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Real Estate by Tai Savet

By Tai Savet | Agent in Los Angeles, CA
  • Can Real Estate Professionals Beat The 3.8% Obamacare Tax ?

    Posted Under: Home Buying in California, Foreclosure in California, Investment Properties in California  |  January 18, 2013 9:23 AM  |  232 views  |  No comments

    If you own real estate, will you end up having to pay the 3.8% net investment income tax (NIIT) that goes into effect in 2013 ?  For purposes of this discussion let us assume that your AGI is over the relevant threshold ($250,000 in the case of a married couple filing jointly).  Even if your AGI is generally low, there may come a year when you sell property, giving you a high adjusted gross income and significant income subject to NIIT in that year.  So there are two important questions.  Will NIIT apply to your real estate income, including gains from the sale of property ?  Is there anything you can do about it ?

    The answers are.  Probably NIIT will apply to your real estate income and there might be something you can do about it.  What you need to do is sit down with someone who understands the passive activity loss rules and consider how you might group your various holdings.  It may turn out that keeping really good records of how you spend your time  will help you avoid the tax.  I have now reached the limit of my ability to explain this problem without going tax geeky on you.  If you have significant holdings and want to try to minimize this tax, you are going to need somebody who understands you and your holdings and is geeky, because the regulations just issued require you to jump from one Code section to the next and reflect on murky definitions.

    What Do The Passive Activity Loss Rules Have To Do With It ?

    The passive activity loss rules (Code Section 469) were part of the Tax Reform Act of 1986.  They were meant to drive the stake through the heart of tax shelters.  The Section led to fairly complicated regulations and quite a bit of case law.  Generally speaking, though, you only had to worry about all these rules if you had losses that you wanted to use to reduce your adjusted gross income.  If everything you did was profitable, then you did not have to worry about them.  Now you may. An activity that would be considered passive under 469 that produces net income will add to the amount subject to NIIT, unless it is subject to self-employment tax.

    The NIIT includes “rents” among the items that it taxes.  Rents are excluded from the tax base if they are derived in the “ordinary course” of a trade or business that is not subject to the passive activity loss rules of Section 469.  It seems that we are at a dead end here.  Rental activities are “per se” passive under 469.  There is an exception though.  The “per se” passive rule does not apply to real estate professionals.

    What The Regulations Say About Real Estate Professionals ?

    The regulations recognize that real estate professionals may be exempt from NIIT on some of their properties.

    Section 469(c)(7) and Sec.  1.469-9 provide special rules for certain individual taxpayers involved in the conduct of real property trades or businesses (real estate professionals). If a taxpayer meets the requirements to be a real estate professional in section 469(c)(7)(B), the taxpayer’s interests in rental real estate are no longer subject to section 469(c)(2), and the rental real estate activities of the taxpayer will not be passive activities if the taxpayer materially participates in each of those activities. .  

    So You Want To Be A Real Estate Professional ?

    If you have a day job outside of real estate, it can border on the impossible to qualify.  The 750 hour standard is not too bad, but what kills most people is the requirement that you spend more time on your real estate activities than anything else.   There was one case a little over a year ago of somebody with a serious day job who was able to pull it off.  He was a harbor pilot and his piloting was on a week on week off basis.  The other thing that people have a lot of trouble with is having good records of how they spend their time.  Both the IRS and the Tax Court are very hard on people who don’t keep contemporaneous records.

    There is a whole new class of persons who are going to be looking to gain the status.  That would be real estate owners whose properties have been consistently profitable.  The “per se” passive rule never mattered to them.  If the properties have been profitable enough to keep them from needing day jobs, they might be able to qualify now.  It is critical, though, that they document their time to make that 750 hour bogey.

    Qualifying as a real estate professional does not get you all the way there.  That just gets you around the “per se” passive rule.  You also need to materially participate  in your properties.  Of course if you have multiple properties, it may be impossible to materially participate in each of them.  You are allowed to elect to aggregate your properties for that purpose, but you must make the election.  Many people miss it.

    Do You Have A Trade Or Business ?

    There is another curve ball to this. 

    However, a taxpayer who qualifies as a real estate professional is not necessarily engaged in a trade or business (within the meaning of section 162) with respect to the rental real estate activities. If the rental real estate activities are section 162 trades or businesses, the rules in section 469(c)(7) and Sec.  1.469-9 will apply in determining whether a rental real estate activity of a real estate professional is a passive activity for purposes of section 1411(c)(2)(A). However, if the rental real estate activities of the real estate professional are not section 162 trades or businesses, the gross income from rents derived from such activity will not be excluded under section 1411(c)(1)(A)(i) by the ordinary course of a trade or business exception.

    You would think that somebody could be able to tell right off whether a particular real estate activity constitutes a trade or business.  It is usually quite important whether an activity is a trade or business.  For most activities, whether deductions go against adjusted gross income will hinge on the “trade or business” question.  Also, trade or businesses are generally subject to self-employment tax.  When you get to rental real estate activities though the “trade or business” question becomes less important.  Related deductions go against adjusted gross income, regardless.  Real estate rentals are specifically excluded from self-employment tax. 

    Well now if you are a real estate professional, the NIIT makes the question important.  The IRS is putting us on notice in the regulations that they are going to be looking at it.  I’ve spent a little bit of time poking at the question and my first impression is that it is something of a gray area.  To illustrate the problem let’s consider someone who owns his own real estate brokerage firm.  The brokerage firm will qualify him as a real estate professional. 

     Suppose our broker owns a building that is triple net leased to a credit tenant for a very long term.  He will probably not be able to get out from paying NIIT on the income stream from that property.  If on the other hand he owns a few three-deckers and deals with the tenants himself, by jumping through the proper hoops he can avoid NIIT on the income from the housing units.  Perhaps more significantly, any gain from a sale will not be subject to NIIT.  An intermediate case might be one like the situation I find myself in – an accidental landlord.  I continue to own a former residence and am renting it out till housing prices recover or hell freezes over.  It is a matter of indifference to me as to whether that rental counts as a trade or business.  If I were a broker, it would be a different story.

    There’s More

    The regulations on the NIIT have a lot more wrinkles to them.  They will require people with multiple activities to look closely at how they are classified.  In the past having a profitable activity classified as passive under 469 was either a good thing or a matter of indifference.  It would be a good thing, if you had losses from other passive activities.  Thanks to NIIT, it is no longer such a good thing.

  • Top Producer Software

    Posted Under: Home Buying in Calabasas Hills, Foreclosure in Calabasas Hills  |  January 1, 2013 5:28 PM  |  251 views  |  No comments
    How many real estate agents really use top producer?
    I just signed up and it seems a bit complicated but good!
    What does everyone else think?

  • Are You Prepared For The ‘Obamacare’ Real Estate Investment Tax?

    Posted Under: Home Buying in San Diego County  |  December 6, 2012 7:05 PM  |  180 views  |  No comments

    That was a real question I was asked two weekends ago when I was in San Diego speaking to 450 active real estate investors.  From the concerned look on the face of the woman asking the question, apparently she was serious!

    Up to that point, I was more concerned as a small business owner, and a successful one at that, about the effects of the health care law and was following closely the Supreme Court announcement simply to be prepared on what steps to take next.  When the question came up, I answered the lady that I had no idea how health care was going to affect me as a real estate investor and I had not given it one thought to that point.  I was much more concerned with concrete matters like avoiding cost overruns, delays in projects, vacant properties, uncollected rents, pending evictions, etc, etc…  You know – I told her to focus on what she was at the conference for and learn – not fret over a non-existent tax!

    That night I decided to Google the lady’s question and see if it had any merit – and here is the answer I came up with.

    Is There A Tax On Real Estate Investment In Obamacare?

    Yes.  And No.  As grey as that sounds, the truth is actual very black and white.  Before I explain, I will tell you that worrying about it is best left to investors that like to worry.  Not worrying about it is best left to investors that like to make money.

    In the healthcare bill, there is a new tax created on investment income for high income households and it is called a 3.8% medicare tax.  This tax will not affect all investment income and will not affect all real estate transactions.  It is not a sales tax, but a levy tax against profit on certain transactions that meet a high threshold.

    What Are The Parameters Of The New Real Estate Tax?

    First of all, it is a tax that will only be imposed on households with a combined income above $250,000 or individuals with an income above $200,000.  Regardless of the transaction, this is the first stipulation that must be met and excludes about 97% of all U.S. households.  From there, well you definitely get penalized for making good business decisions!

    The next stipulation is that you must make a return on the sale of the investment property above the capital gains threshold which is $250,000 for individuals and $500,000 for couples.  That is a high threshold.  At that point the tax does kick in, but only applies to the amount of income above the exclusion.  For instance, if you sell a property and earn a $550,000 return as a couple, you will be subject to a 3.8% tax on $50,000 provided your adjusted gross income is above $250,000 for the year.  If not, then there is no tax.

    Why Is The Medicare 3.8% Tax on Investment Income Even In The Health Care Bill?

    Beats the heck out of me!  In the grand scheme of things, this particular provision promises to raise a very, very small amount of money.  Given that less than 3% of U.S. households earn above $250,000 a year and the median price of a home in the U.S. today is roughly $150,000, I am not sure how this is going to raise much money at all.  It will affect a relatively small number of people on an even smaller number of transactions.

    But that does bring up another point – and this is a close as I will come to a political discussion.

    It’s Only A Little Tax – You Can Afford It!
    At the event, my point to the lady asking the question and to the audience had nothing to do with the size of the tax or if it even existed.  She was there to learn how to be a better real estate investor.  She had an opportunity to network and learn from 450 other investors from all over the country.  Too often, we focus on the negative and not the positive and the negatives tend to get us a lot more fired up!  When they do, our focus is all over the boards and not on the basics, which will ultimately cost each of us a lot more than a tax.

    When I came off the stage a man was waiting for me and I guess he surmised from my answer that I was all for the healthcare plan and all for redistributing wealth.  He mentioned how “all them conservatives make such a big deal when asked to give a little”.  I asked him what he meant by his comment and he said that 3.8% was a small tax and if you are making money in real estate, who cares about giving a little.  I told him that I thought he was missing the point of all those that were tired of giving a little.  He had this perplexed look on his face and I said that I thought if he added one word to his statement he might understand where they were coming from.

    It wasn’t that people don’t want to give a little.  It is that each time they are being taxed to give a little“MORE”.

    Ultimately, this new tax is now the law of the land and we’ll see if the legislature removes it.  I think that is a highly doubtful proposition.  In the end, none of us is going to stop making money simply because there is a new tax attached to it.  Just know that it will affect a very small number of people on a very small number of transactions and as real estate investors we have much bigger issues to focus on!

  • How FHA and VA Loans Affect Your Offer ~ Savet Group

    Posted Under: Home Buying in Westlake Village, Credit Score in Westlake Village, Investment Properties in Westlake Village  |  April 19, 2012 2:56 PM  |  367 views  |  No comments
    How FHA and VA Loans Affect Your Offer

    If you are obtaining a VA or FHA loan in order to finance your purchase, you must include that information in your offer. This is because government loans place additional financial and performance obligations on the seller.

    Non-Allowable Fees

    First, VA and FHA loans prohibit buyers from paying certain types of fees that are often charged by lenders, escrow companies, settlement agents, and title companies. They are called "non-allowable" fees. They still get charged anyway, but as the buyer, you are "not allowed" to pay them. The result is that the seller ends up paying them instead of you.

    Most of these "non-allowable" fees come from your lender. By the time you are making an offer you should have already been pre-qualified by a loan officer, so you or your real estate agent can ask how much the lender’s non-allowable fees will be. Experienced agents should also have an idea of what non-allowable fees will be charged by the escrow or settlement agent and the title insurance company.

    Since these are fees the seller would not pay on an offer with conventional financing, this information must be included in your offer. You should also realize that since the seller will be paying these additional fees, they may be a little less negotiable on the price.

    VA and FHA Appraisals

    Home appraisal inspections on FHA and VA loans are a little more detailed than on conventionalloans (and more expensive). The appraisers are required to perform certain minimum inspections as well as evaluate the market value of the property. Although these inspections are not as detailed as a professional home inspection and should not be considered a substitute, sometimes repairs are required.

    These are additional costs the seller would not be obligated to pay for someone obtaining conventional financing, so your offer should include a maximum figure for these repairs. Otherwise the seller is signing the equivalent of a blank check, and they do not want to do that.

    At the same time, whatever figure you put in will most likely affect the seller’s willingness to negotiate on price. If you put $500 as an estimate, the seller may be $500 less negotiable on their price. If no repairs are required, you may have been able to get the house for $500 less than what you and the seller agreed on as the price. The solution is to add a clause to your offer that goes something like this. "If required repairs cost less than the maximum amount allowed, the excess will be credited toward buyer’s closing costs."

  • Buying a Home With Resale Value ~ Savet Group

    Posted Under: Home Buying in Westlake Village, Credit Score in Westlake Village, Investment Properties in Westlake Village  |  April 19, 2012 2:52 PM  |  359 views  |  No comments

    Buying a Home With Resale Value

    Location – Local Community, Town or City

    Before you can actually pick out a house, you need to choose what cities or communities you would like to live in. There are many factors you should pay attention to, not only for yourself, but because you intend to eventually sell the home to someone else. Carefully choosing your community is the first step in "location, location, location" and can help maximize your future potential resale value.

    Economic Stability

    When choosing a community for your purchase, it makes the most sense to buy in a city with a viable and stable economy. Five, ten, or even fifteen years from now – when you want to sell your home – you can have a reasonable expectation that your community will still be a desirable place to live.

    In addition to residential neighborhoods, there should be a healthy mixture of commercial and business districts. These not only provide jobs to the local residents, but also add an income source that the city can use to upgrade and maintain roads and city services.

    In fact, you should take a drive and see how well the community is maintained. You have probably heard of "pride of ownership" when referring to an individual home or an automobile. Look to live in a city that demonstrates community pride, as well.

    Local Government Services

    In addition to community pride, check on the services provided by local government. One example would be the local library system. Are there several library branches? Do they stock a good selection of books, including recent best sellers?

    You should also look into local crime statistics and see how the city compares to the national average and other local communities. Is the police force effective and responsive to community needs? Are fire stations located strategically around the community so that they also can respond quickly in an emergency?

    Another area of inquiry is community services. Does the city sponsor youth sports and have well maintained athletic facilities and parks? Do they sponsor community events, such as an annual parade? Are there activities available for children, teenagers and senior citizens?

    Your local agent, if they are a good one, will have amassed a wealth of information on these subjects of inquiry. It is also another reason to always use a local agent.

    Schools

    Even if you do not have school-age children and do not intend to have children, you must pay attention to the local school system. That is because when you sell the property, many of your potential buyers will have concerns of this nature.

    You will want to know if the local schools are overcrowded. Take a drive around and see if there are auxiliary trailers outside the local schools. Call up the local school district and see if elementary aged children always attend the school closest to their home. If not, ask why. Are there enough schools to support the local population? If not, are there plans to build new schools? How will building new schools affect local property taxes?

    You should also check to see how local students score on the standardized tests. You can ask your agent about these things, but you should also get the local phone numbers so you can ask yourself.

    There are also school reports available for free on the Internet.

    Property Taxes

    Property taxes may be higher in one town than another nearby city. This can sometimes affect whether potential homebuyers view a community as a desirable place to live. Often, they will choose not to purchase in a community with higher taxes, though this decision is not always justified. Higher property taxes often mean newer and more modern schools, well-maintained roads, and bountiful community services.

    In addition, you will often find that the "cost per square foot" of homes is lower in cities that have higher property taxes. This means you can buy a bigger house for less money. Since the mortgagepayment may be lower, but the property taxes a bit higher, the monthly housing costs may be approximately the same in each city.

    However, many agents and prospective buyers have a bias against a community with higher property taxes. If resale value is important to you, make property taxes a consideration when choosing the location of your new home.

  • Why Buying a Home is a Good Idea ~ Shared by Savet Group

    Posted Under: Home Buying in Westlake Village, Credit Score in Westlake Village, Investment Properties in Westlake Village  |  April 19, 2012 2:50 PM  |  333 views  |  No comments

    Why Buying a Home is a Good Idea

    Income Tax Savings

    Because of income tax deductions, the government is subsidizing your purchase of a home. All of the interest and property taxes you pay in a given year can be deducted from your gross income to reduce your taxable income.

    For example, assume your initial loan balance is $150,000 with an interest rate of eight percent. During the first year you would pay $9969.27 in interest. If your first payment is January 1st, your taxable income would be almost $10,000 less – due to the IRS interest rate deduction.

    Property taxes are deductible, too. Whatever property taxes you pay in a given year may also be deducted from your gross income, lowering your tax obligation.

    Stable Monthly Housing Costs

    When you rent a place to live, you can certainly expect your rent to increase each year – or even more often. If you get a fixed rate mortgage when you buy a home, you have the same monthly payment amount for thirty years. Even if you get an adjustable rate mortgage, your payment will stay within a certain range for the entire life of the mortgage – and interest rates aren’t as volatile now as they were in the late seventies and early eighties.

    Imagine how much rent might be ten, fifteen, or even thirty years from now? Which makes more sense?

    Forced Savings

    Some people are just lousy at saving money, and a house is an automatic savings account. You accumulate savings in two ways. Every month, a portion of your payment goes toward the principal. Admittedly, in the early years of the mortgage, this is not much. Over time, however, it accelerates.

    Second, your home appreciates. Average appreciation on a home is approximately five percent, though it will vary from year to year, and in some years may even depreciate.. Over time, history has shown that owning a home is one of the very best financial investments.

  • Things Not to Do Before Purchasing a Home ~ Shared By Savet Group

    Posted Under: Home Buying in Westlake Village, Foreclosure in Westlake Village, Credit Score in Westlake Village  |  April 19, 2012 2:47 PM  |  277 views  |  No comments

    Things Not to Do Before Purchasing a Home

    No Major Purchase of Any Kind

    Review the article titled, "Don’t Buy a Car," and apply it to any major purchase that would create debt of any kind. This includes furniture, appliances, electronic equipment, jewelry, vacations, expensive weddings…

    …and automobiles, of course.

    Don’t Move Money Around

    When a lender reviews your loan package for approval, one of the things they are concerned about is the source of funds for your down payment and closing costs. Most likely, you will be asked to provide statements for the last two or three months on any of your liquid assets. This includes checking accounts, savings accounts, money market funds, certificates of deposit, stock statements, mutual funds, and even your company 401K and retirement accounts.

    If you have been moving money between accounts during that time, there may be large deposits and withdrawals in some of them.

    The mortgage underwriter (the person who actually approves your loan) will probably require a complete paper trail of all the withdrawals and deposits. You may be required to produce cancelled checks, deposit receipts, and other seemingly inconsequential data, which could get quite tedious.

    Perhaps you become exasperated at your lender, but they are only doing their job correctly. To ensure quality control and eliminate potential fraud, it is a requirement on most loans to completely document the source of all funds. Moving your money around, even if you are consolidating your funds to make it "easier," could make it more difficult for the lender to properly document.

    So leave your money where it is until you talk to a loan officer.

    Oh…don’t change banks, either.

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