Archives for May 2015

The Role Of The Qualified Intermediary In 1031 Exchanges

1031 swaps as a major tax advantage…

The deferment of capital gains tax (currently 15%) on the sale of investment property can be an excellent capital-savings strategy as any property investor looks to limit their overall tax bill. The Internal Revenue Service allows for this in section 1031 of the IRS code. This sections spells out how you can carry your cost basis forward from a newly–sold property to a newly-bought property without having to pay taxes on the sale. The key is in no monetary proceeds ever touching your hands (or your accounts, or accounts of your agents). Yes, it’s complicated, and you should seek further guidance from your tax professional. However, it basically works like this:

1031 exchanges overview

The 1031 exchange, also referred to as a tax deferred exchange, is a way for you to sell one investment property, that’s “qualified,” and then buy another qualified property within a proscribed amount of time. The process of selling your property, then buying a different property, is similar to any traditional buy/sell situation, except that with a 1031 exchange, the total set of this buy/sell transaction is treated as an “exchange” – not a regular sale.

What is a 1031 exchange?

To obtain the tax advantage of deferred capital gains taxes on the sale of your investment property, you’ll need to follow two basic rules set forth by the IRS. The first is that the full purchase price of the “replacement” investment property to be bought must be a “like kind” property. That is, it must be be considered an investment property that acts in much the same way as the property you’re selling. This does not mean they have to be exactly alike. A four family house can be swapped for a small retail building that’s providing rental income…as long as they are comparable in valuation. Even if the property to be bought is worth more, there can still be a partial swap allowable. The second component of the regulations is that all the equity derived as a result of the sale of your investment property must be used to acquire the replacement like kind property. Again, no cash outs of any kind here – or you lose the ability to call it a 1031 swap! And you’ll be paying capital gains taxes on the equity pulled out as cash.

1031 exchange real estate guidelines

The 1031 swap includes strict guidelines for how the proceeds of any sale are handled. To this end, any transaction must use the services of an intermediary company that specializes in these exchanges. These companies are called “qualified intermediaries” (QI’s), and any monies flowing through from the sale must be held, and go exclusively through, the qualified intermediary. Of course, the total proceeds from any sale have to get reinvested when purchasing the new property to be an acceptable 1031 swap. Any leftover cash that comes out of the swap to you will be taxable. In addition, 1031 exchange rules require the replacement property has to have an equal or greater value of existing debt on the property than the property you sold. If not, you’ll need to put in more cash to offset the lower debt on the purchased property.

Qualified intermediaries’ roles

Agents of the property investor (such as their current attorney, certified public accountant or Realtor), cannot be a qualified intermediary for that particular investor. A qualified intermediary does not require a license (except in Nevada), however, they should be bonded and insured against any errors and omissions. A QI will write up an agreement with the client investor that will transfer the property to be sold to the new buyer, and also transfers the replacement property to the investor in escrow, until the transaction is completed. In this way, the investor never takes possession of any proceeds of the transactions.

1031 exchanges time guidelines

There are two basic timeline considerations in any 1031 swap. The first is known as the “identification period.” This refers to the time period when the investor needs to identify other potential replacement properties to place in the exchange for the property he/she is selling. Usually, only one property is selected. This time period is 45 days from the day the investor sells his investment. The second rigid timeline is known as the “exchange period.” This refers to the period between selling their investment property and when he/she actually closes on buying the replacement property. This period allows exactly 180 days in which to do so, in order to still qualify under 1031 swap rules.

photos courtesy of mcgillescrowandtitle.com, roswellescrow.com, layman-nichols.com

Modify A Blank Lease Agreement In Your Favor

Pitfalls of verbal leases…

If I were to take a non-scientific poll of landlords I know, I would say a majority of them operate without written leases. They simply go month to month on a verbal basis with their tenants. In the world of rugged individualism that comprises the small landlord property investor, the same old, same old that has worked for them year in and year out retains the steady preference over a written blank lease agreement…even if the written rental agreement spells out a strictly month to month rental arrangement. Some old school landlords feel, “why bother with a written lease?”

In our heavily litigious society, they are fooling themselves into thinking the simplicity of an oral agreement will always suffice. And I’m sure most have been financially burned at least once or twice due to not having a written agreement in place with their tenants. A written lease gives the landlord a great deal of legal protection, not to mention that a landlord can write the agreement in their favor on a number of important terms. And it’s so easy to simply download any number of free lease agreement templates to work off of…Let’s take a look at what’s included in a standard residential lease agreement.

What’s included in a free lease agreement

Besides the most basic of info, like who the tenant and landlord will be, the monthly rent and the security deposit being held by the landlord, a rental lease agreement also spells out when the rent is due, and what financial penalties accrue should the tenant miss the timely payment (late charges). It also should include who the exact residents of the unit will be, besides the tenant. These usually refer to the tenant’s immediate family members, but they could include non-immediate family members, or friends, if the landlord will allow them. Most importantly, it limits the overall number of people residing in the landlord’s unit during the duration of the tenancy period.

Utilities spelled out…

Other important parts of the lease include spelling out who is responsible for payment of different utilities incurred for the unit. As an example, if there is no separate heating bill for each unit, then traditionally, the landlord is responsible for heating costs. Conversely, each unit will certainly have their own electric meter, and tenants are generally responsible for their own payment of electricity. However, common area (hallways, exterior lighting) electricity is usually paid for by the landlord.

Pets and parking

Another key lease term is whether the landlord will allow any pets. It’s a good idea to state the exact pet(s) that will be residing at the residence. Usually, the landlord can collect an additional security deposit for dogs, in case of any damage done by them. Parking is another important element included in standard residential lease agreements. This will detail the exact number of on-site parking spaces allowed to each tenant. This will also include any parking garage privileges as well…In addition, terms like alterations are a critical part of a lease. The written agreement will note the procedure for a tenant to apply to the landlord should they want to make any physical alterations to their unit (for example, adding a loft bed to a bedroom).

Termination events

Other items included in a standard lease include regulations involving allowable noise, disturbing other tenants, destruction of the premises, and the consequences of a tenant’s actions. It also includes terms relating to what maintenance the tenant will undertake on a regular basis (for example, will they be required to mow the lawn, shovel walkways, place their garbage in certain bins, etc.) In addition, the terms of how the lease will be terminated are also spelled out, both for normal termination (end of the tenancy period), as well as reasons for early termination by the landlord (for damage done by the tenant during their tenancy). Further, reasons for using security deposits to liquidate damages done by the tenant are also stated in the agreement.

Insurance coverage

Insurance responsibility is also an important part of any lease agreement. Writing out that the landlord provides no coverage for a tenant’s personal possessions is very important. A landlord may also require a tenant to obtain renters insurance for their personal possessions. Another key component of a standard residential lease agreement is allowing the landlord to gain access to the unit not only during emergency periods, but for non-emergency periods too, for simple inspections of the property, and to make basic maintenance repairs to the unit. Finally, there is traditionally a term involving whether the landlord will allow a tenant to sublet his unit. It can be a blanket no, or vice-versa. It can also be somewhere in between, allowing a tenant to sublet upon landlord’s written approval of the sub-lessee.

photos courtesy of houstonmortgagetexas.com, lawofficewalterjennings.com, tenantscreeningblog.com, zillow.com, ortak.com

How To Flip Houses

Foreclosure hunting…and the pitfalls

The current trend in house flipping are the return of the daredevil investors who take very large financial risks in order to obtain a very high return on investment (ROI). A tremendous amount of flipping money in the last couple of years has been placed in foreclosed properties. These houses, owned by lenders who went through the judicial process to obtain ownership when their mortgagees defaulted on their loans, represent tremendous potential upside. But they also represent a tremendous ability for financial ruination as well. The reason: most foreclosed properties are sold “as is.” And, this also means that, if services such as electricity and water have been turned off, any buyer has to purchase the house without the ability to test out the plumbing, heating or electrical systems, to say nothing of the inability to test appliances as well.

Expect the unexpected

So if, for example, there have been any winter freeze-ups, and commensurate broken pipes, a buyer will not necessarily be able to ascertain this without turning the water and electricity on. In addition, some lenders of late are placing their houses on the market and are not allowing actual showings of the buildings! They ask for offers sight unseen. So any investor willing to take the risk of incurring huge potential problems with a foreclosure must accurately bracket for the worst case scenario when they crunch their numbers, and ultimately place an offer on a house. Certainly, this is not for the faint-of-heart investor. It takes guts. And a singular lack of emotion to achieve a successful, financial outcome.

Strict guidelines

Making matters even more difficult, investors need to stick to their guns when making offers. Banks have very strict guidelines when they place a foreclosure on the market. And every bank has their own internal set of guidelines. For example, I know some lenders won’t negotiate more than eight percent off their current asking price on a property. And they stick to their guns, that’s for sure…The main reason is that they are trying to unload an inventory of thousands of houses at one time. Other internal guidelines include the length of time a property stays on the market at a given price before a price reduction is made. Also, the percentage amount of that price reduction is another guideline, which is different for each lender.

Staying focused

So trying to purchase a foreclosure when flipping houses is a tricky proposition. It requires discipline, smarts (to crunch your numbers and feel confident you’ve done a good cost analysis of repairs and renovation that are not only needed, but can be reasonably expected to be necessary as well – and include a large amount for an emergency overage slush fund too. The daredevil investors that flip houses tend to be very confident, and know that flipping is not for the weak investor. Ultimately, you need to decide if you have the deep pockets, as well as the correct temperament to invest in foreclosures for the express purpose of house flipping.

photos courtesy of tmgnorthwest.blogspot.com, foreclosuredatabank.com, cbsnews.com, forsalefortcollins.com

Property Renovating: Foundation Slab Repair

Pesky questions to ask when searching for investment property

Got a crumbling or severely cracked foundation wall needing extensive foundation repair? Ever wonder how to tackle an investment property with this problem? Will it be too large a project to tackle because of the concrete slab cost? What will the overall foundation repair cost end up being? How do I estimate the correct costs for any foundation crack repair? And ultimately, is the investment property worth the overall renovation cost when the foundation is in bad shape?

Most investment properties, whether they be house flips or longer-term rental building holdings, will require some amount of fix up work to be done to them when you acquire them…In the end, the decision whether to acquire the property hinges on your ability to finance the renovations along with the overall purchase price. Can the purchase price plus renovation costs (plus carrying costs too) enable you to make a decent return on investment after you purchase the building?

The property inspection report

In figuring out basement repair costs, make sure you have a licensed property inspection company do a thorough inspection of the entire property, and submit their report to you. The report should detail any inherent basement problems, including foundation cracks or even more severe foundation issues. I have acquired a property that needed the entire foundation be dug up and rebuilt. The house had to be jacked up a little bit at a time, one side at a time, in order to gain access to do the repairs. There also was a great amount of excavation work required as well in this undertaking. Was it expensive? You bet! It cost close to twenty thousand dollars to lay in a new foundation. But it was a property I knew I’d be holding for a long time, and the numbers worked out for my model – and the extremely low purchase price I was getting the property for made the deal worthwhile…

Easy fixes vs. large renovations

Sometimes foundation crack repair work can be easy and relatively inexpensive fixes. They may only costs in the hundreds of dollars to re-mortar small, benign cracks. Other times, entire excavations of one side of the building are needed to get at the root problem of the crack, and repair it. If your engineering report shows a problem with a foundation, make sure you obtain several price quotes to effectuate the repair. Or, if you’ve been working with one general contractor for a very long time, and he is already an integral part of your team, then feel free to trust his cost estimates on the repair.

Get to work fast…

Once you close on the property, be sure to start work immediately on fixing the problem. The longer you wait, the longer the problem will get exacerbated, and the bigger the overall repair cost will be to fix it. Make sure these repairs are done in accordance with your local building department code. In addition, make sure to time the repairs to coincide with your other major renovations to the building. This will help ensure the greatest economies of scale for your project, as well as make sure that only one large scale mess is created in one time period, and not spread out over a large period of time.

photos courtesy of foundationrepairdallas.com, douglasfoundationrepair.com, hdfoundationrepair.com, media.merchantcircle.com

Understanding Landlord And Tenant’s Rights

The basics of landlord-tenant law

As a landlord, it’s important to know some basics about landlord tenant law. This is part of common law that spells out the rights for both landlords and their tenants. Modern day interpretations of old English law on the subject include a great deal of basic contract law amongst the rights of either party. In the U.S., a large amount of these rights are included in the Uniform Residential Landlord and Tenant Act. However, states also can have their own set of laws, as long as they don’t go against any included in the federal guidelines. These states tenant rights laws are important to landlords, and you should become familiar with the ones pertaining to your individual state where you own rental property.

Federal guidelines

According to the Uniform Residential Landlord and Tenant Act, the federal guidelines for landlord tenant laws, the landlord is required to deliver possession of the property over to the tenant at the start of a lease. There is also an implied covenant of “quiet enjoyment” that the landlord is also delivering to the tenant. This means that a landlord cannot impede on the tenant’s right to possess the property. Basically, unless it’s an emergency, the landlord must be given access by the tenant – he can’t simply come in unannounced. A landlord must also provide a safe environment for his tenant….one with no health hazards, for example. This is known as the implied warranty of habitability. (You know – like providing clean, running water.)

Landlord duties

Most leases are explicit about the duties of the landlord. If, for example, the landlord does not perform a particular duty, the tenant can legally withhold their rent. Within the landlord tenant act, this is an example of a dependent covenant. And the breach by the landlord of these duties can be used as a defense by a tenant if the landlord attempts to sue for unpaid rent. Besides keeping the property safe and free of health hazards, there is also the covenant to repair. In this instance, the landlord is required to make all repairs to any part of the premises that becomes damaged while the tenant lives there. This assumes the damage was not caused directly or indirectly by the tenant. In addition, when a tenant is moving from the property, in order to get their security deposit returned to them, they must leave the property in the same condition (minus reasonable wear and tear) as when they first moved in.

Tenant requirements

As for the duties of the tenant, chief among them is their paying their rent in a timely manner. But they also have other requirements as well. They have a requirement to maintain the property in a safe manner too. And unless specifically mentioned in the lease, they cannot sublet the property, nor can they leave it vacant for appreciable periods of time without the landlord’s consent.

The eviction process…or not

As a landlord, you also have a number of ways you can reclaim possession or claim unpaid rent for a non-paying tenant who remains in the property. You could use the common law remedy known as forfeiture, which can be achieved if the tenant has left the premises for good. A landlord can also utilize “self-help” remedies. These include forcibly entering the property and removing the tenant. Most self-help remedies are greatly limited by state laws about forcible entry however. On top of this, it’s simply a messy business, and one to be avoided due to risk of physical harm to yourself (and possibly others). And then there’s the good old eviction process. Landlords can recover money damages for unpaid rent. Each state regulates the exact ways and methods of collecting unpaid rent, as well as the amount owed. For example, the eviction process in Florida will be very different than it is in New York. It is because of this that it’s usually best to obtain the services of a local attorney to help in the eviction process of renters.

photos courtesy of mnfamilylawblog.com, news-gazette.com, trashitman.com, nj.com