REFORMS IN CONGRESS?

It is reported that finally members of Congress, based upon the numerous ethics scandals of their fellow congressmen, are looking to enact legislation that would prohibit members of Congress and their aides from trading stocks for which they have received non-public information they garnered on Capitol Hill.  The executive branch of our government and their employees are already banned from trading on this "inside information." 

The proposed legislation, being pushed by two Democrats, requires:  (1)  The Securities and Exchange Commission to create rules that would prohibit members of Congress and their aides from trading stocks based on nonpublic insider information; (2) those  (members of Congress and their staff) who do in fact invest in the stock market disclose their "trades" within 30 days of any stock trades; (3) the requirement that those organizations who "specialize" in gathering "political intelligence" about the status of legislation in Congress to register with both the House and the Senate.  It remains to be seen if additional Democrats and of course Republican members of Congress will agree on this proposed legislation--but it would seem to me--that in good faith this type of legislation should be enacted.

THE TAXMAN GIVETH--NOT TAKE AWAY

In order to complete a Section 1031 tax deferred exchange, the taxpayer must within 45 days of the sale of the relinquished property, identify their proposed replacement property (or properties), and must close on the purchase of the replacement property (or properties) within 180 days of the sale of the relinquished propertynbsp; Sounds complicated, but really it's not. The point is that you have 45 days from the sale to select what you might want to purchase and 180 days (almost 1/2 a year) to close on the purchase of your replacement property

BUT--if you were one of the individuals and/or business taxpayers that were in the most severely damaged parishes and counties of Louisiana and Mississippi, you have now been given an automatic extension of those dates (as well as filing your income tax return) until August 2006. WOW!!! For more information you can call the IRS toll-free hotline at 1-866-562-5227 and to obtain a copy of IRS notice 2006-20. Sometimes the taxman giveth --not just take away.

THE CORNELL QUESTION

I just came back from giving a three hour seminar to the combined Cornell University MBA Real Estate Program and the Law School Program.  Of course, the subject was Section 1031 exchanges.  Cornell University has an absolutely beautiful campus.  As you would expect, I received a number of extremely well thought out questions.  One of the more interesting questions related to the differences between a Section 1031 tax deferred exchange and a Section 1033 condemnation deferral. 

Most of my blog readers understand that under a Section 1031 exchange, the taxpayer can exchange their investment property or property used in a trade or business, for another "like kind" investment property or property used in a trade or business, thereby deferring the payment of capital gains taxes, that would be due.  Of course all of the proceeds from the exchange on the relinquished property (the property sold) must be used and the taxpayer must replace it with a property of equal or greater value, as well as use a Qualified Intermediary, like Bayview Financial Exchange Services, LLC, to hold the funds until the replacement property is purchased. 

However, under Section 1033, a tax deferral occurs as a result of a transfer by condemnation or threat or imminence thereof.  Fancy words.  The question addressed to me at the Cornell presentation was: If the taxpayer is selling a piece of property to a governmental authority as a result of a "taking", should they do a Section 1031 or a Section 1033?   The major difference is that under Section 1033 the taxpayer has at least 2 years to close on the replacement property, does not need the services of a Qualified Intermediary and can hold and use the funds until they purchase the replacement property.  But under Section 1033, there is a more restrictive provision - the taxpayer must purchase property that is "similar or related in use."  That means an apartment building for an apartment building.  Under Section 1031, any type of real estate qualifies for "like kind", so you could exchange an apartment building for a piece of raw acreage.  However, under Section 1031, the identification period and closing date are shorter, 45 days for identification and 180 days to close on the replacement property.  Great question, having major, but finite distinctions.

THE INNOCENT SPOUSE

Seasoned readers of this blog are aware that under Section 1031 of the Internal Revenue Code, an investor can defer paying taxes on the profits of the sale of their investment real estate by using all of the funds to purchase a replacement property.  The taxpayer should use an independent Qualified Intermediary to hold the funds until the replacement property is purchased.  The IRS has been very tough on those taxpayers that do not strictly adhere to the above rules.  Now, the IRS is making it even tougher on spouses to claim “innocence” in a case of tax fraud. 

Author Tom Herman, in his article dated March 13, 2006, in The Wall Street Journal points out:  “Most married couples file jointly, a strategy that typically saves taxes.  But as thousands of taxpayer have discovered in recent years, signing a joint return can turn into a long-running nightmare when a spouse has neglected to report taxable income or committed some other offense.  In an “innocent spouse” defense, one spouse argues that he or she didn’t know, and didn’t have any reason to now, about any wrongdoing—and shouldn’t be responsible for paying the taxes due.”  He further points out: “The IRS’s get-tough attitude is part of the agency’s renewed emphasis on tax-law enforcement, which comes amid growing congressional concern about big budget deficits and unpaid taxes.  Officials repeatedly emphasize their determination to eliminate what they consider to be abusive tax shelters, or transactions with no real purpose other than dodging taxes.  The IRS also has increased the number of audits, especially of people with incomes of $100,000 or more.” 

When I give speeches and seminars around the country, I continue to emphasize the importance of having a knowledgeable, safe, secure and completely INDEPENDENT Qualified Intermediary on the 1031 tax deferred exchange---so follow the rules in order  to avoid any IRS problems in the future.

CREDIT BUREAUS ARE NOW MAN’S BEST FRIEND?

Most consumers believe that the three largest credit bureaus are “…vaguely threatening…and about as friendly as the IRS or a debt-collection agent” according to an article written by Christopher Conkey in The Wall Street Journal.  However, change is on the way.  The three firms, Equifax, Experian and TransUnion are now “…going out of their way to interact with consumers they once shunned, pitching them an ever expanding array of credit-related products.” 

Most of our 1031 exchange taxpayers are required by their lenders to have a credit report supplied as part of the lending approval process.  Now these three bureaus, for a price, are offering additional services to the consumer.  For example:  the consumer’s credit report and score, that will also analyze the consumers debt-to-income ratio and will break down various different loan terms; another report will tell a used car purchaser the history of the automobile and even offer title insurance on the car should one be concerned about fraud.  Another program will give you a credit search from all three of the bureaus and additionally, will alert you if a change should occur on your record.  The bureau's goal is to have the consumer use these services when they are about to secure a new loan or purchase expensive goods on credit.  The bureaus make more fees and the consumer can obtain important information prior to their going through the loan or purchase process.  Well maybe they’re not man’s best friend, but certainly this opportunity to obtain important information makes an investor's life a lot easier.

I'LL TRADE YOU A QUARTERBACK FOR A DEFENSIVE BACK

Well, it's that time again.  Pro sports franchises are trading players left and right.  In Miami, our NFL pro football team is in search of a quarterback.  You do realize that the Miami Dolphins should be doing a Section 1031 exchange don't you??  Ah, you don't understand what I mean?  If you have been reading my blog, then you are aware that under I.R.C. Section 1031, a taxpayer can exchange (sell) an investment property or property used in a trade or business, for another "like kind" investment property or property used in a trade or business, and defer paying any tax on the profit.  Of course they should use an independent Qualified Intermediary to handle the paperwork and monies being transferred, as the taxpayer and its agents should not hold the money. 

So what does that have to do with the Miami Dolphins or any other sports franchise?  Most 1031 exchanges involve real estate exchanges. Personal property exchanges are also allowed, but the standard of what is "like kind" is narrower on personal property exchanges.  Yes, you can exchange an automobile for an automobile.  Likewise, you can also exchange (trade) a major league sports contract for another major league sports contract.  Hmm--I certainly hope these sports franchises are aware of this wonderful tax deferral technique.

KALAMAZOO PROMISE

Imagine the following scenario:  One of our clients at Bayview Financial Exchange Services, LLC (BFES), sells a piece of property in California.  The proceeds come to BFES, serving as the Qualified Intermediary, as the taxpayer intends upon using the proceeds as part of a section 1031 tax deferred exchange.  The taxpayer then purchases 3 homes in Kalamazoo, Michigan as their replacement property, deferring the payment of any tax on their gain. 

Now imagine one of our Exchange Coordinators asking our client why they were purchasing all of their replacement properties in that area of the country.  There are a number of reasons why taxpayers transact Section 1031 tax deferred exchanges, using BFES as their Qualified Intermediary, but in this case two reasons pop-up immediately:  Multiplication and Diversification.  By selling one property and purchasing more than 1 replacement property, the taxpayer is multiplying it's chances of appreciation.  Diversification on the other hand, implies that you are purchasing more than one replacement property in different areas of the country or different types of real estate; for example a piece of raw acreage and an apartment building.  However, neither multiplication nor diversification, was the reasoning behind the replacement property purchases on the example above. 

The client was astutely thinking of another reason, improvements to the community.  As The Wall Street Journal wrote in their March 10, 2006 issue, Page A-1, titled "Civics Lesson"   by author Neal E. Boudette, "...In the past, blighted cities across the nation signed onto various types of urban-renewal plans.  Mainly, they focused on physical improvements--including new public spaces, office parks and other civic amenities--in hopes of spurring economic and social progress".  Starting this June, Kalamazoo is proceeding with a different approach, they are providing free, yes I said FREE, college tuition for any student..."who enters the Kalamazoo school system by the ninth grade--regardless of income or need."  What do you think the "Kalamazoo Promise" as it is now called will do to the value of homes in the Kalamazoo school district?  I think home values will proceed in an upward trend and so does Greg DeHaan, of Allen Edwin Homes, whose company never developed, according to The WSJ, in the "downtrodden industrial city of Kalamazoo", but now has purchased three separate Kalamazoo parcels for more than $7 million.  The WSJ article further adds, "Out of state investors began scouring the area for opportunities, too."  Hmm...if one was looking for a good area to have residential investment, with tenants that would want to stay in the area, it would seem this might be one area to look at.

CAN'T USE THAT EXCUSE ANYMORE

About a year and half ago, the President of Bayview Financial® asked me to take a very difficult exam called the Certified Exchange Specialist examination. I was very concerned about taking the exam because I was told that less than 10% pass the exam.  At that same time, I was 59 years old and I expressed to him that my brain cells were not the same as those of a much younger person.    Fortunately, I took the exam and was in the 10% passing group. 

Now comes the story that appeared on page B1 of the March 3, 2006 edition of The Wall Street Journal, titled: "Old Brains Don't Work That Badly  After All, Especially Trained Ones."  The article written by Sharon Begley said:  " Maybe I'm guilty of wishful thinking, but more and more research seems to be pointing to a rare bit of good news about aging:  Old brains have gotten a bum rap.  Yes, some of the downbeat findings have stood the test of time.  Older brains do process information more slowly, probably starting in middle age.  As a result, they take a bit longer to make decisions or judgments, and to assimilate complex information...But as scientists reassess old results, even findings that have achieved iconic status are being questioned.  For one thing, neurons don't abandon ship.  'It used to be thought that normal cognitive decline occurred because of loss of neurons throughout the brain.' says Marilyn Albert of John Hopkins School of Medicine.  But new techniques show that most regions hold on to their neurons (and even 70-year-olds produce new neurons), with little to no loss in the hippo campus, where memories form, or the frontal cortex, site of such executive functions as planning and judgment." 

Enough of the medical jargon, the conclusion of the article is that brains age, but their ability to remake themselves and respond to training is undeniable.  Therefore, I guess I can't use the excuse that I don't have as many brain cells as you do anymore, so please forgive me.

TITLE INSURANCE AND THEIR SUBSIDIARIES IN TROUBLE?

The Wall Street Journal confirmed that "...New York state authorities are in the late stages of an investigation of whether some of the nation's biggest title-insurance companies illegally paid secret rebates to some favored customers and referral fees to their agents, according to people briefed on the probe....Title insurance is a product that millions of American homeowners need to get a mortgage.  Banks generally won't give a first mortgage without assurance that a property doesn't have hidden owners, liens or other encumbrances.  Title insurers sift through title records and charge borrowers anywhere from a few hundred dollars to hundreds of thousands for such assurances." 

Elliot Spitzer, the New York Attorney General and the New York State Insurance Department are examining the following companies:  First American, Fidelity National Title Group, LandAmerica Financial Group and Stewart Title.  According to the article, First American has already agreed separately to refund more than $20 million as part of an investigation in the State of Colorado, but did not admit any wrong doing. 

Personally, I hope no wrong doing is found, because I have worked with a number of these companies and have found them to be of high ethical character.

RECORD LEVEL OF UNSOLD HOMES

The U.S. Commerce Dept. reported this week that sales on new single family homes has dropped by 5% in the past month.  This is the slowest rate of sales on newly constructed homes in more than a year, leaving a record high of over 528,000 newly built homes unsold. 

As my blog readers are aware, I handle 1031's as a Qualified Intermediary.  But in my previous life, I was a real estate attorney, having closed over 7,000 transactions.  I would receive a contract to review and 3 to 12 months later the real estate closing would occur.  In other words, I would have a good idea of the number of closings I would have in any future month, well in advance of the closings actually happening. 

I have called a number of my fellow brethren and they confirm that the number of new files they are receiving has slowed down.  That would indicate that the numbers mentioned by the U.S. Commerce Dept. will continue to decline.  Of course these are numbers on brand new homes to be constructed.  But when the numbers of new files for real estate attorneys also show a decline, reflecting new home and existing home sales, then you know there is going to be a slowdown in the residential marketplace. 

One more item that an investor may want to look at is the number of days a listing has been on the market before it is sold.  A couple of months ago the Miami Herald reported about 15 to 40 days was the average listing to date of sale period.  This past weekend, the examples went as high as 149 days on the market before the properties were sold----Generally, I have found the result that the longer a piece of property is on the market, the lower the final sales price.  What was that statement by grandfather used to say to me?  I remember:  "Only the future will tell".