Master Lease Option

A Master Lease Option (MLO) may be a good way to purchase real estate. A MLO consists of a lease, usually 1-3 years to rent the property; and an option to purchase at a future date at an agreed-upon price.

Master Leases may be used for a variety of reasons, and most are legitimate. For instance, an owner may not want continue to operate a building day-to-day, but does not want to pay capital gains on a sale if they have a low basis. An option would be to lease the entire building to someone who is more willing to operate the building and take on the management. Presumably, the master lease rate will be lower than the market rent so the "operator" can make a profit and justify investment in upgrades and leasing costs for the building.

Capital gains would be paid by the Seller on the eventually sale of the property, but an MLO allows for the taxation to be deferred by controlling the date of sale.

Sometimes a master lease is used when there is a ground lease on the land. This would allow someone other than the fee owner to build a building and "sublease" it to a tenant. This structure is more frequently used for corporate clients who have good bankable credit but do not want to build, own or operate their own building.

A master lease is just another tool for managing control of real estate. Determine the motivation of the seller to ascertain whether a MLO is a good way to go. Finally, before you enter into a master lease, seek professional advice on how best to structure your deal.

Happy Investing!

The Next Market Crash?

If the housing market crashes, it will likely be due to the steep rise in student loan debt, accompanied with a drop in average earnings for college graduates. The nation’s student-debt tab has more than doubled since the last recession to roughly $1.3 trillion. The unemployment rate for college graduates ages 22 to 27 fell to 5.6 percent in 2013 from 6.4 percent at the recession’s peak in 2009. Among 22-year-old degree holders who found jobs in the past three years, more than half were in roles not requiring a college diploma. Millennials are staying away from buying houses in droves, and these are two of the major reasons.

They have seen their parents suffer through the last housing crisis, and they are understandably concerned. It is their parents' generation that lost the most during that financial crisis.

It is also the higher income middle class who pays the highest percentage in taxes. They are typically employees or wage earners, earning ordinary income which is taxed at the highest tax rate.

Real estate investors are familiar with capital gains tax, which is the second highest tax rate. This is a tax on the profits gained from the sale of an income-producing asset.

True investors are typically taxed on passive income, which is the lowest tax rate. Rent, interest, royalties and dividends typically fall into this category. This income is generated through the least amount of work, in that it does not require the earner to trade hours for dollars, as does an employee.

Managing debt, income, and taxes will determine one's fiscal health. Being savvy about finances will help any investor keep more of their wealth during any economic downturn.

Happy Investing!

Investment Taxes

What Are the Taxes Due on the Sale of Investment Property?

Capital Gains Tax:  Is 15% for most taxpayers, for those with annual income less than $400K per individual or $450K per married couple who file jointly.    

Section 1411 Medicare Surtax or Affordable Care Act (ObamaCare) Surtax:  3.8% only applies to those who have an annual income of over $200K per individual or $250K per married couple filing jointly.

Combined Tax Rate:  That means that those with an annual income over $400K or couples who file jointly making over $450K, would be taxed 23.8% in taxes on the profits from their investments!

Depreciation Recapture:  No matter what your annual income, the portion of your total gains that were depreciated is taxed at 25%. That is called Depreciation Recapture and is often the biggest surprise for most investors.

Tax-Free Exchange?

I know you often see internet mention of a tax-free exchange, but it is really a tax deferred exchange. You get to use the money that you would have paid to the IRS today, and as long as you don’t sell the property, you don’t have to pay the taxes on it. Not unlike a 401K

What about State Taxes

Every state has different rules. In Washington we have an Excise Tax. That is like a sales tax and cannot be deferred in an exchange. If Washington were to enact a capital gains tax that would likely also be exchangeable.

Happy Investing!

Today's blog courtesy of Kevin Hummel, McFerran Law

14 Ways to Avoid Capital Gains Tax

1.) Match Losses - Investors can realize losses to offset and cancel their gains for a particular year. 2.) Primary Residence Exclusion - Individuals can exclude up to $250,000 of capital gains from their primary residence ($500,000 for a married couple). 3.) Home Renovation - Sharp real estate agents and home renovators make their under-market investment purchases their primary residence...then flip the houses, selling for a better sales price but avoiding any tax on their gains via the primary residence exclusion. 4.) 1031 Exchange - You can avoid capital gains and depreciation taxes by rolling the proceeds of your sale into a similar type of investment within 180 days. 5.) Stock Exchange - Stock investors with highly appreciated securities can also do a like-kind exchange.

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6.) Exchange-Traded Funds - ETF's use stock exchanges to avoid triggering capital gains taxes when stocks move in or out of the index... 7.) Traditional IRA and 401k - If you are in the higher tax brackets during your working career, you can benefit from contributing to a traditional IRA or 401k. 8.) Roth IRA and 401k - Traditional accounts can postpone taxes to a more favorable year, but Roth accounts can avoid them altogether. 9.) Health Savings Accounts - HSA's are one of the few accounts where you can receive a tax deduction for contributing to them... 10.) Give Stocks to Family Members - If you are facing a high capital gains rate, you can give your highly appreciated securities to family members who are in lower brackets. 11.) Move to a lower tax bracket state - State taxes are added on to federal capital gains tax rates and vary depending on your location. 12.) Gift to Charity - Instead of giving cash to the charities you support, you can give appreciated stock. 13.) Buy and Hold - Many investors buy good index funds that never need to be sold. 14.) Wait Until You Die - Most people die holding highly appreciated investments. When you die, your heirs get a step up in cost basis and therefore pay no capital gains tax on a lifetime of growth. Happy Investing! Today's blog from www.Forbes.com courtesy of  DJ Vyzis, Sales Executive, Veristone Capital

Capital Gains Tax

There are two ways for property owners to defer capital gains tax: either through a 1031 tax exchange or by offering seller financing. I have blogged extensively about both of these approaches, and a search of this blog site will bring up these posts. But today, I want to focus on capital gains tax.

Wikipedia defines capital gains tax (CGT) as a tax on capital gains, the profit realized on the sale of a non-inventory asset that was purchased at a cost amount that was lower than the amount realized on the sale.

In the United States, with certain exceptions, individuals and corporations pay income tax on the net total of all their capital gains. Short-term capital gains are taxed at a higher rate: the ordinary income tax rate. The tax rate for individuals on "long-term capital gains", which are gains on assets that have been held for over one year before being sold, is lower than the ordinary income tax rate.

The tax rate on most capital gains is no higher than 15% for most taxpayers. Some or all net capital gain may be taxed at 0% if the homeowners are in the 10% or 15% ordinary income tax brackets. However, a 20% rate on net capital gain applies in tax years 2013 and later to the extent that a taxpayer’s taxable income exceeds the thresholds set for the new 39.6% ordinary tax rate ($406,750 for single; $457,600 for married filing jointly or qualifying widow(er); $432,200 for head of household, and $228,800 for married filing separately).

There are a few other exceptions where capital gains may be taxed at rates greater than 15%:

1. The taxable part of a gain from selling section 1202 qualified small business stock is taxed at a maximum 28% rate.
2. Net capital gains from selling collectibles (like coins or art) are taxed at a maximum 28% rate.
3. The portion of any unrecaptured section 1250 gain from selling section 1250 real property is taxed at a maximum 25% rate. 1250 property is generally defined as improved commercial real estate and is real property subject to a depreciation deduction on the taxpayer's return.

Homeowners are allowed an exemption of $250,000 in profits on the sale of a primary residence if the owner is single, $500,000 if a married couple.

Taxpayers may be able to defer, reduce, or avoid capital gains taxes using the following strategies:

• Tax may be waived if the asset is given to a charity.
• Tax may be deferred if the taxpayer sells the asset but receives payment from the buyer over a period of years. However, the taxpayer bears the risk of a default by the buyer during that period.
• In certain transactions, the basis (original cost) of the asset is changed. In the U.S., the basis for an inherited asset becomes its value at the time of the inheritance.
• Tax may be deferred if the seller of an asset puts the funds into the purchase of a "like-kind" asset. In the U.S., this is called a 1031 exchange and is now generally available only for business-related real estate and tangible property.

Additional information on capital gains and losses is available in IRS Publication 550, Investment Income and Expenses, and Publication 544, Sales and Other Dispositions of Assets. If you sell your main home, refer to Topics 701 and 703, and Publication 523, Selling Your Home. 

Happy Investing!

What is a 1031 Exchange?

If one of my commercial properties gets bought out this month, it would generate a significant profit - as well as the corresponding significant tax payments to Uncle Sam. So I have contacted my good friends at McFerran & Burns to discuss one of the two most common methods for deferring capital gains taxes on the sale of property: a 1031 Tax Deferred Exchange.

IN IT’S SIMPLEST TERMS a 1031 Tax DeferredExchange is a method of deferring the capital gains tax paid by an investor as real property is purchased and sold. The tax code permits a taxpayer to exchange property held for a productive use in a trade, business or as an investment for a property of a like-kind without recognizing income, therefore delaying taxes.

One of the best reasons for using this tool is by deferring the tax you are able to reinvest all the cash and equity. This opens the door to many options: property with higher revenues, relocation of investment properties, higher appreciation, increased or decreased actual properties as suits. Essentially it allows the investor to craft their business in manner that suits them best.

Here are some general rules related to a 1031 Exchange:

EXCHANGE must be completed within specific timelines, or capital gains tax is reinstated.

A QUALIFIED INTERMEDIARY is required to ensure Exchangor doesn’t have control over sale proceeds during exchange

EXCHANGE AGREEMENTS must be in place between correct parties on strict timelines

CASH FROM EXCHANGE can only be withdrawn at 4 limited times during the exchange

LIKE-KIND PROPERTY means “productive” investment real property rather than stocks and bonds, and not property to be held only for resale.

Thanks to Kevin Hummel at McFerran & Burns for help with this blog post.

Happy Investing!