National Association of Realtors (NAR) Wants Natural Disaster Insurance

I just returned from the mid-year NAR convention in Washington, DC --  Of course we emphasized Section 1031 tax deferred exchanges.  I truly enjoyed the convention and felt it was well worth attending.  At the conference, NAR took a strong position.  NAR senior economist Lawrence Yun said:  "Natural disasters like hurricanes and earthquakes destroy communities, not only with the forces of nature, but also with the altered insurance landscape that results in their wake."   

I lost what I considered to be my retirement, when Hurricane Andrew came into South Florida and swept away 28 of the single family homes I had accumulated over 25 years.  I worked very hard to pay for those homes; managed them and oversaw their repairs when necessary.   I had homeowner's insurance, as well as flood insurance.  I also had 3 months of loss of income coverage on these rentals.   But it took my insurer over 6 months to get to my claims.  They were not prepared to handle the number of claims that were a result of this natural disaster.   I personally lost over $288,000 in payments to the mortgage lenders that were not recoverable.  Additionally, I lost the income stream and the assets which were not fully reimbursed. 

Finally, it became very difficult to obtain new homeowner's insurance, which becomes a necessity when you need to obtain financing on your real estate.  NAR's  Mr. Yun, further pointed out that the hardships produced by not being able to obtain insurance "...can slow redevelopment, depress the local housing market, and prevent residents from buying and owning homes."   As a victim myself, I agree with NAR's urging Congress to "...make natural disaster insurance, affordable and available for homeowner's and reduce the circumstances under which insurance companies cancel natural disaster policies."  I feel for the victims of Katrina and Wilma and as I write this missive, the hurricane season begins again.

SWITCHING IN MID STREAM?

Last week a taxpayer called our office stating that they were already in the middle of a Section 1031 tax deferred exchange.  They had hired a Qualified Intermediary (QI) who had prepared his documents and the QI had received the sales proceeds as required by law.  However, the taxpayer was very unhappy with the services given by this other QI and asked if we (Bayview Financial Exchange Services, LLC) could take over the job.   My simple answer to this issue is that it would not be a good idea to change QI's in midstream.  In fact, one of the written authorities on the subject states:  "Once a taxpayer has transferred his or her property to a Qualified Intermediary, it is questionable whether the intermediary may be replaced and the exchange saved."   Other authorities on the subject agree, because the taxpayer could be charged with "control of the proceeds" by having the power to change QI's in midstream.  It's not that we don't want the business, but we had to tell that taxpayer that we would not be a "replacement" QI, because we believe it would void their exchange.  We, and most other knowledgeable QI's, take the same position on the law.

What About Other Taxes?

After giving the keynote presentation at the Arizona Association of CPA's convention,  I was asked the following question:  We are aware that Section 1031 defers capital gains taxes, but what about depreciation recapture taxes?  I answered as follows:  the beauty of Section 1031 is that the Internal Revenue Code allows you to defer the payment of capital gains taxes on the sale of the taxpayer's investment real estate and on property they have held for productive use in a trade or business.   I know, I still haven't answered the question of what about depreciation recapture taxes, but let me explain again to those viewers of this blog, that on investment property, IRS allows a deduction called "depreciation" against the income taxes to be paid by the taxpayer.   This deduction originally started with a fiction that the investment real estate is "deteriorating" a certain per cent each year.    However, when the real estate is sold, the depreciation tax deduction is "recaptured" and may be taxed at a rate of 25% of the amount  additionally depreciated.   

Before I answer the big question, there is another issue to be addressed and that is what about the individual state taxes?  State taxes are an important issue, because a number of states have an additional "sales tax" on the sale of investment real estate.  O.K. already, what is the good news?  ANSWER:  If the taxpayer does a Section 1031 exchange, all of the federal capital gains tax, federal depreciation recapture tax, and the state "sales tax" are ALL deferred.  More importantly, if planned correctly, these taxes may NEVER be paid.  Is this a great world or what!!!  That's what I think is amazaing about acting as the Qualified Intermediary for 1031 exchanges at Bayview Financial Exchange Services, LLC.  I can make my clients happy, save them from paying taxes and Iet them leverage their investment funds, which results in the purchase of more property and/or more cash flow.  Gosh, don't ya just love my job!!

NOT SAVING ENOUGH

Last week on my way back from the American Escrow Association annual conference, I was given a free copy of USA TODAY at my hotel.  Kathy Chu wrote an article on retirement savings.  She pointed out that a "...growing number of Americans are at risk of a diminished standard of living once they are not working."  In fact, a study produced by the Center for Retirement Research, showed that 43% of all working households in America are in danger of not having income to fund for their retirement. 

The major reasons for these "at risk" households is the growing uncertainty of Social Security payouts and not enough savings by perspective retirees.  The Center's research found "...that nearly half of today's workers, at their current savings rate, will be unable to fund a comfortable retirement.  People will have to work longer or save more..."  A final question:  How much more money should a worker put away for retirement? The Employee Benefit Research Institute reports:  "...most future retirees must put away 5% to 25% more of their pay each year to cover basic needs, as well as health care expenses..."  for retirement.   So our motto should be:  Start Saving Now.

TRUST ME ON THIS ONE

Prior to specializing in Section 1031 tax deferred exchanges, I handled as a real estate attorney, real estate closings and some minor estate and probate legal work.  I recently read an article in MARKET WATCH by Marshall Loeb, and it refreshed my knowledge on some of the techniques of good estate planning.  He re-emphasized a central tenant for successful estate planning, which is to try to give away, tax free, most of your assets while you are alive.  One of the best vehicles to accomplish this goal is called the Grantor Retained Annuity Trust, or GRAT for short.  What do you do?  "First you transfer assets--cash, stocks, bonds and so forth--into an irrevocable trust that will pay you a set amount of money each year for a specified term of years.  At the end of the of the specified term of years, if you're still alive, the trust's remaining assets go to your beneficiaries at a substantially reduced tax rate.  That's because the IRS uses a complicated system to calculate the value of your gift when the trust is first established" emphasized Loeb.  He gives a good example:  "...you put $1 million in a GRAT and receive $40,000 a year for 15 years.  That would leave $400,000 for your children, but the IRS factors in life expectancy and interest rates and ends up with a number that is significantly less.  And during the trust's life time, the money should be earning interest, which compounds, tax free, so your gift ends up being much greater than what you'll pay tax on when the assets are finally transferred."  As I have always recommended, get a good lawyer and CPA to help set these up, as is the case when you need a good Qualified Intermediary, like Bayview Financial Exchange Services, LLC (sorry, I felt like I had to get that promo in) to help you when handling a Section 1031 tax deferred exchange.

WHO DOESN'T HAVE A REAL ESTATE LICENSE?

According to INMAN NEWS   
"There are about 4.3 real estate agents per 1,000 Texans...In 1986, Florida led the nation with 19.5 real estate agents for every 1,000 residents. By 2000, that rate had dropped to 9.4 agents per 1,000 residents. The agent-to-resident ratio is up 30% in California, up 20% in Florida, and up 26% in New York since 2001, and up 5% in Texas since 2000."   

I think it is amazing that one out of every 52 people in California has a real estate license.   But hold your horses, yes all three of these states, Florida, California and Texas, have a lot in common, they all have a lot of horses.  What about those states which don't have a large horse population, can they beat California's almost 2% of the population figure?  Yes they can!!  Again, according to INMAN News "... The record for the greatest saturation of agents per population is Massachusetts, where there were 37.8 agents for every 1,000 residents in 1992."  These figures will probably decline should the real estate market decline in any of those states.  I personally help the numbers in Florida, because I have had a real estate license for close to 30 years.  I don't use it, have never earned a commission, but needed it at the time in order to teach the state's real estate course.  Oh well, I have messed up that state of Florida figure.  I guess it should really be 9.39999 agents per 1000 people in Florida.

PRIVATE ANNUITY TRUSTS---YEA OR NEA

Rachel Emma Silverman wrote an informative article in the June 1, 2006 issue of The Wall Street Journal discussing a number of options that may reduce the taxpayer's tax hit when they sell their investment real estate.  She briefly discussed structured sales, 1031 exchanges and then explained private annuity trusts.  For informational purposes, a structured sale occurs when a taxpayer sells their investment and in return receives a series of payments over a specified time period.  The result is that the taxpayer spreads the capital gains tax over a number of years as they receive the payments.  In a structured sale the taxpayer will receive the payments from a financial services business, who receives a fee for their service. 

As you are aware, a Section 1031 tax deferred exchange, allows the taxpayer/investor to defer all capital gains and depreciation recapture taxes when selling their investment property and purchasing a replacement property of equal or greater value and following the guidelines as set forth in the statute.  As First Vice President of one of the fastest growing Qualified Intermediaries, I know this strategy is the most cost effective and most widely used method to defer paying Uncle Sam. 

The third method, private annuity trusts, allows the taxpayer to sell the asset to a trust.  In exchange, the taxpayer receives annuity payments hopefully over the life of the taxpayer.  Should there be any money left over, these funds go to the heirs tax free.  Sounds great doesn't it?   But of course there are always two sides to a coin.  Atlanta Tax Lawyer Kevin McGrath pointed out in the article: "...Contrary to the claims of promoters, it is a very risky transaction and in any event it will cause you to pay more tax than had you not done the transaction."     As the article pointed out:  "On each annuity payment, you'll owe taxes on both capital gains as well as ordinary income, which is taxed at a higher rate.  And if you out live your life expectancy, all of the annuity payments beyond that point will be taxed at ordinary income rates...also the trust itself has to pay taxes on its earning over the years, depending on how the assets inside it are invested.   Another caveat:  Because these trusts are IRREVOCABLE, once you sell your property, you don't have any direct control over how the proceeds are invested.  Instead, a separate trustee manages the assets.  You also can't simply invade the trust to get more money beyond the annuity payments."  In my mind, there is no question, that probably 90% of the time the right way to proceed is to do a Section 1031 exchange.  You get the income, pay no annual "management fees", get the appreciation and if planned correctly, your estate will pay little or no taxes. 

I will conclude this long blog, with a quote from the last page of that article: "If you get pitched in a private annuity trust, it's smart to have an independent lawyer and tax adviser study...the arrangement...to see if it works for you, depending on your age and income needs."