real estate investing Archives

Tax Deferred Exchange Tips – Pulling cash out of an exchange

Our friends at McFerran & Burns, PS (www.mbs-law.com) have shared these tips regarding tax deferred exchanges.

Pulling Cash out of an Exchange

This is a common subject of questions when an Exchangor is selling a property with a large taxable gain. Sometimes it just makes sense to pull out “Boot” in an exchange. This is a term commonly used by the IRS or tax professionals to define taxable funds within an exchange.

Where does that silly name come from? It is not defined in the tax code, or in any court cases. There are several theories, like the ones that talk about the early West where in a swap of items, something might have been slipped into a boot (like tobacco, sugar, or money) to settle a discrepancy or sweeten the deal. My favorite though is when Congress was discussing the exchange process, a Senator from The South drawled, “Are you trying to tell me, you can do an exchange and pull out some cash to boot”.

Keep in mind that when you do pull cash out of an exchange, that amount becomes taxable but it does not necessarily ruin or disqualify the exchange.

Timing

The Qualified Intermediary can only release funds at certain times defined by the IRS:

The most common time would be as you are closing the sale. The escrow closer can be instructed to release certain funds during that initial closing process. Please know that once those funds have been released out of the exchange, they cannot be returned to the exchange account.

The next opportunity would be after the 45^th day, if no properties have been identified. Of course not identifying any replacement properties means that the exchange has failed and all funds can be released on the 46^th day or later.

The next opportunity would be after the 45^th day and you have closed on all identified properties, then all remaining funds can be released. It is common for us to instruct the closer of the last transaction to release all remaining funds to the exchanger while funding that last purchase, as long as there are no other properties identified.

The final opportunity is after the 180 days of the exchange has passed.

No matter how often exchangors are reminded that they cannot pull their funds out at any time, they often request it. After all, isn’t it their money?

Other Examples of Boot

Boot is also created if there is debt paid off in the sale, and it is not replaced in the purchase. In other words, the mortgage is paid off in the sale, but there is no debt or cash added in the purchase to replace that. The IRS views debt relief the same value as cash in an exchange. Another common situation that can lead to boot in an exchange is when escrow includes the proration of rents and deposits on the Settlement Statement. Those are actually relating to the business operating on the property, not the purchase or sale of the real estate.

For more information

If you would like more information, be sure to contact us. We may help you get in contact with our friends at MBS if we can’t help.

Thanks to our friend, Kevin Hummel, CES, manager of MBS’s Tax Deferred Exchange Practice Group for sharing this information.

Tellus introduces you to the world of real estate investing this coming Tuesday, 11/5/2013

We are holding our Real Estate Investing 101 class this coming Tuesday

The class will be held at Park Place Middle School in Monroe as part of Sky Valley Community Schools. This class will introduce you to the basic terminology and concepts of real estate investing and give you tools that you can put to use immediately to be successful in real estate investing.

For information about the class schedule and registration, check our calendar here: https://tellusre.com/ai1ec_event/class-introduction-to-real-estate-investing/?instance_id=870

There is still time to register!

The myth of the midnight clogged toilet

Its amazing how many times I’ve heard this from a potential landlord “I don’t want to unclog toilets at midnight!” Its a common myth that landlords have to deal with emergencies such as these in the middle of the night.

It is true that you might have to deal with some emergency in the middle of the night. But, thankfully, unclogging toilets is not one of them. Washington State has some pretty clear requirements for how long landlords have to respond to tenant’s when they have a problem. The minimum response time is 24 hours, and that is for emergencies such as loss of water or heat. Clogged toilets don’t count as one of these emergencies. In fact, clogged toilets may be just the kind of maintenance issue you tell tenants is their responsibility to take care of.

This is just one of the issues we cover in our Landlord 101 class. Check out this video recorded in our last class. We go over the subject of ongoing relationship with tenants, including the landlord’s responsibilities for dealing with clogged toilets and other maintenance issues.

Landlord 101 – Ongoing relationships with tenants

Is real estate a good investment? Compared to what?

Many folks ask the question “Is real estate a good investment?” And, almost many people are quick to provide an answer… some will say yes, and some will say no. This question came up recently in a blog post over at www.SeattleBubble.com (http://seattlebubble.com/blog/2012/06/29/king-county-home-prices-affordability-1950-q2-2012/). The post noting value changes ends with the comment:

“Ten to thirteen years, zero real appreciation. What a great long-term “investment!”

Whenever I see a comment like this, I have to ask “Compared to what?” You should never look at an investment in isolation. You have many options and you should compare them to each other. Is 0% return good? Is -10% return good? You can’t answer unless you answer “compared to what”. -10% return is great compared to -20% return. But, its terrible compared to +1% return.

Before we go any further, let me provide this one statement:

I do not believe that your home is an investment. Period. The home you live in is almost always an expense, whether you purchase or rent. The decision to purchase vs. rent should be a matter of weighing the benefits, including financial, of the two options. I believe that in most cases, the benefits that are most important to home buyers are the non-financial benefits.

OK. Back to the question at hand. The article on SeattleBubble.com didn’t really look at real estate as investment, at least not the kind of investment I’m looking for. Instead, I’m pretty sure “The Tim” was simply taking a shot at the NAR rhetoric about home ownership. Good for him. Someone needs to. But, I think there is a serious side to this question, so I decided to take a look.

So, what are we comparing?

Tim compared prices, taking into account inflation. So, he is looking at real estate investing from the ‘appreciation’ side, not the income side. Can we find another common investment to compare it to? Sure, the most common is stocks, and many people invest in stocks for their appreciation potential.

I decided to look up the return for the S&P 500 for the same period Tim used for his comparison. And to keep things fair, I calculated the ‘real return’, the return after inflation.

Email me if you would like the spreadsheet. I’m going to simply show you the charts:

Yearly and cumulative returns from S&P 500 since 1950:

You will notice that the cumulative return is about 300%. Not bad at all. And appears pretty good compared to the 200%+ return on real estate for the same period.

Now, “The Tim” specifically noted the return from 1999-2012, so lets take a closer look at that:

The cumulative return is a small 3%. Still that is higher than the 0% appreciation noted by Tim. So, all other things being equal, the return from stocks would be better.

There is more to the issue of course

Things are not quite so simple, but you get the idea. You should compare the options. Keep in mind that no matter what, you will have some living expense. So, if you can purchase a home for the same expense you can rent, you might be better off with the home. But, like any investment there are risks. With stocks or with homes, prices/values fluctuate.

That is one reason I feel that looking at the home you live in as an investment is not a good idea. When investing in real estate, I prefer income producing properties. If they have positive cash flow, you are less concerned with asset appreciation. You still want it, of course, but you don’t need it… and your calculation of ‘return’ is a bit more complex (its also more complex with stocks if they are returning a dividend).

The point I want you to remember is: Ask both questions. If you are thinking of real estate as an investment, or any investment, ask how that investment compares to other options you have. (Don’t just ask, do the math!)

Another good idea when looking at blog posts and news articles is to check the viewpoint of the author against their motivations. I’m a real estate broker and I teach classes on real estate investing. You can guess that my ‘slant’ is going to be towards the positive on real estate investing. Does www.SeattleBubble.com have its own slant? That is for you to decide. (My opinion is “yes”, but I like their slant. It helps balance the propaganda of NAR, NWMLS, and large brokerage companies who have a vested interest in home sales.

Good luck and good investing!

Sources

S&P 500 historical data: Yahoo Finance – http://finance.yahoo.com/q/hp?s=%5EGSPC+Historical+Prices
Consumer Price index historical data: Bureau of Labor Statistics – http://www.bls.gov/cpi/