THE NEW YORK TIMES REPORTS THAT IRS IS INCREASING ITS WATCH ON THE WEALTHY

If you have ever been audited by IRS, you are not going to be happy with the information given in the November 26, 2006, edition of the NY TIMES.  The Internal Revenue Service reports a sharp increase in the number of tax audits for the fiscal year that ended September 30 and warned high earners that they will continue to face scrutiny in the coming year.  It was pointed out that “almost one out of every 16 taxpayers who earned $1 million or more faced audits last year.  This is a 33 percent increase over the previous year.”   More importantly, IRS also “audited last year 257,000 taxpayers with incomes over $100,000; that is an increase of 18 percent” and "... the most in more than a decade." 

Last year alone, nearly 1.3 million individual returns were audited.   Mark W. Everson, The I.R.S. Commissioner, said the agency would continue to investigate high-income taxpayers to maintain "faith" in the system.  "If you earn more than $100,000 or you're a millionaire," he said, "you're a lot more likely to be audited these days than just a few years ago."

MONEY MAGAZINE SAYS

Just received my December 2006 issue of Money Magazine and read with interest the article written by Stephen Gandel.  He says, "Real estate in 2006 turned a corner---and not a good one."  He quotes the National Association of Realtors saying prices have dropped by 2.2% in the past year. 

I will disagree with those figures, because NAR is always trying to prop up their industry.  In yesterday's Miami Herald (I live in Miami so I subscribe to the Miami Herald) the real estate editor pointed out that sales were down this past year over 30% in South Florida, and the year is not even over. 

Gandel quotes the economists at NAR, who have said, "...home prices will start rising again in 2007, though just by 1.5%."  But Money Magazine's Gandel counters, "Don't believe it.  Housing prices are going to fall longer and harder than most experts thought just a few months ago.  First of all, the boom lured more investors into real estate than anyone thought.  Most economists believed speculators made up 15% of buyers.  But recently, even in places not associated with the bubble, such as Idaho and Vermont, nearly a quarter of sales were for second homes or investments.  In parts in Florida, half of all 2006 housing deals were made by investors.  Such buyers don't have to move when they sell, so they're quick to cash out.  The result has been a surprising jump in the number of properties on the market.  A million more homes are for sale than there were a year ago." 

I think Gandel's most important observation is:  "No matter where you are, don't expect the market to be nearly as sweet as it had been."  So what advice does Money Magazine give to Buyers and Sellers? 

Their advice for Buyers is:

(1)  Remember it's a buyer's market--so drive a hard bargain---"Once you've found the house you want, start the bidding at least 15% below the asking price";

(2) Buy from a Builder because most homeowners can wait out the real estate bust, but builders can't afford to--that's the reason they are giving lower prices or offering many financial incentives such as upgrades, etc;

(3) If you’re not sure you are getting the best deal, go get a second opinion by hiring your own appraiser. 

Their advice for Sellers is: 

(1) Make your house stand out from your competition--"The reason so many people are stuck with a house they can't sell is that they haven't priced it right."  They quote Lars Fahlberg of Prudential California Realty who said, "These days upgrades will get your house sold, but they won't get you any more money";

(2)  Get a stager--"Stagers will tell you how to make you home more attractive, and some will do the redecorating, even renting furniture";

(3)  "Rent to Sell--If you can't sell, consider renting...renting can be a good way to snag a buyer."

CORNELL STUDENT ASKS: WHO CANNOT ACT AS A QUALIFIED INTERMEDIARY?

The IRS Regulations refer to these types of parties as "disqualified persons."  Well then, who is a "disqualified person?" Disqualified people include:

-The taxpayer's agent at the time of the transaction
-Family members, including ancestors, descendants, and siblings--but interesting  enough-- not in-laws or cousins
-Corporations in which the taxpayer owns more than 10% of the stock of the corporation
-Trusts in which the taxpayer is both the fiduciary and beneficiary or fiduciary and grantor
-Partnerships in which the taxpayer owns more than 10% of the partnership, etc. 

I know you are asking yourself, “OK, what is an agent?”  The Regs define an agent for disqualification purposes as anyone who may have acted as the taxpayer's employee, attorney, accountant, investment banker, broker or real estate agent within the two year period of the sale of the relinquished property. 

ANOTHER QUESTION FROM THE CORNELL STUDENTS--DURING THE 45 IDENTIFICATION PERIOD, CAN THE TAXPAYER REVOKE THEIR IDENTIFICATION?

The Taxpayer can at any time during the 45 day identification period revoke or substitute properties that were previously identified.  According the Regs, see Section 1.1031(k)--1(c)(6) and (7), the taxpayer should revoke, in writing and in the same manner, the original properties that were identified.   So if the identification was in writing to a Qualified Intermediary, then the revocation should also be in writing to that same Qualified Intermediary.  A second part to that question was “Can the revocation for identification purposes be given orally?”  The answer to that is an unequivocal “NO.”

QUESTIONS FROM CORNELL UNIVERSITY

I was asked a number of very interesting questions at the end of my lecture at Cornell University.  The next 3 blogs will try to cover some of those questions. 

“What is incidental property, and must you identify it when doing a 1031 transaction?” 

The technical answer is that property whose use is merely incidental to the operation of a more valuable item of property is disregarded for identification purposes.  According to the Regulations, Section 1.1031(k)-1(c0(50(i), incidental property is property that is transferred, together with a larger item of property, and has a fair market value that does not exceed 15 percent of the value of the larger property to which it relates.   

What does this goble-dee-gook definition really mean?  Let me give you an example.  The taxpayer is selling a motel for $1,000,000.  Included in that sale is personal property consisting of 50 beds, 25 tables, 100 chairs, and 100 lamps, with a total value of $78,000.  15% of $1,000,000 is $150,000.   Obviously, the value of the personal property ($78,000) is less than 15% of the sales price and would not have to be separately identified.   This "incidental" rule is only important for figuring out whether proper identification was made pursuant to Section 1031. 

This type of transaction would be a multiple property exchange, because the taxpayer is exchanging real estate (value of $922,000) and also exchanging personal property (value of $78,000). This would require the taxpayer to find replacement real estate property totaling at least $922,000 and replacement personal property totaling at least $78,000.  This was a technical question which, unfortunately for you the reader, required a technical answer.

HOW DOES ONE VALUE A PIECE OF REAL ESTATE IN A DECLINING MARKET?

Ken Harney in his Washington Report recently asked the following question:  "How do you value a specific piece of property when local home sales are down 20 percent to 40 percent from last year, inventories of unsold homes have ballooned by 200 percent or more, and all the trend lines are pointing negative?"

I am friends with the former president of the State of Florida Appraiser's Association.   He pointed out that, in the past, one of the major tests appraisers used to determine property value was to use recent sales of similar properties as a comparable.  Unfortunately, that doesn't work anymore. As Ken pointed out, it won’t "...work well in markets where recent closed sales prices often were flattened by incentives provided by sellers to buyers--contributions to closing costs.” For example, "buydowns" of mortgage interest rates and other sweeteners are not always on the public record.  So what is an appraiser to do?  Some are having to look at additional data, such as:

1. What is the market supply and demand?
2. How long have similar properties been on the market?
3. Are there any price reductions on those properties that are presently listed with Realtors?
4 Are there a lot of foreclosures in the area or on similar types of properties?
5. Did anyone give the new owner a concession when they purchased the property?
6. Check with Realtors on recent sales activity.

Not all of the above factors can be easily determined.  For example, some realty agents are playing a game with the public by re-listing the property after it has been on the market for a long time.  "Since multiple listing system data reveals how long each property has been on the market, agents with unsold houses now sometimes cancel the listing---take the property off the market for a short period of time---and then list it again with a different price..." with a new Multiple Listing Code.  This results in the general public thinking that the property was just put up for sale, when in fact that was not the case.

HOW DOES ONE IDENTIFY A PROPERTY FOR A 1031 EXCHANGE THAT HAS NOT BEEN BUILT YET?

The regulations, specifically Section 1.1031 (k)-1(e)(2), state that the taxpayer should give the legal description on the underlying land and, in addition, should give as much detail about the specific improvements that they can.  Do they have the plans?  Well then, attach the plans to the identification statement--give as many of the particulars as you can about the improvements.  You could give the size of the building, how many stories will it be, what type of construction is going to be used and what is the building going to be used for (i.e. motel, office building, warehouse, residential, etc).  The taxpayer should try to be as specific as possible.

CITIGROUP'S KARWCHECK TALKS ABOUT LEADERSHIP AT WHARTON

Wharton has a wonderful information site, which is: knowledge@Wharton.com.  I recommend that site to every investor/manager/owner.  One of the guest lecturers at Wharton this past year was Sallie L. Krawcheck, who is the chief financial officer for strategy for Citigroup.  She spoke on Leadership and was quoted at the above site saying that in order to be a good leader   "...you have to have a really thick skin, and in order to be successful you have to learn to take rejection....there is no substitute for hard work, none...additionally you have to accept that people are occasionally going to be mad at you, and that you may have to zig when everyone else is zagging."   

She pointed out that "...leadership can be very lonely.  Leadership is sometimes consensus-building, but leadership is very often making decisions and leading a group to a place where they may or may not want to go....Leadership can be a very uncomfortable experience." 

When asked what the essentials were to being a good leader, she answered,  "...Learn to work alone; ...Be comfortable being uncomfortable; ...Accept that you are not perfect---you have the opportunity to be wrong a lot...Making mistakes is part of it.  You use all parts of your brain, you get negotiating skills, and you are constantly learning from the clients as well....Develop a healthy ego."   But remember that "...Being a leader is not necessarily (about) shining a spotlight on yourself but going into the spotlight when it's important to get your message across.  Maintain the ability to look forward."  Krawcheck's last piece of advice is "Lose the arrogance--Some of the most successful people I know are smart.  They work hard, they have great insights, and they know it.  That really turns people off."

USA TODAY ASKS: WHERE WILL WE LIVE IN THE FUTURE?

Interesting question.  Last month the United States reached 300 million people and it is predicted that by 2040, just 36 years from now, we will add another 100 million.  Today most Americans live "within 50 miles of the Atlantic, Pacific, Gulf and Great Lake coasts"--which is on about 20% of our country's land area.  But as "people can't live on land alone, especially if they want water in the desert, plentiful fuel to power long commutes, energy to cool and heat bigger houses and clear air and water...how and where they live could determine how well the nation--and the environment will handle the added population....Each American today occupies almost 20% more developed land (housing, schools, stores, roads) than 20 years ago." 

So where will Americans be 30 to 40 years from now, and what are some of the best ways to be economical and environmentally conscious?  According to USA TODAY, the nation can absorb the next 100 million people by using: 

Brownfields--"Industrial sites along river banks, abandoned warehouses near train depots and gas stations on street corners are becoming prized properties"

Infill--"Every abandoned strip mall, boarded-up row house, or underused parking lot is a potential house or condo or apartment'

Going Vertical--"Building up instead of out can accommodate more people on less land"

Rail lines and transit villages--"Cities that had let public transit wither are revitalizing it and encouraging development around transit stops"

Ready-made cities--"Detroit, Washington and St. Louis supported hundred of thousands more residents in 1950 than they do today.  Dozens of cities across the country are well past their heyday but still have all their streets, roads, power lines and water supplies in place.  If only people would return."

IS A DEFERRED EXCHANGE THE SAME AS A STARKER EXCHANGE?

First and foremost there is no such thing as a Starker Exchange. The correct terminology is “Tax Deferred Exchange.”  There were a number of cases, by a family with the last name of Starker that were filed in the Federal Court system.  The Starker family won 2 cases in the Tax Court, but also lost 4 cases.  As a result of this litigation, the IRS promulgated, in 1991, new Regulations relating to Section 1031 exchanges.  These 1991 Regulations started the revolution in the 1031 exchange industry, because they set up rules allowing "deferred" exchanges (also called "delayed" exchanges). 

A number of the authorities on Section 1031 define a deferred exchange as "...an exchange in which, under a written agreement, the taxpayer transfers property held for productive use in a trade or business or for investment and subsequently receives property to be held either for productive use in a trade or business or for investment." 

I guess the important part of the above definition is that the taxpayer can transfer their "relinquished" property and then receive the replacement property at a later date.  You can go to our website (www.bayview1031.com) for a more thorough definition of the process.