All Forum Posts by: Mike Watkinson

For an offer on a ~$150k vacant commercial lot, is it common to include a financing contingency for the lot and my proposed build out? I will already need to make my offer contingent on getting a conditional use permit for what I intent to do, which is an approved conditional use but needs to get plans approved which will take around 6 months. 

If say I make the offer contingent only on financing for the lot itself and zoning conditional use approval, is it common to show some pre-approval/qualification like you would for a residential property? Or is it more a blind trust thing for these types of deals? 

I'm just looking for some opinions on what is the norm since I'm getting some "yes man" vibes from my agent and I haven't purchased a commercial property before. I don't want to get to aggressive on the offer and give them reservations about me tieing up the lot for such a long approval process.

@Drew Denham

In your example, if you had a gain of $50K and $10K on the sale of the first and second property, respectively, you would be taxed on the total gain of $60K when you sell the second and don't do another like kind (1031) exchange. The benefit is that you don't pay taxes on your gain until you cash out allowing you to leverage the funds for a better property.

This is especially nice since you are going to have taxable income for the recapture of the depreciation expense you've written off to shield your rental income over the years which has reduced your basis in the asset.

@David Krulac

It was my understanding that they closed the loophole allowing you to use the primary residence exclusion for built in gains related to investment use years ago. I believe that all of the depreciation taken over the life of the asset is recaptured and taxable at the max section 1250 rate (25%?), with the pro rata portion of the capital gain attributable to the investment period, as opposed to the primary residence period, being taxed at the capital gains rate. 

@Jon Klaus

There is a 5 year holding period after a 1031 transaction before the property will qualify for the primary residence exclusion. This can be overlapped with the 2 of 5 years, but both requirements need to be met. Two years of subsequent investment use is not required to qualify for 1031, but it is the time needed for safe harbor treatment if the IRS were to challenge your motives. After all this, you can still only exclude the amount I mentioned above.  

@Ethan Mace

1. Talk to your accountant about a 1031 exchange. It simply allows you to deffer taxes on any gain you would have by allowing you to transfer your basis from the old house to the new house. Your responsibility to pay back the bank for your old mortgage and tax treatment on the sale of the house are separate considerations. Lets say of the $100K, $80K is the banks and $20K is your down payment. Under the assumption you had an interest only loan and there are no closing costs for simplicity, $70K is now yours and the $80K is owed to the bank. Skipping all the steps around who can and can't hold this money, you now need to buy a house in a set period of time. The basis in your old house, $100K (less one year depreciation) will now be the basis in your new house, plus any amount above $150K which you paid for the house. Any amount paid under the $150K for the replacement house is taxable, as your will be forced to recognize the tax gain to the extent that your receive consideration (cash or debt reduction). Any gain is taxed at your normal tax rate to recapture depreciation you have taken as a deduction on the house, and as a capital gain thereafter.

Basically, a 1031 exchange is just a tax strategy which allows for deferred taxes. You can't take money out of a house with it, but rather trade up without paying any taxes on the gains you have made until you sell the replacement house. Think of it like using a equity line of credit to remodel your investment property, but instead buying a bigger one. 

2. With respect to the loan type, the IRS doesn't care how you finance a house. They do care if it is owner occupied through, which I believe is a requirement for the FHA loan. You may be able to use it on the investment portion of a multi family though, i.e., half of your duplex is treated as investment and half is not.

3. How to ensure capital gains rather than losses? Invest in treasury stock instead of real estate. Your gain is derived from the risk premium. Do your homework and you have a better shot of doing well. To tie it in to #1, the purpose of a 1031 exchange is to defer yours gains (ordinary and capital).

4. Don't speculate on appreciation for your investment strategy. Your buying an income producing asset, so count on the income. If your not in it to hold, then make your money on the front end rather than hoping for some luck on the back end. 

I hope that helps. I'm not an expert on tax law and have never used an FHA loan so take my understanding with a grain of salt.

@Elizabeth Colegrove Cash on cash is an important metric to know but looking at factors such as the asset yield and NOI as a function of the asset value is still very important. Your higher your risk tolerance when it comes to leverage is rewarded by cash on cash, but the leverage works both ways. Looking at the investment without consideration of your financing method can't be replaced.