pull cord sooner rather than later?

[boont]

"Let's say the owner stays in the home for three years. Can the owner then sell the property and take $250k (assuming single not married) tax free?"

That is correct. If you meet the requirements that I outlined you would qualify for the $250/$500 exemption.

The total of 5 years rule is a fairly recent change because the IRS saw people abusing the 1031. They would do an exchange, rent it for a year, move into it and sell it.

They changed it so one has to own the property a total of five years to do a conversion that would exempt it from taxes.

b.

 

[Martha]

Martha:

From your point of view what is the upside of a LLC over a TIC deal ?

Is it knowing the management and the other players ? Or is the structure of the LLC itself ?

If it was structured as a TIC, I would not want to be an owner in my individual name because all owners are personally liable for any debts of the entity. With an LLC the most I have at risk as a passive investor is my investment. I think the LLC structure just works better for real estate investments. But some people like TICs because they can do a 1031 into the TIC. I don't like the risks. I also don't like most of the TIC agreements I have read that gives absolute power to management.

 

[Martha]

If I understand this correctly, someone could sell a rental propty and do a 1031 into, let's say, a single family home as long as that home was going to be used as a rental and not the residence of the new owner.  Two years after the exchange, the owner could experience a "change of heart", remove the tenants and move into the home.  Let's say the owner stays in the home for three years.  Can the owner then sell the property and take $250k (assuming single not married) tax free?

As a practical matter, this would be a pain to do.  But it's an interesting way to extract equity from rental propty tax free.  I wonder how this would stand up in an audit.

However, to the extent you took depreciation on that property and the previous property you will have to pay tax on the section 1250 gain (the depreciation), usually at the 25% rate. This is true even if you later convert the property to your homestead.

 

[Martha]

Keep in mind it's been hard to go wrong in real estate in the last 10 years.  It will be much harder the next 10 years.  I have done really well but wouldn't project results from the past 10 years out to the next 10.  Now, I assume that appreciation will follow inflation and buy only for the cash flow.

Absolutely. However, I think that there will not be a soft landing for this bubble. Maybe in a year or two there might be some excellent deals out there. Our real estate investor friend and I both think that in about a year the foreclosures will really hit and there may be some great deals at that time.

Sorry for the third post in a row.

 

[justin]

If it was structured as a TIC, I would not want to be an owner in my individual name because all owners are personally liable for any debts of the entity. With an LLC the most I have at risk as a passive investor is my investment. I think the LLC structure just works better for real estate investments.

In your dealings, does the LLC typically obtain nonrecourse financing? Or do you, as a member or shareholder, have to personally guarantee part or all of the debt? If the former, what kind of LTV's are you usually able to get nonrecourse financing for? -thanks

 

[dumpster56]

I've taken a closer look at the balance sheet and budget needs for ER and wanted to run it by the group. I've received a lot of good info and advice since first posting in Dec 05 and wanted to get feedback on most recent financial situation. This is sort of an updated "Hello I am..." post.

Hey calif

Interesting numbers.

My gut feeling is yes go for it.

66,000 pre tax, I am gonna do it on 40,000 here in North Carolina.

We sold the house, bought a great new one with a small 50K mortgage at 6% fixed.

I am going to finish my contract thru jan 07 then my pension kicks in.

I have had so many teaching offers here in NC that I will probably take a sub job in feb and decide if i would like a full time gig for the following school year.

The sub job will bring in about another 12K a year which would bring my funds up to 50+ a year.

Seems doable since my medical bennies are covered.

I figure the 5 months of work at my 80K salary will be enough to pay off a big chunk of my new mortgage.

 

[Nords]

However, to the extent you took depreciation on that property and the previous property you will have to pay tax on the section 1250 gain (the depreciation), usually at the 25% rate.  This is true even if you later convert the property to your homestead.

Ah, you're reading my mind, Martha. Great point.

As for those excellent deals in a year or two... they'll be even better in three years or four.

 

[Martha]

In your dealings, does the LLC typically obtain nonrecourse financing?  Or do you, as a member or shareholder, have to personally guarantee part or all of the debt?  If the former, what kind of LTV's are you usually able to get nonrecourse financing for?  -thanks

The loans were technically recourse loans, but the LLCs are single purpose entities so the only real recourse is against the assets of the LLC, which are mortgaged to the lender anyway.  "Non-recourse" technically means that the borrower itself has no personal liability. No personal guaranties are required for these kind of projects.  Even if guaranties were required, it would be from the managing member only and it would be highly atypical to require guaranties from passive investors.  I do a fair amount of securitized financing in my work and I never see personal guaranties from passive investors.  

Loan to value?  I am not remembering.  I think in the 75 to 80% range.

TICs usually don't have non-recouse loans either as often owners do a 1031 exchange to get into the TIC and I believe the loan has to be recourse to make the exchange work.  

Most non-recourse loans I have seen have been to limited partnerships, for tax reasons.

 

[cute fuzzy bunny]

He is the best negotiator I have ever know. He makes CFB look like a CFB.

I *am* a CFB!

I am however going to have to take umbrage at the suggestion that someone is a better negotiator than I am...whats it going to take to change your mind?

 

[justin]

The loans were technically recourse loans, but the LLCs are single purpose entities so the only real recourse is against the assets of the LLC, which are mortgaged to the lender anyway. "Non-recourse" technically means that the borrower itself has no personal liability. No personal guaranties are required for these kind of projects. Even if guaranties were required, it would be from the managing member only and it would be highly atypical to require guaranties from passive investors. I do a fair amount of securitized financing in my work and I never see personal guaranties from passive investors.

Loan to value? I am not remembering. I think in the 75 to 80% range.

TICs usually don't have non-recouse loans either as often owners do a 1031 exchange to get into the TIC and I believe the loan has to be recourse to make the exchange work.

Most non-recourse loans I have seen have been to limited partnerships, for tax reasons.

Thanks for the response.

I was considering a real estate investment locally that would have required me as a passive investor/partner in the partnership (not sure if LP or GP) to personally guarantee part or all (not sure) of the debt up to a certain amount ($750,000). The personal guarantee plus lack of disclosure of just about everything put the dampers on that deal! Of course it was a smallish deal involving purchase of a ~$2-3 million office building. Maybe the LLC's you were talking about were a little larger?

I had assumed recourse financing was more typical for these types of deals. Wonder if it varies regionally?

 

[Martha]

Thanks for the response.

I was considering a real estate investment locally that would have required me as a passive investor/partner in the partnership (not sure if LP or GP) to personally guarantee part or all (not sure) of the debt up to a certain amount ($750,000).  The personal guarantee plus lack of disclosure of just about everything put the dampers on that deal!  Of course it was a smallish deal involving purchase of a ~$2-3 million office building.  Maybe the LLC's you were talking about were a little larger? 

I had assumed recourse financing was more typical for these types of deals.  Wonder if it varies regionally?

Stay away from GPs.  They are not for passive investors. And limited partners in a LP should not be signing guaranties. 

A two to three million dollar deal is a different situation.  The loan generally will not be sold to institutional investors, but often participated out to banks who have to make bank examiners happy.  Lenders almost always require personal guaranties from the controlling owners. Sometimes they will limit the guaranties to the percentage of ownership in the deal.  I work on these small deals as well and they are very different from loans sold on the secondary market. The LLCs I am involved in have loans of 20 million plus. 

Structures for these small deals are all over the board.  If it is a general partnership no guaranty is required because partners are always liable for the debts of the partnership.  Limited partnerships are becoming rare. Most people are structuring these entities as LLCs or LLPs now because you have so much flexibility in the structure and for tax planning.  For small deals it is not unusual to have every member of an LLC guaranty the debt.  But there usually isn't many owners and you don't often have the situation where you have 50 2% owners. 

I don't think there are a lot of regional differences. I work on securitized loans all over the US. (Except your possibly regional difference of how you use the word "non-recourse" to mean no personal guaranties rather than to mean no personal liability by the borrower").

 

[justin]

The deal may have been structured as an LLP, not sure. They had good corp. counsel, so I would assume that is how it was done. The problem I kept running up against was the complete lack of disclosure. No offering letters disclosing basic terms of the deal. No draft of the partnership agreement. No budget. No projected financial statements. Nothing. This was one of those "don't touch it with a ten foot pole" deals for me. Who knows what I was paying for? Plus, the company I work for is the primary tenant. If the company goes under and doesn't pay rent, then all partners would share in paying the mortgage note based on % ownership in the owning entity. Too much risk for the potential of a 10% return per annum with extremely limited liquidity and zero control with a single person having in excess of 50% control. And no expected distributions (any surplus earnings would pay down the mortgage), and no exit strategy. This one screamed DANGER to me!

 

[Martha]

The deal may have been structured as an LLP, not sure.  They had good corp. counsel, so I would assume that is how it was done.  The problem I kept running up against was the complete lack of disclosure.  No offering letters disclosing basic terms of the deal.  No draft of the partnership agreement.  No budget.  No projected financial statements.  Nothing.  This was one of those "don't touch it with a ten foot pole" deals for me.  Who knows what I was paying for?  Plus, the company I work for is the primary tenant.  If the company goes under and doesn't pay rent,  then all partners would share in paying the mortgage note based on % ownership in the owning entity.  Too much risk for the potential of a 10% return per annum with extremely limited liquidity and zero control with a single person having in excess of 50% control.  And no expected distributions (any surplus earnings would pay down the mortgage), and no exit strategy.  This one screamed DANGER to me!

Screams danger to me too. 

I only invest after careful review of a private placement memorandum that includes all applicable agreements, budgets, etc.

 

[Martha]

I *am* a CFB!

I am however going to have to take umbrage at the suggestion that someone is a better negotiator than I am...whats it going to take to change your mind?

I first need to think about what I want, then have each of you try to get it for me.

 

[cute fuzzy bunny]

You're going to have to do a little something for me first, just to let me know you're serious about this relationship and not just trying to use me to leverage someone else. I think that if we're both serious about this, having a little bit invested in the other might help us build the foundation of a better long term situation far beyond just this one deal.

 

[justin]

Screams danger to me too.

I only invest after careful review of a private placement memorandum that includes all applicable agreements, budgets, etc.

Any kind of investment of this nature that I've heard of where there is 10-20 partners would have some kind of a "private placement memorandum" or memorandum of understanding that summarizes the key terms of the deal. It was noticeably absent in this case, as was all kinds of disclosure except "we'll work it out once we get all the money in". This particular "investment" deal was offered to all employees of the company, and probably 10 took them up on the offer for $5000+ each. I told all my buddies at work I wouldn't touch it. Good thing they took my advice!

 

[Martha]

Hum. Also sounds like a potential securities issue.

 

[justin]

Hum. Also sounds like a potential securities issue.

I wondered about that, too. The offer was only made to those employed here (25 people or so). Out of all of those, the only accredited investor (I would guess) is the principal partner making the offer. It was phrased more as an invitation to form a partnership to acquire the office building.

 

[califdreamer]

Hey calif

Interesting numbers.

My gut feeling is yes go for it.

66,000 pre tax, I am gonna do it on 40,000 here in North Carolina.

We sold the house, bought a great new one with a small 50K mortgage at 6% fixed.

I am going to finish my contract thru jan 07 then my pension kicks in.

I have had so many teaching offers here in NC that I will probably take a sub job in feb and decide if i would like a full time gig for the following school year.

The sub job will bring in about another 12K a year which would bring my funds up to 50+ a year.

Seems doable since my medical bennies are covered.

I figure the 5 months of work at my 80K salary will be enough to pay off a big chunk of my new mortgage.

Thanks newguy,

You've got a great stable situation with, if I remember correctly, a COLA'd pension and health bennies.  Plus you relocated from an area you were getting tired of.  Pluses all around.

I think I may need to develop a bit more in a stock/bond portfolio to balance the dependency on real estate or just get to a point where I generate so much real estate cash flow I don't need to worry about its volatility. And I'm still skittish about leaving San Diego.   Feel like I'm sorta close but not quite there.  Driving me crazy...