Thursday, July 15, 2010
Georgia's New Retirement Income Legislation
In May 2010, new legislation was passed that will phase out Georgia personal income taxation of retirement income. For Georgia income tax purposes, beginning with the 2012 tax year, taxpayers who are age 62 but less than age 65 during any part of the taxable year, or permanently and totally disabled, can exclude up to $35,000 per year for each taxpayer. Taxpayers 65 or older during any part of the taxable year can exclude up to $65,000 for the tax year beginning in 2012 increasing to $100,000 for 2013, $150,000 for 2014, $200,000 for 2015. Then, in the 2016 tax year, taxation on retirement income for Georgia income tax purposes is completely eliminated for taxpayers age 65 or older during any part of the taxable year. Retirement income includes interest income, dividend income, net income from rental property, capital gains income, income from royalties, income from pensions and annuities, and no more than $4,000 of an individual’s earned income.
Saturday, April 17, 2010
The HIRE Act
The Hiring Incentives to Restore Employment (HIRE) Act was signed into law on March 18, 2010. This new law provides tax benefits to employers who hire workers who were previously unemployed or working part time.
Hiring and payroll tax incentives
Employers who hire previously unemployed workers (after February 3, 2010 through the end of 2010) may qualify for a 6.2% payroll tax incentive. This incentive effectively exempts the employer from Social Security taxes on wages paid to these workers after March 18, 2010. Employers are still responsible for the Medicare tax and the employees are still responsible for income taxes as well as their share of Social Security taxes and Medicare taxes.
For each qualified newly hired worker, retained at least a year, the business may claim an additional non-refundable tax credit up to $1,000 per worker on their 2011 income tax return.
A few key details regarding the Act are:
New employees filling existing positions qualify only if the previous worker left voluntarily or was terminated for cause.
Eligible new employees must sign a statement certifying that they were unemployed during the 60 days prior to beginning work or that they worked fewer than 40 hours per week at their previous job.
New employees cannot be family members.
New employees are not required to work a minimum number of hours.
The payroll tax benefit also applies to not-for-profit organizations.
Section 179 Expensing limits extended for businesses
The HIRE Act also extended the increased Section 179 expensing limits in effect for tax years beginning in 2008, 2009 and 2010 which provided for expensing qualified machinery and equipment additions up to a maximum of $250,000 with a phase out beginning at $800,000 in qualified additions. For tax years after 2010, the expensing limit returns to $25,000 and the phase out limitation starts at $200,000.
For additional information about the HIRE Act tax benefits, please contact your tax advisor.
Hiring and payroll tax incentives
Employers who hire previously unemployed workers (after February 3, 2010 through the end of 2010) may qualify for a 6.2% payroll tax incentive. This incentive effectively exempts the employer from Social Security taxes on wages paid to these workers after March 18, 2010. Employers are still responsible for the Medicare tax and the employees are still responsible for income taxes as well as their share of Social Security taxes and Medicare taxes.
For each qualified newly hired worker, retained at least a year, the business may claim an additional non-refundable tax credit up to $1,000 per worker on their 2011 income tax return.
A few key details regarding the Act are:
New employees filling existing positions qualify only if the previous worker left voluntarily or was terminated for cause.
Eligible new employees must sign a statement certifying that they were unemployed during the 60 days prior to beginning work or that they worked fewer than 40 hours per week at their previous job.
New employees cannot be family members.
New employees are not required to work a minimum number of hours.
The payroll tax benefit also applies to not-for-profit organizations.
Section 179 Expensing limits extended for businesses
The HIRE Act also extended the increased Section 179 expensing limits in effect for tax years beginning in 2008, 2009 and 2010 which provided for expensing qualified machinery and equipment additions up to a maximum of $250,000 with a phase out beginning at $800,000 in qualified additions. For tax years after 2010, the expensing limit returns to $25,000 and the phase out limitation starts at $200,000.
For additional information about the HIRE Act tax benefits, please contact your tax advisor.
Friday, March 12, 2010
Could converting your IRA to a Roth IRA benefit you? Maybe.
Although there are benefits to converting
your IRA, especially in light of the 2010 provisions, there are also variables and potential pitfalls you should consider.
The traditional IRA allows for contributions to the IRA by an individual taxpayer with the benefit of a deduction on the taxpayer’s individual tax return. The taxes on an IRA’s earnings are “deferred” until the individual taxpayer begins to withdraw distributions. Each future distribution would generally be taxed at the individual’s current tax rate.
Roth IRAs, established by the Taxpayer Relief Act of 1997, do not require a minimum annual distribution and the distribution’s earnings are tax free. Thus, the assets can grow without taxation for as long as the individual chooses. However, the amount of money converted to a Roth IRA must be reported as income and taxed in the year of conversion at the then individual tax rate in effect. Due to the Tax Increase
Prevention and Reconciliation Act of 2005, there are a few key changes effective January 1, 2010, that make conversions to Roth IRAs worth considering. First, if the conversion occurs in 2010, the individual can elect to delay reporting the conversion for one year and then “split” the taxable converted amount between 2011 and 2012 (50% each year). This delayed reporting and “split” election is available only for 2010 conversions. In addition, effective January 1, 2010, the original $100,000 income limitation for Roth IRA conversions was eliminated.
Although a conversion from a traditional IRA to a Roth IRA may be a good strategy for some taxpayers, there are a few questions to consider:
What should I consider before deciding on a Roth IRA conversion?
Each taxpayer should determine if he/she has the cash available to pay the taxes on the conversion, especially in today’s economic environment. In addition, the taxpayer should determine what effect individual taxes and tax rates will have on his/her financial situation now and in the future.
When is a Roth IRA conversion beneficial?
The Roth IRA conversion is beneficial when you expect to have higher average income tax rates during retirement than in the year of conversion. There can be other instances in which a Roth conversion makes sense. You should discuss possible conversions with your tax advisor in light of your individual
circumstances.
What potential pitfalls should the taxpayer avoid in a Roth IRA conversion?
One potential pitfall is the value of your Roth IRA account could suffer market declines after the conversion. Consequently, you would have paid tax on the higher value when you converted to the Roth. You can minimize this potential pitfall by strategically splitting the IRA (or a portion) into two Roth IRA’s to separate the investment risk should you need to re-characterize your Roth IRA conversion back
to a regular IRA. The ability to re-characterize your conversion expires on the due date (including extensions) of your income tax return. If you are considering converting all or a portion of your IRA to a Roth IRA, your tax advisor can assist you with the risks and rewards of your particular situation.
In summary, the Roth IRA conversion may be a good strategy for some taxpayers; however, a detailed examination and analysis of individual circumstances,calculations of “what if” scenarios and careful planning should occur before any decision to effect the Roth conversion is made. Contact your tax professional for additional information regarding Roth IRA conversions.
your IRA, especially in light of the 2010 provisions, there are also variables and potential pitfalls you should consider.
The traditional IRA allows for contributions to the IRA by an individual taxpayer with the benefit of a deduction on the taxpayer’s individual tax return. The taxes on an IRA’s earnings are “deferred” until the individual taxpayer begins to withdraw distributions. Each future distribution would generally be taxed at the individual’s current tax rate.
Roth IRAs, established by the Taxpayer Relief Act of 1997, do not require a minimum annual distribution and the distribution’s earnings are tax free. Thus, the assets can grow without taxation for as long as the individual chooses. However, the amount of money converted to a Roth IRA must be reported as income and taxed in the year of conversion at the then individual tax rate in effect. Due to the Tax Increase
Prevention and Reconciliation Act of 2005, there are a few key changes effective January 1, 2010, that make conversions to Roth IRAs worth considering. First, if the conversion occurs in 2010, the individual can elect to delay reporting the conversion for one year and then “split” the taxable converted amount between 2011 and 2012 (50% each year). This delayed reporting and “split” election is available only for 2010 conversions. In addition, effective January 1, 2010, the original $100,000 income limitation for Roth IRA conversions was eliminated.
Although a conversion from a traditional IRA to a Roth IRA may be a good strategy for some taxpayers, there are a few questions to consider:
What should I consider before deciding on a Roth IRA conversion?
Each taxpayer should determine if he/she has the cash available to pay the taxes on the conversion, especially in today’s economic environment. In addition, the taxpayer should determine what effect individual taxes and tax rates will have on his/her financial situation now and in the future.
When is a Roth IRA conversion beneficial?
The Roth IRA conversion is beneficial when you expect to have higher average income tax rates during retirement than in the year of conversion. There can be other instances in which a Roth conversion makes sense. You should discuss possible conversions with your tax advisor in light of your individual
circumstances.
What potential pitfalls should the taxpayer avoid in a Roth IRA conversion?
One potential pitfall is the value of your Roth IRA account could suffer market declines after the conversion. Consequently, you would have paid tax on the higher value when you converted to the Roth. You can minimize this potential pitfall by strategically splitting the IRA (or a portion) into two Roth IRA’s to separate the investment risk should you need to re-characterize your Roth IRA conversion back
to a regular IRA. The ability to re-characterize your conversion expires on the due date (including extensions) of your income tax return. If you are considering converting all or a portion of your IRA to a Roth IRA, your tax advisor can assist you with the risks and rewards of your particular situation.
In summary, the Roth IRA conversion may be a good strategy for some taxpayers; however, a detailed examination and analysis of individual circumstances,calculations of “what if” scenarios and careful planning should occur before any decision to effect the Roth conversion is made. Contact your tax professional for additional information regarding Roth IRA conversions.
Friday, August 7, 2009
When Commercial Real Estate Bargain Hunters May Become the “Prey”
Commercial real estate bargain hunters may become the “prey” due to “tax traps” in acquiring debt.
In today’s distressed Commercial Real Estate marketplace there are many opportunities for aggressive bargain hunting investors to acquire properties at a discount. They can execute the acquisition of the property direct from the distressed seller, from the lender as an REO acquisition and also acquire the note direct from the lender, as well, with one of the objectives of owning the underlying property through foreclosure or deed-in-lieu of foreclosure.
The investors are motivated to purchase notes at a discount from lenders that need cash or don’t want to add more REOs to their portfolios. The unwary or ill advised investors acquire the notes and could very well create tax nightmares as opposed to dreams coming true.
The culprit is “phantom income”. “Phantom income” is not a derivative of economic benefit, but it still exists. The most onerous issue when acquiring discounted debt is the creation of “phantom income” that is taxable with little or no cash to pay the taxes. As an example, a note is acquired from the lender by an investor for $1,000,000 (basis) and then forecloses on the underlying property that has a fair market value of $1, 300,000. The difference between the FMV of the property and the “basis” is $300,000 which creates recognized “phantom income”, which could be taxed as high as high as 35% for federal taxes plus the applicable state taxes.
The next example of taxable “phantom income” is when an investor acquires a note from the lender at a discount for $1,000,000 and the note’s fair market value is determined to be $1,500,000, the recognized “phantom income” is $500,000 which could be taxed as high as 35% for federal taxes plus the applicable state taxes.
We have not even taken into consideration the possible triggering of alternative minimum tax (AMT) from the taxable “phantom income” eliminating the AMT exemption amount and adding more to the investors’ tax bills, again, possibly with no cash to pay the tax! Ouch!
The tax accounting problems examples above regarding “phantom income” issues can be exacerbated and when “pools” of loans are acquired. Sorting out the “basis”, “fair market values” and the taxable “phantom income” in those pools can keep tax advisors working well late into the night.
Still, another example of taxable “phantom income” creation is through “significant” modification” to the notes by investors who modify the yields of the notes and or the term lengths, even adding guaranties or more collateral to non-recourse notes could very well be construed as a “significant modification”. And, depending on the new note holders’ activities – is the “phantom income” short capital gain or ordinary income? The best preventative solution, if possible, is to have the original lenders modify the notes prior to acquisition by the investors.
In conclusion, before investors dive into note acquisition bargain hunting, they should make certain that they have competent legal and tax council and understand the tax traps and risks that await them. We have only touched on just a few of the tax issues regarding debt acquisitions here. There are even more tax traps and risks that need to be understood or the bargain hunter investors could very well becoming the prey, with tax bills that they can’t pay.
Caveat Emptor!
My next post will include the acquisition of distressed properties, REOs and even the underlying properties of non-performing notes utilizing Section 1031 Tax Deferred Exchange strategies.
Copyright William B. Hood, 2009
In today’s distressed Commercial Real Estate marketplace there are many opportunities for aggressive bargain hunting investors to acquire properties at a discount. They can execute the acquisition of the property direct from the distressed seller, from the lender as an REO acquisition and also acquire the note direct from the lender, as well, with one of the objectives of owning the underlying property through foreclosure or deed-in-lieu of foreclosure.
The investors are motivated to purchase notes at a discount from lenders that need cash or don’t want to add more REOs to their portfolios. The unwary or ill advised investors acquire the notes and could very well create tax nightmares as opposed to dreams coming true.
The culprit is “phantom income”. “Phantom income” is not a derivative of economic benefit, but it still exists. The most onerous issue when acquiring discounted debt is the creation of “phantom income” that is taxable with little or no cash to pay the taxes. As an example, a note is acquired from the lender by an investor for $1,000,000 (basis) and then forecloses on the underlying property that has a fair market value of $1, 300,000. The difference between the FMV of the property and the “basis” is $300,000 which creates recognized “phantom income”, which could be taxed as high as high as 35% for federal taxes plus the applicable state taxes.
The next example of taxable “phantom income” is when an investor acquires a note from the lender at a discount for $1,000,000 and the note’s fair market value is determined to be $1,500,000, the recognized “phantom income” is $500,000 which could be taxed as high as 35% for federal taxes plus the applicable state taxes.
We have not even taken into consideration the possible triggering of alternative minimum tax (AMT) from the taxable “phantom income” eliminating the AMT exemption amount and adding more to the investors’ tax bills, again, possibly with no cash to pay the tax! Ouch!
The tax accounting problems examples above regarding “phantom income” issues can be exacerbated and when “pools” of loans are acquired. Sorting out the “basis”, “fair market values” and the taxable “phantom income” in those pools can keep tax advisors working well late into the night.
Still, another example of taxable “phantom income” creation is through “significant” modification” to the notes by investors who modify the yields of the notes and or the term lengths, even adding guaranties or more collateral to non-recourse notes could very well be construed as a “significant modification”. And, depending on the new note holders’ activities – is the “phantom income” short capital gain or ordinary income? The best preventative solution, if possible, is to have the original lenders modify the notes prior to acquisition by the investors.
In conclusion, before investors dive into note acquisition bargain hunting, they should make certain that they have competent legal and tax council and understand the tax traps and risks that await them. We have only touched on just a few of the tax issues regarding debt acquisitions here. There are even more tax traps and risks that need to be understood or the bargain hunter investors could very well becoming the prey, with tax bills that they can’t pay.
Caveat Emptor!
My next post will include the acquisition of distressed properties, REOs and even the underlying properties of non-performing notes utilizing Section 1031 Tax Deferred Exchange strategies.
Copyright William B. Hood, 2009
Monday, June 22, 2009
Investors can go "Green" save "Green" with 1031 Exchanges
The "“Green” Movement" has quickly gone from fad to trend to global initiative. In the United States, corporations as well as commercial owners are being challenged to find ways to
embrace “Green” Initiatives" in responseto demands for greater sustainability, and beyond social accountability to more profitability.
Guided by the U.S. “Green” Building Council's Leadership in Energy and Environmental Design (LEED) certification program, energy efficiency, resource conservation and environmental sustainability are increasingly important factors in maximizing asset value.
Of course, many of today's commercial buildings are anything but “Green.” Outdated heating, ventilation and air conditioning (HVAC) systems can result in continually increasing operating costs. Antiquated and drafty windows, leaking pipes, old asbestos panels and new patches of
mold can create a costly environmental nightmare.
For those investors and businesses saddled with “Brownfield” properties, one approach is to undertake expensive renovations, hoping upgrades to building and systems eventually pay off in terms of higher rents and lower operating costs.
Many property owners and corporations are now also using a 1031 Tax-Deferred Exchange strategy to quickly divest themselves of environmentally outdated properties, and acquire modern, energy-efficient ones, thus solving “Green" and financial needs.
How Does It Work?
Under I.R.S. Code Section 1031, a taxpayer can defer payment of capital gains, depreciation recapture and state taxes on the sale of investment or business property provided the proceeds are used to purchase a replacement property within certain time frames. To qualify for a
Safe Harbor Protection tax deferral, proceeds must be held by a Qualified Intermediary (QI) between the sale of the relinquished property and the purchase of the replacement property.
For property investors and corporations considering exchanging their investment residential or commercial properties, "going ‘Green’" offers a host of highly tangible benefits:
• Lower operating costs;
• Ability to attract a higher class of tenants (Federal Government Agencies are striving to lease only properties that are designated “Green”);
• Greater leasing value;
• An improved cap rate and
• Potential to increase asset value.
Property owners also enjoy the personal satisfaction, goodwill and potential positive publicity generated by taking action to improve the environment. For corporations that have included sustainability and environmental concern as corporate goals, 1031 Tax-Deferred Exchanges deliver immediate results to that bottom line.
Why use a 1031 approach?
Sophisticated property investors have used 1031 Tax-Deferred Exchanges for many years as a highly effective strategy to preserve their wealth and grow assets by reinvesting part or all of the equity plus tax savings from sale of the first building into the replacement property.
Under a typical 1031 Exchange, the owner relinquishes an income-producing property, then identifies and purchases a replacement property of equal or greater value in accordance with strict rules.
In a typical 1031 Exchange, the owner can defer paying 25 percent recapture on the depreciation, a 15 percent federal tax on any remaining capital gains, and state income taxes. A property owner who plans to go “Green" with the new property may also be eligible for a growing number of federal, state and local incentives as well.
As an added benefit, 1031 Exchanges also provide flexibility in terms of a real estate investment strategy. An owner can consolidate several holdings and purchase better-performing properties while deferring the tax consequences indefinitely. In addition, 1031 Exchanges can be used with virtually any type of business or investment property, including hotels, apartment buildings, motels, shopping centers, warehouses, oil and gas, and even residential homes and land held for investment.
Cases in Point
In 2007, an investment property owner renting three single-family homes with septic tanks in a major metro suburb learned those homes needed a costly connection to municipal water and sewer services. The farsighted owner used a 1031 Exchange to relinquish the three properties
and rolled all of the profits, including the deferred taxes, into the purchase of a new strip shopping center.
Recently, an investor who effected a 1031 Exchange purchased a decaying hotel in a rural Western setting as his replacement property. In this case, the investor used the equity and tax savings gained in the exchange to turn a "brownfield" property into a "Green" property. He
renovated the facility into a modern executive conference lodge and cleaned up a muddy stream running through the property. Today, the property is a popular destination retreat with a much higher valuation. Retreat guests now can walk down to the stream and catch large brown trout
- a true example of the “Greening” of America.
Creative Exchange Strategies
Due to the fact that the “Green” building movement is still in its infancy in the United States, many property investors seeking to capitalize on these benefits may be faced with construction and renovation issues. Fortunately, there are several variations on a traditional 1031 strategy that can allow an owner to develop or build a modern energyefficient property and still enjoy potential tax advantages.
One 1031 Exchange strategy is a reverse construction exchange. In this case, the taxpayer first closes on the purchase of the replacement property and then sells the currently owned property within 180 days. A property investor could also purchase a new property while it is still under construction and enjoy the 1031 tax advantages, provided the current value of the new property is equal to or greater than the prior holding at the time of transfer to the taxpayer of the replacement property.
There are a variety of ways for corporations and real estate investors to use 1031 Exchanges to upgrade their holdings and reap the social, sustainability and financial benefits of going "Green.” For the 1031 investor or corporation utilizing a 1031 Exchange strategy, going "Green" offers a win-win proposition: a win for the investor and a win for the community where the property
is located.
Copyright © 2008 by William B. Hood,
Roswell, Ga. All rights Reserved
embrace “Green” Initiatives" in responseto demands for greater sustainability, and beyond social accountability to more profitability.
Guided by the U.S. “Green” Building Council's Leadership in Energy and Environmental Design (LEED) certification program, energy efficiency, resource conservation and environmental sustainability are increasingly important factors in maximizing asset value.
Of course, many of today's commercial buildings are anything but “Green.” Outdated heating, ventilation and air conditioning (HVAC) systems can result in continually increasing operating costs. Antiquated and drafty windows, leaking pipes, old asbestos panels and new patches of
mold can create a costly environmental nightmare.
For those investors and businesses saddled with “Brownfield” properties, one approach is to undertake expensive renovations, hoping upgrades to building and systems eventually pay off in terms of higher rents and lower operating costs.
Many property owners and corporations are now also using a 1031 Tax-Deferred Exchange strategy to quickly divest themselves of environmentally outdated properties, and acquire modern, energy-efficient ones, thus solving “Green" and financial needs.
How Does It Work?
Under I.R.S. Code Section 1031, a taxpayer can defer payment of capital gains, depreciation recapture and state taxes on the sale of investment or business property provided the proceeds are used to purchase a replacement property within certain time frames. To qualify for a
Safe Harbor Protection tax deferral, proceeds must be held by a Qualified Intermediary (QI) between the sale of the relinquished property and the purchase of the replacement property.
For property investors and corporations considering exchanging their investment residential or commercial properties, "going ‘Green’" offers a host of highly tangible benefits:
• Lower operating costs;
• Ability to attract a higher class of tenants (Federal Government Agencies are striving to lease only properties that are designated “Green”);
• Greater leasing value;
• An improved cap rate and
• Potential to increase asset value.
Property owners also enjoy the personal satisfaction, goodwill and potential positive publicity generated by taking action to improve the environment. For corporations that have included sustainability and environmental concern as corporate goals, 1031 Tax-Deferred Exchanges deliver immediate results to that bottom line.
Why use a 1031 approach?
Sophisticated property investors have used 1031 Tax-Deferred Exchanges for many years as a highly effective strategy to preserve their wealth and grow assets by reinvesting part or all of the equity plus tax savings from sale of the first building into the replacement property.
Under a typical 1031 Exchange, the owner relinquishes an income-producing property, then identifies and purchases a replacement property of equal or greater value in accordance with strict rules.
In a typical 1031 Exchange, the owner can defer paying 25 percent recapture on the depreciation, a 15 percent federal tax on any remaining capital gains, and state income taxes. A property owner who plans to go “Green" with the new property may also be eligible for a growing number of federal, state and local incentives as well.
As an added benefit, 1031 Exchanges also provide flexibility in terms of a real estate investment strategy. An owner can consolidate several holdings and purchase better-performing properties while deferring the tax consequences indefinitely. In addition, 1031 Exchanges can be used with virtually any type of business or investment property, including hotels, apartment buildings, motels, shopping centers, warehouses, oil and gas, and even residential homes and land held for investment.
Cases in Point
In 2007, an investment property owner renting three single-family homes with septic tanks in a major metro suburb learned those homes needed a costly connection to municipal water and sewer services. The farsighted owner used a 1031 Exchange to relinquish the three properties
and rolled all of the profits, including the deferred taxes, into the purchase of a new strip shopping center.
Recently, an investor who effected a 1031 Exchange purchased a decaying hotel in a rural Western setting as his replacement property. In this case, the investor used the equity and tax savings gained in the exchange to turn a "brownfield" property into a "Green" property. He
renovated the facility into a modern executive conference lodge and cleaned up a muddy stream running through the property. Today, the property is a popular destination retreat with a much higher valuation. Retreat guests now can walk down to the stream and catch large brown trout
- a true example of the “Greening” of America.
Creative Exchange Strategies
Due to the fact that the “Green” building movement is still in its infancy in the United States, many property investors seeking to capitalize on these benefits may be faced with construction and renovation issues. Fortunately, there are several variations on a traditional 1031 strategy that can allow an owner to develop or build a modern energyefficient property and still enjoy potential tax advantages.
One 1031 Exchange strategy is a reverse construction exchange. In this case, the taxpayer first closes on the purchase of the replacement property and then sells the currently owned property within 180 days. A property investor could also purchase a new property while it is still under construction and enjoy the 1031 tax advantages, provided the current value of the new property is equal to or greater than the prior holding at the time of transfer to the taxpayer of the replacement property.
There are a variety of ways for corporations and real estate investors to use 1031 Exchanges to upgrade their holdings and reap the social, sustainability and financial benefits of going "Green.” For the 1031 investor or corporation utilizing a 1031 Exchange strategy, going "Green" offers a win-win proposition: a win for the investor and a win for the community where the property
is located.
Copyright © 2008 by William B. Hood,
Roswell, Ga. All rights Reserved
Monday, May 25, 2009
The "Obama Effect" on Today's Commercial Real Estate Market
Throughout much of the 20th century, capital gains have been taxed at a lower rate than other income or were only partially exposed to taxation. This lower rate was justified because it encouraged capital formation and investment, fostered risk-taking and helped to offset the effect of inflation on capital gains. History has shown that the tax rate applied to capital gains and dividends has a substantial impact on the way taxpayers handle income from capital.
Even before the last Presidential election, commercial real estate investors were making statements that when they sold their property they wanted to “cash out” because “if Obama gets elected he will raise the capital gains tax to 20% or much more”. Many of these investors have been living up to their word and cashing out of the properties (and condoned by some of their advisors). Now quite frankly, before the election I was calling this the “McCain/Obama effect” because no matter who would have been elected to the office of President, part of their agenda would be to increase the capital gains tax.
Since the election and the subsequent passage of the TARP and TALF and other huge scheduled spending bills have given birth to a second concern among investors and their advisors: hyper-inflation. Let’s dissect these issues on an individual basis and then re-assemble them into a solution for concerned investors and advisors.
Although capital gain tax rates are set to be increased to 20% in 2011, many taxpayers are uncertain as to what rates might be in the future due to what they are hearing from the White House and congress. Let’s compare what happens to the taxpayer who sells today at the current 15% maximum rate versus the same taxpayer electing to defer all capital gain taxes via a §1031 tax deferred exchange and selling at a presumed higher capital gain tax rate of 20% in the future. Assume the following: A taxpayer is selling an investment property for $1,200,000 with $300,000 remaining debt and $820,000 net equity (after cost of sale of $80,000, but before taxes); the taxpayer’s adjusted basis is $400,000 and their gain is $720,000, of which $37,500 is the capital gains tax on depreciation (the 25% tax was signed into law by President Clinton in 1997) and $570,000 (taxed at 15%) is the remaining capital gain; the state tax rate (example-each state is different) is 6% on the entire capital gain of $720,000. This nets to total taxes of $166,200 leaving, net equity after tax, of $653,000. Assume the after-tax sale proceeds are reinvested into another investment property with a 25% down payment (75% LTV), the taxpayer would be able to acquire a property valued at $2,615,200. However, by utilizing a §1031 Tax Deferred Exchange the taxpayer would be able to use the entire gross equity of $820,000 and acquire a property valued at $3,280,000. The incremental value of property acquired would be $664,800.
CALCULATE NET ADJUSTED BASIS
Original Purchase Price (Basis) $500,000
plus Capital Improvement +$50,000
Less Depreciation -$150,000
equals Net Adjusted Basis $400,000
CALCULATE CAPITAL GAIN*
Sales Price $1,200,000
Less Adjusted Basis -$400,000
Less Cost of Sale -$80,000
equals CAPITAL GAIN $720,000
CALCULATE CAPITAL GAIN TAX DUE
Recaptured Depreciation (25% x $150,000) $37,500
plus Federal Capital Gain (15%x$570,000) +$85,500
plus State Tax (GA 6.0%x $720,000) +$43,200
TOTAL TAX DUE $166,200
The elimination of the Alternative Minimum Tax exemption and the creation of Capital Gains Tax Preference items that could create even more taxes are not addressed in this scenario, however, AMT implications need to be considered.
CALCULATE AFTER-TAX EQUITY
Sales Price $1,200,000
Less Cost of Sale -$80,000
Less Loan Balances -$300,000
equals GROSS EQUITY $820,000
Less Capital Gain Taxes Due $166,200
Equals AFTER-TAX EQUITY $653,800
ANALYZE REINVESTMENT - SALE
After-Tax Equity x 4 $2,615,200
ANALYZE REINVESTMENT – EXCHANGE
Gross Equity = Net Equity $820,000
Gross Equity x 4 $3,280,000
Albert Einstein was once asked what he felt was the most powerful force in the world and his answer was “The Theory of compounding Interest”:
Let’s assume that the taxpayer is 35, 40, 50 years old or older and doesn’t need the cash until retirement and replacement investment property appreciates at only 6% per year.
Theory of Compounded Interest:
Utilizing the original $166,200 Tax Deferral Money exponentially creates wealth (e.g. 6% per Year) appreciation of original leveraged amount of $664,800 to over $1,300,000 in 12 Years. Even if the capital gains tax rates (depreciation, capital gains and state blended rises to 40%, the investor is still well ahead of the game.
Also, there is no limit to the number of exchanges a taxpayer can effect , therefore if the taxpayer decides that a replacement property has peaked in value and effects other §1031 exchanges to leverage their additional gains/equity and deferred capital gains taxes into other opportunistic replacement properties.
Hyperinflation:
If our national spending habits do create an inflationary economy; what is one of the best hedge assets to have in one’s portfolio? Commercial Real Estate: and if we see inflation rates skyrocket to 20% or more, the exchanger’s $166,200 tax deferral that leveraged the additional value of $664,800 would double that value in a lot less time than 12 years.
Conclusion:
Investors and their advisors should examine all factors regarding the individual investor's financial goals and tax situations and before they make hasty uninformed decisions.
Copyright William B. Hood, 2009
Even before the last Presidential election, commercial real estate investors were making statements that when they sold their property they wanted to “cash out” because “if Obama gets elected he will raise the capital gains tax to 20% or much more”. Many of these investors have been living up to their word and cashing out of the properties (and condoned by some of their advisors). Now quite frankly, before the election I was calling this the “McCain/Obama effect” because no matter who would have been elected to the office of President, part of their agenda would be to increase the capital gains tax.
Since the election and the subsequent passage of the TARP and TALF and other huge scheduled spending bills have given birth to a second concern among investors and their advisors: hyper-inflation. Let’s dissect these issues on an individual basis and then re-assemble them into a solution for concerned investors and advisors.
Although capital gain tax rates are set to be increased to 20% in 2011, many taxpayers are uncertain as to what rates might be in the future due to what they are hearing from the White House and congress. Let’s compare what happens to the taxpayer who sells today at the current 15% maximum rate versus the same taxpayer electing to defer all capital gain taxes via a §1031 tax deferred exchange and selling at a presumed higher capital gain tax rate of 20% in the future. Assume the following: A taxpayer is selling an investment property for $1,200,000 with $300,000 remaining debt and $820,000 net equity (after cost of sale of $80,000, but before taxes); the taxpayer’s adjusted basis is $400,000 and their gain is $720,000, of which $37,500 is the capital gains tax on depreciation (the 25% tax was signed into law by President Clinton in 1997) and $570,000 (taxed at 15%) is the remaining capital gain; the state tax rate (example-each state is different) is 6% on the entire capital gain of $720,000. This nets to total taxes of $166,200 leaving, net equity after tax, of $653,000. Assume the after-tax sale proceeds are reinvested into another investment property with a 25% down payment (75% LTV), the taxpayer would be able to acquire a property valued at $2,615,200. However, by utilizing a §1031 Tax Deferred Exchange the taxpayer would be able to use the entire gross equity of $820,000 and acquire a property valued at $3,280,000. The incremental value of property acquired would be $664,800.
CALCULATE NET ADJUSTED BASIS
Original Purchase Price (Basis) $500,000
plus Capital Improvement +$50,000
Less Depreciation -$150,000
equals Net Adjusted Basis $400,000
CALCULATE CAPITAL GAIN*
Sales Price $1,200,000
Less Adjusted Basis -$400,000
Less Cost of Sale -$80,000
equals CAPITAL GAIN $720,000
CALCULATE CAPITAL GAIN TAX DUE
Recaptured Depreciation (25% x $150,000) $37,500
plus Federal Capital Gain (15%x$570,000) +$85,500
plus State Tax (GA 6.0%x $720,000) +$43,200
TOTAL TAX DUE $166,200
The elimination of the Alternative Minimum Tax exemption and the creation of Capital Gains Tax Preference items that could create even more taxes are not addressed in this scenario, however, AMT implications need to be considered.
CALCULATE AFTER-TAX EQUITY
Sales Price $1,200,000
Less Cost of Sale -$80,000
Less Loan Balances -$300,000
equals GROSS EQUITY $820,000
Less Capital Gain Taxes Due $166,200
Equals AFTER-TAX EQUITY $653,800
ANALYZE REINVESTMENT - SALE
After-Tax Equity x 4 $2,615,200
ANALYZE REINVESTMENT – EXCHANGE
Gross Equity = Net Equity $820,000
Gross Equity x 4 $3,280,000
Albert Einstein was once asked what he felt was the most powerful force in the world and his answer was “The Theory of compounding Interest”:
Let’s assume that the taxpayer is 35, 40, 50 years old or older and doesn’t need the cash until retirement and replacement investment property appreciates at only 6% per year.
Theory of Compounded Interest:
Utilizing the original $166,200 Tax Deferral Money exponentially creates wealth (e.g. 6% per Year) appreciation of original leveraged amount of $664,800 to over $1,300,000 in 12 Years. Even if the capital gains tax rates (depreciation, capital gains and state blended rises to 40%, the investor is still well ahead of the game.
Also, there is no limit to the number of exchanges a taxpayer can effect , therefore if the taxpayer decides that a replacement property has peaked in value and effects other §1031 exchanges to leverage their additional gains/equity and deferred capital gains taxes into other opportunistic replacement properties.
Hyperinflation:
If our national spending habits do create an inflationary economy; what is one of the best hedge assets to have in one’s portfolio? Commercial Real Estate: and if we see inflation rates skyrocket to 20% or more, the exchanger’s $166,200 tax deferral that leveraged the additional value of $664,800 would double that value in a lot less time than 12 years.
Conclusion:
Investors and their advisors should examine all factors regarding the individual investor's financial goals and tax situations and before they make hasty uninformed decisions.
Copyright William B. Hood, 2009
Sunday, May 17, 2009
2009 Commercial Real Estate Trends
2009 Commercial Real Estate Trends: Taking Advantage of Opportunities and Avoiding Tax Traps in Today’s Distressed Real Estate Markets
2009 Trends in the CRE Market Place
The federal government has infused unprecedented massive amounts of money into financial markets nationwide, yet the credit crunch continues; and when lenders are loaning money the new loan rates are higher and loan to value ratios are lower. The same lenders are looking for a Debt Coverage Ratio that is above 1.2 and often in the 1.25-1.35 + range. Lenders are also looking at higher cap rates for determining value.
Sale-Leaseback transactions are increasing as businesses seek alternative sources of working capital from existing real estate assets.
Due to higher priced oil and future projected consumption, the energy sector is becoming more popular as an investment. Adding to that is the ensuing need to become energy independent and therefore solar farms, wind power and other alternative energy are gaining favor with investors.
“Green” initiatives are being aggressively pursued due to decreasing construction costs and the ROI on sustainability due to operating efficiencies and tenant demand.
In the commercial real estate market many investors are under water due to note balances that are in excess of Fair Market Value and/or not being able to pay the note balance on the due date (with many coming due in 2009-2010).
Ominous Tax Consequences Looming for Commercial Borrowers with Non-Performing Debt
Loan balances that are in excess of fair market value of the property could inflict onerous taxable events upon unsuspecting investors if there is COD (cancellation of recourse debt and/or deeding-in lieu or actual foreclosure by the lender (recourse and/or non-recourse debt in excess of the adjusted basis on the property) triggering capital gain tax recognition; resulting in investors having little or no cash to pay the debt or the tax liabilities.
With recourse debt; there are two types of tax liabilities that are created where the investors will recognize capital gain (or loss); the difference between the fair market value of the property (immediately prior to the disposition) and the property’s adjusted basis (purchase price plus capital improvements less depreciation). Many investors believe they have a loss, when in fact they may have a huge capital gain (especially a BIG (built in gain from a previous tax deferred exchange). In addition to the capital gains tax consequences, cancellation of debt (COD) triggers recognized ordinary income to the extent of the deficiency when fair market value is less than recourse liability, unless excepted (proof of insolvency, bankruptcy, etc.).
THE AMERICAN RECOVERY AND REINVESTMENT ACT OF 2009 – STIMULUS AND TAXES
For tax purposes, the cancellation of debt is taxable income in the year cancelled. The Act provides that for debt discharges in 2009 and 2010, a taxpayer can elect to have the debt discharge income included in gross income ratably over 5 years, starting in the fifth tax year (fourth tax year if the discharge occurs in 2010) after the year of discharge. Unfortunately, at this point in time, this election is not available to real estate investors. Therefore, the COD will remain as ordinary taxable income in the year the debt is discharged.
Following are examples of the onerous tax consequences that can occur from foreclosure, deed-in-lieu, and “workouts” that discharge recourse debt:
Calculation of Adjusted Basis & Debt:
Original Purchase Price (Original Basis includes $300,000 Land) $2,200,000
Depreciation Basis $1,900,000
Less: Depreciation $600,000
Adjusted Basis (includes land) $1,600,000
Calculation of COD Recognized Ordinary Income:
Amount of Loan Outstanding $2,000,000
Fair Market Value (Mark to Market) $1,800,000
equals COD “Ordinary” Income $200,000
Calculation of Recognized Capital Gain Income:
Fair Market Value $1,800,000
minus Net Adjusted Basis $1,600,000
Additional Capital Gain Income $200,000
Total Recognized Income: Ordinary & Capital
Gain Income $400,000
Note1): the “Ordinary” Income Tax on the $200,000 created by the COD could be as much as $80,000 + (35% Federal + 6% GA state tax (each state tax is different)) There could be more taxes if the additional ordinary income may eliminate the Alternative Minimum Tax exemption amount (another possible onerous tax consequence).
Note 2): (The Capital Gains Tax on depreciation is “Front Loaded”) 25% X $200,000 = $50,000 + 6.0 % GA state tax (each state is different) x $200,000 = $12,000. Total capital gains tax would be approximately $60,000 +. The total potential taxes would be $140,000 + (each state income tax will make a difference).
And, there could be even more taxes levied on the investors if the additional income eliminates the Alternative Minimum Tax (AMT) exemption amount and the Capital Gains Tax Preference items trigger Alternative Minimum Tax (another possible onerous tax consequence).
Non-Recourse Debt
And just when investors think it’s over, it’s not; if there is non-recourse debt on the distressed property, the investors will recognize capital gain income in an amount equal to the total debt secured by the property less the property’s adjusted basis.
Calculation of total Non-Recourse debt recognized as income $2,000,000
Less: adjusted basis $1,600,000
Recognized capital gain $400,000
Note 3: (The capital gain tax on depreciation is “Front Loaded”) 25% X $400,000 = $100,000 plus (Georgia state taxes) 6.0% x $400,000 = $24,000 The total taxes would be approximately $120,000 + (each state income tax will make a difference).
Unfortunately, many real estate investors are very much unaware of these onerous tax consequences; and by conveying title (deed-in- lieu or foreclosure) and/or debt discharge from “workouts” they could end up with tax bills and debt that they can’t pay.
There are Solutions available for Investors and Lenders
Now for some viable Win-Win solutions; Investors that are holding non-performing/under performing properties (or even performing properties) may be able to mitigate or eliminate onerous tax consequences due to COD and capital gain taxes (recourse and non-recourse debt) via strategies that may include “§1031 Workout Strategies”. The scenarios could include selling the property and exchanging it for a property of equal or greater value and equal (or greater) debt, thereby deferring the entire capital gain taxes. A partial exchange could also be an option with the results of deferring part of the capital gains taxes. Part or all of capital gains taxes deferred savings could be used to pay down the recourse debt and mitigate or eliminate the ordinary income recognition.
On the flip side the buyers of these distressed commercial real estate properties could be investors looking for opportunities to acquire valuable properties at discounts through a number of IRC §1031 strategies themselves. These §1031 Tax Deferral Strategies can be structured where the investors have properties scheduled for relinquishment but wish to wait for the market to stabilize in order to get the best price. Through an Exchange Accommodation Title Holder/Qualified Intermediary; the acquisition of the non-performing property direct from the current owner or the lender’s REOs and/or the notes portfolio now (and via the notes; the subsequent acquisition of the underlying properties) and afford themselves ample time (via a §1031 reverse exchange - Safe Harbor or non-Safe Harbor) to sell their scheduled relinquished properties.
If a buyer of the exchange property is short on capital, there are also §1031 Tax Deferred Exchange strategies utilizing creative "Seller Financing" options that can help the exchanging investors defer much or ALL of the capital gain taxes on the sale of the Relinquished Property.
All of the above strategies may very well create Win-Win Scenarios (for lenders, investors and borrowers alike). The lender is cashed out to the fullest extent possible, the investors own valuable properties at a discount to FMV and the distressed borrowers have mitigated onerous tax consequences. In addition, current commercial occupant(s) may have uninterrupted use of the property via leases negotiated i.e. lease payments vs. extensions or even Lease/Option to Buy?
There may be even Win-Wins in the residential sector where viable current residents remain in their homes? Could negotiations lead to the families paying less rent than previous mortgage payments with a lease/option to buy? The Big win? Neighborhood home values stabilize (due to fewer foreclosures which would depress the comparables even more).
Caveat:
Each individual investor, borrower and property situations should be analyzed by a team of skilled professionals. Each situation will fall under the “Snow Flake” theory. No two will be exactly alike.
Copyright William B. Hood, 2009
William B. Hood. CPA is the Southeast Division Manager with Asset Preservation, Inc. Bill is a graduate of Seton Hall University with a B.S. degree in Public Accounting. Bill is a Certified Public Accountant and is a member of the American Institute of Certified Public Accountants, Georgia Society of Certified Public Accountants, the Atlanta Commercial Board of Realtors and CREW.
2009 Trends in the CRE Market Place
The federal government has infused unprecedented massive amounts of money into financial markets nationwide, yet the credit crunch continues; and when lenders are loaning money the new loan rates are higher and loan to value ratios are lower. The same lenders are looking for a Debt Coverage Ratio that is above 1.2 and often in the 1.25-1.35 + range. Lenders are also looking at higher cap rates for determining value.
Sale-Leaseback transactions are increasing as businesses seek alternative sources of working capital from existing real estate assets.
Due to higher priced oil and future projected consumption, the energy sector is becoming more popular as an investment. Adding to that is the ensuing need to become energy independent and therefore solar farms, wind power and other alternative energy are gaining favor with investors.
“Green” initiatives are being aggressively pursued due to decreasing construction costs and the ROI on sustainability due to operating efficiencies and tenant demand.
In the commercial real estate market many investors are under water due to note balances that are in excess of Fair Market Value and/or not being able to pay the note balance on the due date (with many coming due in 2009-2010).
Ominous Tax Consequences Looming for Commercial Borrowers with Non-Performing Debt
Loan balances that are in excess of fair market value of the property could inflict onerous taxable events upon unsuspecting investors if there is COD (cancellation of recourse debt and/or deeding-in lieu or actual foreclosure by the lender (recourse and/or non-recourse debt in excess of the adjusted basis on the property) triggering capital gain tax recognition; resulting in investors having little or no cash to pay the debt or the tax liabilities.
With recourse debt; there are two types of tax liabilities that are created where the investors will recognize capital gain (or loss); the difference between the fair market value of the property (immediately prior to the disposition) and the property’s adjusted basis (purchase price plus capital improvements less depreciation). Many investors believe they have a loss, when in fact they may have a huge capital gain (especially a BIG (built in gain from a previous tax deferred exchange). In addition to the capital gains tax consequences, cancellation of debt (COD) triggers recognized ordinary income to the extent of the deficiency when fair market value is less than recourse liability, unless excepted (proof of insolvency, bankruptcy, etc.).
THE AMERICAN RECOVERY AND REINVESTMENT ACT OF 2009 – STIMULUS AND TAXES
For tax purposes, the cancellation of debt is taxable income in the year cancelled. The Act provides that for debt discharges in 2009 and 2010, a taxpayer can elect to have the debt discharge income included in gross income ratably over 5 years, starting in the fifth tax year (fourth tax year if the discharge occurs in 2010) after the year of discharge. Unfortunately, at this point in time, this election is not available to real estate investors. Therefore, the COD will remain as ordinary taxable income in the year the debt is discharged.
Following are examples of the onerous tax consequences that can occur from foreclosure, deed-in-lieu, and “workouts” that discharge recourse debt:
Calculation of Adjusted Basis & Debt:
Original Purchase Price (Original Basis includes $300,000 Land) $2,200,000
Depreciation Basis $1,900,000
Less: Depreciation $600,000
Adjusted Basis (includes land) $1,600,000
Calculation of COD Recognized Ordinary Income:
Amount of Loan Outstanding $2,000,000
Fair Market Value (Mark to Market) $1,800,000
equals COD “Ordinary” Income $200,000
Calculation of Recognized Capital Gain Income:
Fair Market Value $1,800,000
minus Net Adjusted Basis $1,600,000
Additional Capital Gain Income $200,000
Total Recognized Income: Ordinary & Capital
Gain Income $400,000
Note1): the “Ordinary” Income Tax on the $200,000 created by the COD could be as much as $80,000 + (35% Federal + 6% GA state tax (each state tax is different)) There could be more taxes if the additional ordinary income may eliminate the Alternative Minimum Tax exemption amount (another possible onerous tax consequence).
Note 2): (The Capital Gains Tax on depreciation is “Front Loaded”) 25% X $200,000 = $50,000 + 6.0 % GA state tax (each state is different) x $200,000 = $12,000. Total capital gains tax would be approximately $60,000 +. The total potential taxes would be $140,000 + (each state income tax will make a difference).
And, there could be even more taxes levied on the investors if the additional income eliminates the Alternative Minimum Tax (AMT) exemption amount and the Capital Gains Tax Preference items trigger Alternative Minimum Tax (another possible onerous tax consequence).
Non-Recourse Debt
And just when investors think it’s over, it’s not; if there is non-recourse debt on the distressed property, the investors will recognize capital gain income in an amount equal to the total debt secured by the property less the property’s adjusted basis.
Calculation of total Non-Recourse debt recognized as income $2,000,000
Less: adjusted basis $1,600,000
Recognized capital gain $400,000
Note 3: (The capital gain tax on depreciation is “Front Loaded”) 25% X $400,000 = $100,000 plus (Georgia state taxes) 6.0% x $400,000 = $24,000 The total taxes would be approximately $120,000 + (each state income tax will make a difference).
Unfortunately, many real estate investors are very much unaware of these onerous tax consequences; and by conveying title (deed-in- lieu or foreclosure) and/or debt discharge from “workouts” they could end up with tax bills and debt that they can’t pay.
There are Solutions available for Investors and Lenders
Now for some viable Win-Win solutions; Investors that are holding non-performing/under performing properties (or even performing properties) may be able to mitigate or eliminate onerous tax consequences due to COD and capital gain taxes (recourse and non-recourse debt) via strategies that may include “§1031 Workout Strategies”. The scenarios could include selling the property and exchanging it for a property of equal or greater value and equal (or greater) debt, thereby deferring the entire capital gain taxes. A partial exchange could also be an option with the results of deferring part of the capital gains taxes. Part or all of capital gains taxes deferred savings could be used to pay down the recourse debt and mitigate or eliminate the ordinary income recognition.
On the flip side the buyers of these distressed commercial real estate properties could be investors looking for opportunities to acquire valuable properties at discounts through a number of IRC §1031 strategies themselves. These §1031 Tax Deferral Strategies can be structured where the investors have properties scheduled for relinquishment but wish to wait for the market to stabilize in order to get the best price. Through an Exchange Accommodation Title Holder/Qualified Intermediary; the acquisition of the non-performing property direct from the current owner or the lender’s REOs and/or the notes portfolio now (and via the notes; the subsequent acquisition of the underlying properties) and afford themselves ample time (via a §1031 reverse exchange - Safe Harbor or non-Safe Harbor) to sell their scheduled relinquished properties.
If a buyer of the exchange property is short on capital, there are also §1031 Tax Deferred Exchange strategies utilizing creative "Seller Financing" options that can help the exchanging investors defer much or ALL of the capital gain taxes on the sale of the Relinquished Property.
All of the above strategies may very well create Win-Win Scenarios (for lenders, investors and borrowers alike). The lender is cashed out to the fullest extent possible, the investors own valuable properties at a discount to FMV and the distressed borrowers have mitigated onerous tax consequences. In addition, current commercial occupant(s) may have uninterrupted use of the property via leases negotiated i.e. lease payments vs. extensions or even Lease/Option to Buy?
There may be even Win-Wins in the residential sector where viable current residents remain in their homes? Could negotiations lead to the families paying less rent than previous mortgage payments with a lease/option to buy? The Big win? Neighborhood home values stabilize (due to fewer foreclosures which would depress the comparables even more).
Caveat:
Each individual investor, borrower and property situations should be analyzed by a team of skilled professionals. Each situation will fall under the “Snow Flake” theory. No two will be exactly alike.
Copyright William B. Hood, 2009
William B. Hood. CPA is the Southeast Division Manager with Asset Preservation, Inc. Bill is a graduate of Seton Hall University with a B.S. degree in Public Accounting. Bill is a Certified Public Accountant and is a member of the American Institute of Certified Public Accountants, Georgia Society of Certified Public Accountants, the Atlanta Commercial Board of Realtors and CREW.
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