Managing Real Estate - a question

[Offgrid Organic Farmer]

Guys help

I have gotten into an argument on another forum, and I want to see how you view this topic.

Say I buy Real Estate for $100k, I paid $8k upfront in closing fees and escrow. It is a set of apartments. Over the next 10 years, the rental income pays all expenses including the property taxes, insurance, mortgage P&I, and a monthly principal-only payment to buy down the mortgage. Over a few years, it buys down the mortgage principal to say $10k remaining. During this period I manage the property, but I do not take any profits for myself, as I am watching what I perceive to be the growth in my Net Worth.

Then the property has appreciated up to $150k. So I refinance the property running a new mortgage up to $120k, and the rental income continues to pay all expenses, including the mortgage P&I, and a monthly principal-only payment to buy down this new mortgage.

Now I have $120k that I have borrowed from this property, sitting in my pocket tax-free. And the property is once again re-building its Net Worth.

So when the appreciation reachs $200k, I decide to sell it. I get my $200k asking price, at this time the mortgage was down to $100k, so the buyers pay off my mortgage and I get $100k 'income'.

I am allowed 3 years in which to reinvest this $100k into a 'like-kind' property, or else this $100k will be taxed. [1033 exchange]

So 2 years later I reinvest $100k into a second Real Estate property, effectively moving that $100k out from being taxed.

And I now own a second set of apartments. Its rental income pays all expenses including the mortgage P&I, and a monthly principal-only payment to buy down the mortgage.

Now lets go back a minute, remember the $120k that I got from mortgaging the first property?

It was never taxed. And now that the property is no longer owned by me, it will never be taxed.

Did I overlook something?

I have owned four apartment complexes in the past. I am currently on my next apartment building.

In my way of thinking, I am making out big time with these properties.

But other investment folks are saying that it can not be done like this.

 

[Jerry1]

Did I overlook something?

Yes. You don't seem to understand basis. You will be taxed on the capital gain, not the difference in the loan or equity you have in the property.

That $120 is just a reflection that somewhere in your assumptions, you are not recognizing the income you're receiving on a regular basis. If everything is as you assume, you must be making income (cash flow is exceeding expenses, not just covering expenses). Don't forget depreciation. In other words, your assumptions are too simplistic, you didn't make assumptions for income on the property and paying annual taxes and you did not assume basis or capital gain at the time of the sale.

 

[calmloki]

We've had rental real estate over 30 years and you are correct: you are making out big time with rental real estate. You are wildly incorrect in how a 1031 exchange works.

 

[COcheesehead]

Were you depreciating the property for tax purposes while you owned it?

 

[38Chevy454]

Basic issue is that you were paying some taxes on the excess income from the rents received over the years that was part of that $120K. If you ignore any depreciation, you still had positive cash flow on the properties which you were taxed each year, so the cumulative effect is that you did not get $120K as free money. Any positive cash flow after your allowable deductions was not free money. The monthly principle only payment was not deductible, which was the main source of your $120K.

 

[Offgrid Organic Farmer]

Yes we have used depreciation every year, and we have updated the cost-basis each year.

I failed to explain that part of it.

As for the 1033 'like-kind' exchange, the profits from selling one property need to be rolled into the next property within 3 years [before or after the sale], and the cost-basis of that property must account for that capital going into it.

We have always used CPAs to do our taxes.

 

[ERD50]

"I have gotten into an argument on another forum,"...

Why did you get into an argument? It seems clear that you were wrong, you should have been thanking them for setting you straight.

As Jerry1 said: "You don't seem to understand basis. ".

You should go back to that other forum and apologize.

-ERD50

 

[Souschef]

I did something similar by taking out a HELOC out on the property.When I sold the property, some of the proceeds went to pay off the HELOC.
BUT the profit (or loss) was based on the difference between my cost basis when I bought the property and the sale price.
Here is a simple example:
Purchase price: 100K all cash

Present value: 200K
Loan: 50 K
Sold at 200K
Profit $100 K
Proceeds $150K after loan is paid off.
The money you took out is not tax free, it is deferred until you sold the property.

 

[calmloki]

!031, not 1033.
NOT 3 years:
Measured from when the relinquished property closes, the Exchangor has 45 days to nominate (identify) potential replacement properties and 180 days to acquire the replacement property. The exchange is completed in 180 days, not 45 days plus 180 days.

 

[Offgrid Organic Farmer]

We started doing this in 1985. I think we did use the principal-only payments as deductions, along with the P&I payments but on a different line.

 

[Offgrid Organic Farmer]

We were audited for the years 1997, 1998, and 1999.
But the IRS did not catch the error.
By then we were into our fourth property.

 

[Jerry1]

We have always used CPAs to do our taxes.

You should go discuss this with your CPA. Seriously. You need to better understand this and he/she is the right person to sit down with you and explain this. Given that you own property, this is something that is very much worth your time and effort. You could get the information from the internet, but why. You have a professional that you engage. Go talk to them.

 

[ExFlyBoy5]

We were audited for the years 1997, 1998, and 1999.

I cannot imagine why.

 

[ExFlyBoy5]

You should go discuss this with your CPA. Seriously. You need to better understand this and he/she is the right person to sit down with you and explain this. Given that you own property, this is something that is very much worth your time and effort. You could get the information from the internet, but why. You have a professional that you engage. Go talk to them.

I would also point out that it might be a good idea to find a good tax ATTORNEY that is familiar with these types of arrangements. Not saying a CPA isn't equipped, but an attorney (that is properly qualified/certified) *might* have better insight into IRS/legal implications.

 

[Mr. Tightwad]

There is no 3 years anything involved with a 1033 exchange. Go get tax advice.

 

[Offgrid Organic Farmer]

You should go discuss this with your CPA. Seriously. You need to better understand this and he/she is the right person to sit down with you and explain this. Given that you own property, this is something that is very much worth your time and effort. You could get the information from the internet, but why. You have a professional that you engage. Go talk to them.

Since there were each in different states and one was over-seas, we used different firms.

The apartment building that I have now was purchased with cash. I do not have a mortgage.

 

[Offgrid Organic Farmer]

I cannot imagine why.

We signed a contract in 1997 with a Property Management firm, right before we went over-seas again.

That Property Manager's book-keeper claimed to have had a house fire that destroyed all records for 1997. Since I was stuck over-seas, I did not see any options other than accepting their word for it.

Then for 1998 taxes, they sent us a police report about another structural fire.

And for 1999 taxes, they sent us yet another police report about another structural fire.

So in 2000, my wife contacted the IRS requesting all the data they held, from which we could re-construct our taxes for those years.

In 2001, we returned stateside, we fired the Property Manager, and the IRS contacted us that they wanted to audit those years.

 

[Jerry1]

You should go discuss this with your CPA. Seriously. You need to better understand this and he/she is the right person to sit down with you and explain this. Given that you own property, this is something that is very much worth your time and effort. You could get the information from the internet, but why. You have a professional that you engage. Go talk to them.

Since there were each in different states and one was over-seas, we used different firms.

The apartment building that I have now was purchased with cash. I do not have a mortgage.

Then go find your next CPA. Since you always use a CPA to do your taxes, you should be in the market right about now. This will be a good conversation for you to have with them.

 

[ExFlyBoy5]

We signed a contract in 1997 with a Property Management firm, right before we went over-seas again.

That Property Manager's book-keeper claimed to have had a house fire that destroyed all records for 1997. Since I was stuck over-seas, I did not see any options other than accepting their word for it.

Then for 1998 taxes, they sent us a police report about another structural fire.

And for 1999 taxes, they sent us yet another police report about another structural fire.

So in 2000, my wife contacted the IRS requesting all the data they held, from which we could re-construct our taxes for those years.

In 2001, we returned stateside, we fired the Property Manager, and the IRS contacted us that they wanted to audit those years.

Wow, talk about bad luck. It took you until 2001 to fire them?!?

 

[Offgrid Organic Farmer]

Wow, talk about bad luck. It took you until 2001 to fire them?!?

I was in Kosovo in support of KFOR exchanging fire with Serbian Christian Forces and I was approaching my retirement. I was not capable of managing the property myself.

After I retired, we returned stateside and we moved into one of the apartments. One of the tenants was a couple girls, who had not paid rent for a long time, they had been exchanging 'services' instead of paying rent.

That was nearly 20 years ago. Some details of what happened may be fading from my memory.

 

[ExFlyBoy5]

I was in Kosovo in support of KFOR exchanging fire with Serbian Christian Forces and I was approaching my retirement. I was not capable of managing the property myself.

After I retired, we returned stateside and we moved into one of the apartments. One of the tenants was a couple girls, who had not paid rent for a long time, they had been exchanging 'services' instead of paying rent.

That was nearly 20 years ago. Some details of what happened may be fading from my memory.

Gotcha. I still have a KFOR squadron T-shirt from a deployment that I wear on occasion...it's one of the best t-shirts I have ever owned! Any chance you ever took a C-130 down range from Ramstein during that time (ran shuttles to Camp Novo, Prizen, Pristinia and a couple of other places)? If so, chances are pretty good it was the deployed squadron that did it. Small world, eh?

 

[Offgrid Organic Farmer]

Then go find your next CPA. Since you always use a CPA to do your taxes, you should be in the market right about now. This will be a good conversation for you to have with them.

I skipped eight years without owning any apartments.

In 2016 I bought another property. This time I had a law firm and an accounting firm, both advising me. We formed two LLCs, one LLC owns my farm, and the other LLC owns my apartment building. Everything I am doing now is being done with these guys in tow.

I do not plan to bounce around between states or countries anymore.

In 2016, as we were shopping for a law firm and accounting firm to combine together in our future investments, we were trying to put together an L3C corporation [a 'low-profit limited liability' or for-profit non-profit corporation]. My wife still insists that we had everything together as the laws of this state layout for an L3C corporation. But the lawyers and accountants are not comfortable doing that kind of thing.

We were able to talk them into an LLC that can roughly accomplish the same thing as an L3C.

 

[Jerry1]

I skipped eight years without owning any apartments.

In 2016 I bought another property. This time I had a law firm and an accounting firm, both advising me. We formed two LLCs, one LLC owns my farm, and the other LLC owns my apartment building. Everything I am doing now is being done with these guys in tow.

I do not plan to bounce around between states or countries anymore.

In 2016, as we were shopping for a law firm and accounting firm to combine together in our future investments, we were trying to put together an L3C corporation [a 'low-profit limited liability' or for-profit non-profit corporation]. My wife still insists that we had everything together as the laws of this state layout for an L3C corporation. But the lawyers and accountants are not comfortable doing that kind of thing.

We were able to talk them into an LLC that can roughly accomplish the same thing as an L3C.

So do you have an attorney and or CPA or not? If not, get one. Discuss basis with them.

Personally, as a CPA, it causes me concern when you seem to not want to take their advice (note your comments on the L3C). You might as well do your taxes and your legal work on your own. Not much point in paying someone if you're not going to take their advice. It seems more like you would try to convince them that your scenario in your original post is correct rather than listen and learn from them. Oh well. To each their own.

 

[Offgrid Organic Farmer]

So do you have an attorney and or CPA or not? If not, get one. Discuss basis with them.

Personally, as a CPA, it causes me concern when you seem to not want to take their advice (note your comments on the L3C). You might as well do your taxes and your legal work on your own. Not much point in paying someone if you're not going to take their advice. It seems more like you would try to convince them that your scenario in your original post is correct rather than listen and learn from them. Oh well. To each their own.

I have a local law firm handling our LLC and a local accounting firm doing our taxes.

We really wanted to start an L3C, but they refused. So we figured out a way to operate an LLC as if it were an L3C. I do not see how I am not taking their advice. I did not start an L3C.

 

[Jerry1]

Great. I stand corrected. Please go discuss this scenario with them. Then, unfortunately, you may have to go to the other forum and mia copa. But at least you will be doing it from a better place.