and easy to read/understand

Linda Weygant · Answer

Your CPA  is correct - here in the US we do not write up any appreciation of our assets.  However, I get what you're trying to do in order to be able to just print off a balance sheet to show your Net Worth.

I do disagree with your CPA about putting in an offsetting liability as this still will not get you what you're looking for.

Instead, I would create a separate asset called "After Purchase Appreciation of Asset" and debit that for the increased value.

I would then create an Other Expense (Not an Operating Expense) and I would call it "Non - Taxable/Non Deductible Transactions".  You would then use this account for your credit from the above transaction.

Make sure it's not included with your other expenses because you want your Profit and Loss to look like this:

Income  xxx

Expenses xxx

Net Income xxx  <-----  This number is still really important to keep track of

Non Taxable Transactions xxx <----- This number will need to be added back to the Retained Earnings number as a manual adjustment on the tax return, if this is a multi member LLC, S-Corp or C-Corp. for each year going forward.  Your CPA might hate you for this.

Final Income xxx <-----  This will be a nonsense number that you won't use for anything.

John Thedford · Answer

If you want a quick snapshot why not CMV- mortgage balance? That is a quick shapshot of health of the company. As to depreciation, 80% of structure value can be depreciated. If residential 27.5 years. Commercial depreciation is taken at 39 years. Refinancing does not affect depreciation.

David Dachtera · Answer

Indeed. I believe one may need to consider separately the depreciation value for accounting / tax purposes and the current market value based on income as it's value as an asset.

We'll see ...

Mike Carstens · Answer

@David Dachtera

What I do find out here should not impact taxes or depreciation in any way if we can even accomplish it.  Hopefully Simon W. has a solution.

Mike Carstens · Answer

@John Thedford,

Hey John,

Yes, I believe that a separate spreadsheet will work.  As we move forward, I was just thinking that we could save a lot of paperwork by having the accounting program accurate.  It sounds like it may not be feasable though.  I kind of get a kick out of the description of what a balance sheet is (a financial snapshot of the health of your company) but then have the rules of no you cannot have the actual value of your property listed on your balance sheet.  Ha ha ha wow.  Gotta love it :-)  Not really sure what good it would be then.  Maybe I am missing something obvious.

Mike Carstens · Answer

@Simon W.

That is not the answer I want to hear!  LOL.  Seriously, I do very much appreciate you taking the time to respond.  I agree that depreciation would be off of the purchase price and definitely not off of the appreciated value.  I am not looking to alter the taxes in any way, but instead to give a more accurate snapshot of the financial state of the business.

My accountant mentioned that if I insisted we could add a line to the long term assets that would depict the appreciated value, but then we would need to also add an offsetting line in the liabilities so that we would not "screw things up".  Have you ever seen something like that?  Do you have any advice or suggestions along that line?

Thank you!

Mike

Simon W. · Answer

You can't add appreciated value into your books. Your purchase price is the number you would depreciate it at.

You bought the property for $70K, being conservative, I would do the ratio at 80/20, building/land respectively.

I do not know how much your initial mortgage is.

Assuming this building is residential, you can only depreciate 80% of the purchase price and straight-line it for 27.5 years.

John Thedford · Answer

Would it be easy to have a spreadsheet with each property, value that year, and mortgage amounts?  I probably would not worry about depreciation because that is a tax benefit ...but I am not a great numbers guy either. I am following this thread as well.

How do I enter the appreciation of value after a refi & cash out?

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