Practical Real Estate Techniques
Posted by Thomas K. Bryan
Hey say that "death and taxes" are the only two certainties in
this life. When it comes to achieving financial independence,
death and taxes are essentially the same thing. Just as friction
wears the tread off your tires, tax friction rubs the shine
right off your financial statement.
Over time, the friction of taxation will do to your financial
future what the Colorado River has done to the Grand Canyon.
In order to build wealth, you must maximize your tax deductions,
thus minimizing your recognized taxable income.
Many property Sellers mistakenly think they need to pull all of
the equity out of the sale of their real estate. Uncle Sam
doesn't seem to think that's such a good idea, especially if you
are an investor. Thats why he slaps our hands so hard by taxing
us on our gains and rewards us handsomely with tax savings when
we structure our transactions creatively.
The U.S. Tax Code provides several strong incentives for doing
just that, and the effects can be extremely powerful in building
wealth. Two of these incentives make it exceptionally profitable
for you to "both a lender, and a borrower be!"
Section 453 of the United States Tax Code (Installment Sales)
allows investors to avoid the bulk of their taxes due on capital
gains. Utilizing the Seller Financing technique, we can defer
these taxes by paying them in very small increments over a long
period of time. There are several other benefits as well.
When offering Seller Financing it improves the marketability of
our properties. If structured correctly it also creates an
opportunity to maximize sale values. Although the value added
appears more pronounced in a slow market, the tax benefits make
Seller Financing extremely attractive regardless of economic
conditions.
Seller Financing or a carryback note also provides us with a
well-secured, high-yielding, near-cash asset that offers us a
broad foundation and a great deal of flexibility in building our
investment portfolio. Such notes strengthen our financial
statements, while earning much better returns than saving
accounts.
Interest payments can kill our efforts to achieve financial
independence. There is an exception, besides the tax break, that
lending our equity brings to the table. Uncle Sam throws
investors another meaty bone as well: Tax Code Section 163,
allows us to write off interest on debt used to finance the
purchase of our investment assets!
Financing a high percentage of the purchase price provides a
large interest deduction in the early years of ownership. This
deduction generates a tax shelter, which shields any positive
cash flow. It also shelters the non-cash equity buildup
occurring through principal reduction on the loan. At times it
may even shelter some of our other income from taxation as well.
Investment debt allows us to control more properties, so we can
build our wealth portfolios more rapidly. At the same time the
mortgage interest deduction reduces taxation. This allows more
of our dollars to remain where they belong -- working for us to
further speed up our accumulation of assets.
By loaning our equity in the form of Seller Financing, and
borrowing more heavily on new acquisitions, we can maximize our
yields through increased profits and reduced taxation. For the
investor looking to pyramid real estate assets -- the use of
these practical financing techniques is often the best way to go.
Here's a perfect example -- Say a client or an acquaintance owns
a $75,000 rental home with $35,000 in equity. He wants to sell
this rental in order to purchase a $120,000 duplex, which has
$30,000 in equity. At first glance, a Section 1031 tax deferred
exchange might seem like a good way to go. That could be an
excellent strategy. But what about this
Say, your client has a solid Buyer who only has $8,000 cash to
cover the down payment for your client's property. The duplex
Seller wants to cash out from the sale of his property. What do
you do then? Here is a practical technique that will satisfy
everybody and pump up our client's investment portfolio to boot.
Your client sells his rental home and carries back a Seller
Financed second note of $28,000 for 25 years, at 11.5% interest
with an eight year balloon payment due (charging the Buyer a
$1,000 premium to offset your client's closing costs). Your
client nets $7,000 after closing. But with only $7,000 net cash
from the sale of the rental, he is still $23,000 short for
closing on the duplex. If your client sells his note to a note
investor or gives the note to the duplex Seller as part of the
down payment, it will trigger a taxable event for your client.
Your client offers the duplex Seller $7,000 cash down and a new
second mortgage for $23,000, which he will sell to an Investor
for $20,500 at the close of escrow (a "simultaneous closing").
This new mortgage is amortized over 135 months at 10% with a
balloon due in eight years. To make the note more attractive and
reduce the discount, your client pledges his own $28,000 note
(from the sale of his rental property) as additional collateral
for the new $23,000 note he gave to the duplex Seller.
This strategy mitigates your clients capital gains taxes, so
his dollars go to work acquiring more investment assets. The
financing structure also gives him a higher mortgage interest
deduction and increases his tax shelter as a result of a new and
higher depreciation basis. Meanwhile, the 11.5% mortgage
payments he receives from his Buyer are covering the payments on
the 10% second mortgage he gave to the duplex Seller.
At the end of the day, your client received all of the same
benefits he would have realized from an exchange. The difference
with this more practical approach -- your client was also able
to loan out $5,000 of his equity and gain an additional $11,042
over eight years. This is a 14.66% annualized return on his
$5,000, by the way.
Using a few practical techniques and the services of a good note
broker, you accomplished your client's investment goals and made
him an extra $11,042 in the process! We aren't surprised when he
refers two of his friends to us.
For more articles or to get any question you have answered
visit http://fustigation.net or call Thomas K. Bryan toll free
at 707 272 1585
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