All Forum Posts by: Daniel Klein

@Jay Hinrichs yes, the IRS looks at intent and a few other variables. The IRS looks at each property individually, but I don't see how someone flipping 5-7 homes a years with no other job income, for multiple years could successfully argue "investment" during an audit. There are far more sophisticated exit strategies and business structuring that can be done to keep deferment of income/cap gains intact while being a dealer. Here are the variables: The IRS determines real estate dealer status based on the "intent" of the taxpayer holding or buying the property. The characterization of gain or loss on the sale or exchange of real property turns on whether the property was held "primarily" for sale or investment. The Courts have come up with their top fifteen items that they look for in determining the status:

• Taxpayer's purpose for acquiring, holding and selling the property
• Number, frequency and continuity of sales
• Duration of ownership
• Time and effort expended by the taxpayer in promoting sales
• Taxpayer's use of brokers
• Extent of improvements and subdivision made to facilitate sales
• Ordinary business of the taxpayer
• Extent and value of the taxpayer's real estate holdings
• Extent and nature of the transactions involved
• Amount of income from sales as compared with the taxpayer's other sources of income
• Taxpayer's desire to liquidate landholdings unexpectedly obtained
• Taxpayer's overall reluctance to sell the property
• Amount of advertising
• Use of a business office for sales
• Taxpayer's control over any sales representatives

Of these, the most important issue appears to be the number, frequency, and continuity of sales. In other words: If you sell a lot of property, you might be considered a dealer simply because that appears to be the type of real estate "investing" you do. It is also possible to be treated as a dealer on one property and an investor on another.

In this case, the IRS will look at the taxpayer's intent with that particular property. For example, they will look for sales activities that show that property was held primarily for sale if they are attempting to prove dealer status. These activities would include advertising, "for sale" signs, a sales office, and employment of sales personnel.

@Thomas Rutkowski my attorneys are on retainer, and if they are the ones who wrote legislationfor the IRS I don't see why "paying" them would change the outcome. 2nd, here a quote from IRS handbook....it seems your attorneys like to bet the audit game.

If you sell property for which you claimed or could have claimed a depreciation deduction, you must report any depreciation recapture income in the year of sale, whether or not an installment payment was received that year. Figure your depreciation recapture income (including the section 179 deduction and the section 179A deduction recapture) in Part III of Form 4797. Report the recapture income in Part II of Form 4797 as ordinary income in the year of sale. The recapture income is also included in Part I of Form 6252. However, the gain equal to the recapture income is reported in full in the year of the sale. Only the gain greater than the recapture income is reported on the installment method. For more information on depreciation recapture, see chapter 3 in Pub. 544.

The recapture income reported in the year of sale is included in your installment sale basis in determining your gross profit on the installment sale. Determining gross profit is discussed under , earlier.

3rd...even IF you can defer depreciation, and even IF it's an armslength transaction, how do you account for unrelated business income tax? When a trust borrows money ( grantor/non grantor) and the grantor receives loan proceeds, the IRS considers that to be sales proceeds and is taxes at an excise tax rate.

4. And assuming the property isn't ever in a trust ( which it is, but let's assume not) the "lender" isn't really a lender. It's the trust (you) lending the selling client their proceeds back at interest. Which means it's not arms-length, because any BofA, Morgan, etc don't lend on these assets ( because it can't be done tax efficiently)

5. There are probably a few points I'm missing, but my biggest question is....if these were so clean and advantageous, why does anyone bother with a 1031 exchange? Your rebuttal of it doesn't make sense for everybody doesn't hold water, because clients who save at least $250k in taxes would be all over this, and NOBODY will touch this after understanding the real rules, not the promotion. Otherwise pretty much everyone in CA would be doing this transaction, and by default every business sale too.

a word about Delaware Statutory trusts... value-add dst exist, a few have returned 20%+ over the past 1000 transactions, and even buy and hold DST have caps in the 8-9% range. Can you make more buying your own property? Yes, but these are set and forget it type investments

@Thomas Rutkowski could you provide greater detail to the monetized installment contract? As a Series 7/6/66, Real Estate and Loan Broker I specialize in tax deferment for real estate investors. I have been pitched this by promoters recently, and my top 5 corporate tax law firm and accountants have advised against both deferred sales trusts and monetized sales contracts. Primarily, the issues raised were they aren't arms length transactions, so loan proceeds are considered sale proceeds. The lender isn't really an unrelated 3rd party, but the Trust which lends the sales proceeds out to seller ( at interest no less, creating unrelated business income tax)  and all the examples of business using them happened before 2012. Plus, you can't defer the depreciation recapture, which in most cases is at least 50% of the gain. I'd love to hear your opinion

@TD Wolf Ok, so you have $175,000 into the property (this is your equity). Your IRR on the rent (and I don't know the property taxes, maintenance etc, but lets say its 35% of the rents. So.

$1,450*.65 = $942.50 a month Net

$942.50X12 = $11,310 per year NET Operating income (NOI

IRR = NOI/Cash (equity)+ appreciation

$11,310/$175,000= .0646 = 6.46% Rate of Return Pre Tax

You may get 2-3% a year in appreciation ( $4,000) and could depreciate the value over 27.5 years)  $6,545 per year deduction. Based on your tax rate, that might be worth $2,160 today (whatever your tax rate is * deduction.

So true return is $11,310 Cash, $4,000 in appreciation, and $2,160 in tax savings = $17,470 So 9.98% a year return....

Or, you Sell at $175,000 and make $0. You take that $175,000 and you do another flip which you sell in a year for $220,000.

After sales commissions etc, you may net $204,600 on your $175,000 investment for a gain of $29,600. That NOI is $16,9% and when you sell in a year, there is no "appreciation" as its already baked into the sales price, and no depreciation, as you have no holdings. So if you can find a flip, where you can spend $175,000 and sell for $206,950 ($175,000 + $17,470)/.93 you will break even. (the .93 is the % you would net after escrow, sales commissions etc). So find something where you can sell for more than $204,000 and the better solution would be to sell current property, and make the money up on the next flip.

Look at the numbers....Take what you would net on rents $1,450 minus loan costs (and make sure the loan isn't due before your lease term is up) and whatever that number is and figure out the IRR (internal rate of return) on the property. For example, lets say its $1,450 minus $700 (mortgagne), 250 taxes insurance etc, so Net Operating is $500/month. $500x12= $6,000 per year on $100,000 invested. So 7.2% per year.

Now compare that with selling at break even and taking that $100,000 back and doing another flip, possibly making $30K profit in 9 months. Whichever number is higher (assuming risks are the same...the whole bird in the hand, 2 in the bush), that would be the logical solution.

You cant win on every fix/flip, that's the game. Concentrate on making the money work the hardest for you, and it will work itself out.

That commission structure sounds great for the Broker...unless they are providing you with set listing appointments or are bringing mass clients to you through marketing.

Basically, you would have to sell roughly 10 homes a year to make $60K (the broker made $40k), another 7 to make $49k.

The chances of you selling more than 20 homes in a year (and I don't know your market) but to do that well, and then really only Gross $110k (minus probably 30% in marketing, and 30% in taxes) just doesn't make much sense to me personally.

we reposition assets within their current geography...I wish more investors opened their investment horizons and diversified out of california.

@Osazee Edebiri With $420,000 to invest you should be making a killing. I would look at taking down a multi-family with a master lease with option to purchase (use the $420,000 for option payment, rehab, and increasing cash flow of the property) or, I would look into the Senior Living Space. Literally no competition, 20% Cash on Cash in California. 

Retirement accounts can be tapped of 1st time home buyer down payment without penalty. If its an investment property, if your Plan provider allows it you can borrow up to $50K or 1/2 the Value of the fund, without penalty. You have to pay it back in 5 years (if its NOT a primary ) or up to 15 years on a Primary.