Nearly 6 percent of fixed-rate mortgages to borrowers with good credit were in the foreclosure process. About 50% of all adjustable-rate loans made to borrowers with shaky credit were past due or in foreclosure.

The worst of the trouble continues to be centered in California, Nevada, Arizona and Florida, which accounted for 46 percent of new foreclosures in the country.  

The number of people receiving unemployment benefits was the highest on record.  The U.S. unemployment rate is now 8.9 percent. The number of unemployed U.S. workers was 13.7 million in April, according to the federal government.  The largest increases in initial claims for the week ending May 16 were in California, 5,447; North Carolina, 2,693; and Georgia, 1,595.

Billionaires Are Made in Real Estate

           It’s tangible, it’s solid, it’s beautiful. It’s artistic, from my standpoint, and I just love real estate.    -Donald Trump

The Donald’s not alone either…there are at least 45 other billionaires who think real estate is a good investment.

In an article titled The 10 Common Traits of Real Estate Billionaires , Karen Hanover says 46 of the world’s billionaires made their fortunes in real estate.

One of the beauties of real estate is that, for middle and high income individuals alike, the tax advantages can be substantial. Here are just three things to consider about real estate:

1. Real Estate cash flows are sheltered from taxes

• Depreciation is a long term write off against cash flow

2.    Real Estate has the ability to defer profit over time with an installment sale

• Installment sales will be big in the wake of the sub-prime crisis

3.    Real Estate offers nontaxable exchanges (a.k.a. 1031 swaps) to avoid taxes altogether

• Some real estate gurus suggest a literal “swap till you drop” strategy

1.    Tax Sheltered Cash Flows

As a real estate investor, you are very familiar with the concept of cash flow: buy a property that has more money coming in on a monthly basis than what is going out.

Investing in real estate allows you to shelter that cash flow using depreciation to write off the cost of your investment over a set number of years. So even while you have money coming in, and the market value of your property is rising, the government let’s you deduct (write off or depreciate) the cost of the building as it ages.

Depreciation is writing off (expensing) a portion of your investment each year until its value reaches zero. Because of depreciation, you will show less cash flow than you actually receive. Let’s look at an example

• You buy a residential rental property for $100,000 with a $20,000 down payment.
• You finance the remaining balance of $80,000 at 7% for 30 years, and a monthly note of $532.
• We’ll assume repairs are $3,500 in the first year.
• Other expenses (taxes, insurance, cleaning, etc) are assumed as 25% of revenue.
• The property rents for $1,100 per month.

Looking at this case on an annual basis:

Income   

Rental Income                              $ 13,200            $ 13,200

Expenses

Mortgage Interest                            $ 5,574            $ 5,574

Remaining Expenses (25%)            $ 3,300            $ 3,300

Repairs                                            $ 3,500            $ 3,500

Depreciation                                      $ 0 -               $ 3,448

Total Expenses                             $ 12,374           $ 15,822

Total Income/(Loss)                         $ 826            ($ 2,622)

This is one of the few times in life when we’re happy to lose!

Rather than pay tax on $826, depreciation gives you $2,622 to use as a write off against other income. Assuming a 25% tax bracket, this puts $656 (25% of $2,622) in your pocket.

2.    Real Estate Installment Sale

An installment sale is when the real estate owner provides the financing for the buyer to get the property. It’s also known as “seller financing” or “owner financing.”

An advantage of an installment sale is that the profit is spread out over the term of the financing. This profit is recognized as interest (ordinary income), and profit (capital gain).

Installment sales provide an advantage by lessening and deferring the tax bite over time.

As a simple example, let’s say you sell a property for $350,000. Let’s look at what happens with an outright sale.

Property Sales Price                    $ 350,000

Net Profit on Sale                         $   85,000

Tax on Net Profit (25%)               $   21,250

Let’s assume you provide owner financing for the sale (rather than the buyer finding financing somewhere else and cashing you out). The sales price is still $350,000. You get a 10% down payment of $35,000, and you finance the $315,000 balance at 10% for 30 years. This gives a monthly payment of $2,764. You receive 6 payments during the year.

With owner financing, the sale is broken up into three parts. The first part is return of capital (your cost of the asset). The other two parts combine to form the income received. This income is broken up into interest (your charge for financing) and profit (your capital gain on the property).

The installment sale looks like this:

Property Sales Price                    $ 350,000

Net Profit on Sale                       $  85,000

Net Profit Percentage   ($85,000/$350,000)        24.3%

Total received during the year

Down payment                                 $ 35,000

6 Monthly Payments ($2,764 each) $ 16,584

Total Received                                 $ 51,584

Interest Income on 6 payments               $ 15,732

1. 24.3% of principal & down payment     $ 8,712

Total taxable income                  $ 24,444

Tax at 25%                                  $  6,111

Please note that this simple example does not include depreciation recapture which would increase the taxable amount of this transaction. We will deal with depreciation recapture in a later article.

Installment sales have the benefit of stretching out the tax due over the life of the financing.

In the wake of the sub-prime crisis, many people thrown out of their homes will continue to look for creative financing to get another home. An installment sale will be one major option for savvy investors to meet this need and pocket substantial profits.

3.    Nontaxable Exchanges

A nontaxable exchange is when you exchange your property for a similar type of investment property. Nontaxable exchanges are commonly known as a 1031 swap. A gain or loss is not recognized until the property is disposed of.

You can see how 1031 swaps are a very good way to avoid tax on your real estate assets. There are, of course, a few things to keep in mind when you’re considering a 1031 exchange:

• The properties have to be “like-kind.” This term is not as restrictive as it may seem. You could exchange a single family home for an apartment building, for example.
• The transaction has to take place with a third party, known as a qualified intermediary. This intermediary is a specialized position, and usually has an inventory of properties available for exchange.
• The “swap until you drop” approach involves the inheritance of 1031 property. You never dispose of real estate. You continue to do 1031 swaps until you die (“drop”). In this case, your heirs receive the property at the Fair Market Value (FMV).

As a simple example, you have a single family home worth $250,000. You have equity built into the property of $50,000. You exchange the property for a 4 unit apartment building worth $250,000. You pay zero tax on the $50,000.

The idea is to continue to swap properties to defer tax, and then pass this property on to your heirs at FMV. You heirs receive all your deferred profit (equity) tax free.

Using the same example, let’s say you hold onto the apartment building until you die. The apartment is now worth $500,000. Your profit in the property is now $300,000. Your heirs would receive the property at a FMV of $500,000, without recognizing the $300,000 gain on the transfer.

This is a brief overview and introduction to the tax advantages of investing in real estate which are:

• Protection of cash flows using depreciation
• The ability to defer profit over time with an installment sale
• The possibility of avoiding any tax using a 1031 swap

For more information, the IRS web site has a specific section on real estate tax tips.

http://www.irs.gov/businesses/small/industries/content/0,,id=98947,00.html

In a joint effort, the U.S. Department of the Treasury and the Department of Housing and Urban Development (HUD) launched a new Website on Thursday for troubled homeowners seeking information about the administration’s Making Home Affordable loan modification and refinancing program.
The online resource, MakingHomeAffordable.gov, offers interactive self-assessment tools for borrowers to determine their eligibility and calculate the monthly mortgage payment reductions they could realize under the government’s program. The site is an effective tool that lenders and servicers can point distressed homeowners to in order to learn more about the criteria and benefits of the new Making Home Affordable program.
First announced by President Barack Obama in February, Making Home Affordable is expected to offer assistance to as many as 7 to 9 million homeowners making a “good-faith effort” to meet their mortgage payment obligations, while helping to prevent the destructive impact of the housing crisis on families and communities.
Speaking about the new site for troubled homeowners, Treasury Secretary Tim Geithner said, “Education and outreach is central to the success of our Making Home Affordable program. Putting resources and tools directly in the hands of homeowners will expedite the process of delivering relief to responsible borrowers, and stabilizing the housing market is central to our overall economic recovery.”
HUD Secretary Shaun Donovan added, “The tools offered on this site will help American families access the help they need even faster. Communicating how this program works and who is eligible to those who need it is critical to the program’s success, and this website does just that.”
Since releasing the guidelines to enable servicers to begin modifications of eligible mortgages under Making Home Affordable on March 4th, representatives from Treasury, HUD, and other members of the inter-agency task force have conducted briefings and training sessions for mortgage loan servicers and investors, nonprofit housing counselors, and nationwide borrower advocacy groups. Through these efforts to arm those interacting directly with borrowers with information, inter-agency representatives say they have briefed more than 2,500 participants on the administration’s plans in the last two weeks.
According to the Treasury Department, a wide array of large banks to small lenders have already agreed to participate in Making Home Affordable, and servicers have undertaken steps to proactively engage borrowers and respond to their inquiries related to the new program.
As an example, the Department points to JP Morgan Chase, which has put several special tools into place and initiated proactive solicitations to eligible borrowers around the Making Home Affordable program, including their own online site to provide program details and allow borrowers to download a new financial information package. The bank has also increased staffing for a dedicated service center that provides home retention assistance to all its borrowers, including those from Washington Mutual and EMC, which Chase acquired last year. In addition, Chase has entered into a partnership with Fannie Mae to solicit over 125,000 borrowers eligible for the government program and has also begun petitioning an additional 180,000 non-GSE eligible borrowers.
Government officials said with efforts like these from banks already in motion, the administration is now accelerating efforts to communicate directly with borrowers about the Making Home Affordable program, including today’s launch of MakingHomeAffordable.gov. Features of the new Website include:
- Self assessment tools to allow borrowers to determine if they are eligible for the program
- A calculator feature that allows homeowners to estimate the reduction to their monthly mortgage payment that they might stand to realize under the plan
- Resources to find free, HUD-approved counseling services for borrowers who have additional questions
- A checklist to ensure homeowners collect all the documents they need before calling their servicers