2009 February

Archive for February, 2009

Avoid the Pitfalls of Lease Options With the Equity Holding Trust

February 24th, 2009 categories: Land Trusts, Seller Financing

Lots of people are exploring whatever it takes to get their properties sold in today’s market, even considering low down payments, or a small option payment. Lease options/rent-to-owns are popular in part because the property owner/seller can get more up front and each month than if they just did a straight lease.

So, even if the buyers don’t exercise their option (and I suppose some sellers hope they don’t), the owner has maximized his cash flow all along. Lease options have been around a long time, and even though they’re considered fairly standard, there are some compelling reasons to take a good look at other ways of achieving the results you’re after.

But first, the basics. By definition, a lease option (L/O) is a unilateral agreement to sell with bargain terms at a future date:

Buyer pays the seller option money for the right to later purchase the property. The lease option money may be small or substantial.
Buyer and seller may agree to a purchase price up front, or the buyer may agree to pay market value at the time the option is exercised. It’s negotiable; however, most buyers want to lock in the future purchase price upon inception.
During the term of the lease option, the buyer agrees to lease the property from the seller for a predetermined rental amount.
The term of the lease option agreement is commonly one year to three years.
Option money does not usually apply toward the down payment.
A portion of the lease payment typically gets applied toward the purchase price.
Option money is rarely refundable.
No one can buy the property out from under the option holder
If the buyer does not exercise the lease option at the end of the term, the option expires.
The buyer has the right, but not the obligation to buy the property.

So what’s the down side?

Lease options are explicitly named in numerous laws and legal documents. The fact that most real estate brokers won’t let their agents be involved in putting together a lease option for their clients is evidence of the liability involved.

The lease option violates a lender’s due-on-sale clause, and the lender has the right to ‘call’ or accelerate the loan.
In California, they can trigger a reassessment of property taxes.
L/O’s can lead to an inability to evict a defaulting tenant. A tenant in default can claim having “Equity” in the property, and in so doing, force a judicial foreclosure process versus an eviction. This can really eat up your return on investment as the defaulting party sits around peeling grapes on your dime.

And then there’s the doctrine of substance over form, which says that what you call something does not necessarily determine what the law will regard it to be. If it looks like a duck, walks like a duck, and talks like a duck, the official IRS position is this, and I quote:

“It’s a duck.”

If, from an economic standpoint, you’ve created the equivalent of an installment sale (seller carry back), you could potentially be in for all sorts of unpleasant surprises. You could have a 1031 exchange invalidated, or have the IRS coming after you for overdue taxes and penalties.

So how can you get the rewards of the lease option without the associated risks? I’m glad you asked, because this is where the Equity (or Title) Holding Trust rides in like a white steed.

More than a simple land trust, this is a whole trust transfer system with the following advantages:

Prevent the lender from exercising its “due on sale” clause
Be able to evict a defaulting “resident beneficiary” instead of having to foreclose on them
Get privacy, safety and legal protection
It’s quick and easy (you can often close in 21 days)
Defer capital gains
Superior income tax treatment
Preserve tax basis (property is not reassessed)
Protection from litigation, creditor judgments, tax liens and probate issues
Reduces the risk of taking a relatively small down payment
Freezes the seller’s equity until some point in the future when housing has begun to appreciate again. This insulates the seller somewhat from further price depreciation in the current market.
Sell without short sale or foreclosure, even if you’re a little bit upside down (if you have a decent loan and you’re not too far behind on payments)

The Title-Holding Land Trust (often referred to as the “Illinois Land Trust”) is accepted throughout the United States. This may arguably be the best possible means of real property asset protection and/or transferring real estate. I like to call it ‘Seller Financing on Steroids.’

A Note from Jerry …

February 22nd, 2009 categories: Seller Financing

Who’s the most influential person in your life?

Here’s a clue … it isn’t the guy who sells lottery tickets.

If it’s important to do … it’s up to you.

Jerry

“Of all the people you will know in a lifetime, you are the only one you will never leave nor lose. To the question of your life, you are the only answer. To the problems in your life, you are the only solution.” - Anonymous

The nice man at the 7-Eleven is going to miss me.

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Spoken by Jerry Hannan | Discussion: No Comments »

CPA Corner: Real Estate Write Offs and Capital Gains

February 20th, 2009 categories: Seller Financing

“I’m proud to pay taxes in the United States; the only thing is, I could be just as proud for half the money.” - Arthur Godfrey

Have you ever heard someone say “I can write this off” or “I’ll just write it off”, and wondered what they were talking about? They were talking about a tax deduction. A tax deduction or “write-off” is a powerful financial tool that most people have not been taught to utilize.

Why should I care?

To calculate out how much money you’re really making you need to understand taxes. Would you rather make $80 and pay $20 in taxes or make $100 and pay $50 in taxes? You’d rather make the $80 right? This illustrates a simple point: always consider the tax consequences of what you’re doing with your money.

Ok fine, so what is a write-off?

A write-off is an expense that reduces your taxable income. In other words you do not pay taxes on your total income; you pay taxes on your income minus your deductible expenses.

$50,000 (income)
- $20,000 (expenses/write-off)
= $30,000(taxable income)

For example, lets say you make $50,000 a year and you are able to deduct $20,000 in business expenses (things like a home office, wear and tear on your car, computer equipment, phone, etc).

That $20,000, that’s your write-off.

What if I didn’t use the write-off?

Assuming you’re in the 30% tax bracket if you don’t deduct your expenses you pay $15,000 ($50,000 x 30%) in taxes, however if you do deduct your expenses you only pay $9,000 ($30,000 x 30%) in taxes.

Taxes paid with your write off = $9,000
Taxes paid without your write off = $15,000

That’s savings of $6,000, or the equivalent of a $8,571 raise at your work.

Another way to think about it.

You might notice that the $6,000 in tax savings is 30% of the $20,000 in deductions you took ($6,000 = $20,000 x 30%). In other words for each $1 you are “writing-off” you are saving 30 cents in taxes. Or to put it another way, everything you purchase is actually 30% cheaper if you are able to write it off.

This example is for the purpose of illustration; you should adjust this example to your personal tax rate and consult an account for a list of acceptable deductions.

Real Estate

What does this have to do with real estate?

Once you own a piece of investment real estate you are now a small business owner. There are many tax benefits available to small business owners in addition to the tax benefits available to real estate owners, such as depreciation on the property, avoiding capital gains with a 1031 exchange, and of course the ability to write off all expenses incurred as a result of owning the property.

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Spoken by Mathew Owens, CPA | Discussion: No Comments »

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