REI INK

Taxes

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The Rising Costs of Real Estate Taxes By Suzanne Andresen I attended the launch of the Atlanta Chapter of the National Rental Home Council a few months ago and heard a lot about the SFR arena and the current concerns facing the industry. There were a few discussion points that I felt were more pressing than others. Certainly, the concerns about trespass were front and center, as Atlanta seems to have become one of the industry’s hot beds for that activity. Other areas of focus were the escalating insurance fees affecting certain markets, following the many catastrophic weather events we have seen across the country. If you would like to learn more about that topic, consider attending the AmeriCatalyst event in Washington, DC April 18th and 19th — Going to Extremes. The Rise in Real Estate Taxes The topic that I was most interested in was centered around real estate taxes. It seems that every year these fees continue to rise. In theory, that should not be the case. I am an elected official in Maine, and we recently completed the 10-year state required revaluation process for real estate and personal property. We were a few years behind due to COVID and needed all of the 18 months allocated to this task. We followed the state valuation process, hired an appraisal firm, and visited each and every real estate asset in the town. The state mandates that the town can assess a maximum of 5% overlay for items not currently projected as budgetary items. We have specific guidelines in this process where the town is prohibited from overcharging taxes to the residents and remaining within the limitation of the 5% rate as our overlap buffer. Once we receive the completed analysis with updated determination of current asset valuations, the elected officials then review what the town expects to spend annually to meet the town demand of services provided. As I am sure that all town budgets allocate the highest percentage to the school budget, the remainder of the monies in our town budget are reserved for the other municipal elements necessary to keep the town running like road repairs, first responders, public library, etc. In theory, as the values rise, the mill rate used to determine the tax bill falls. In the end, your real estate tax bills should remain relatively fixed unless you have altered your property for improvement. The new valuation the town received projected our tax rate to a significantly higher value from the previous assessments, — nearly 60%. Some of the increased value was the 15-year timeframe from the last revaluation. Additional increased value stemmed from an anomaly yet to have been experienced in the past following the frenzied acquisition appetite and fall out of COVID relocation — work from home scenarios. As a licensed real estate designated broker, I was surprised that this atmosphere trickled into Maine and was sustainable for more than two years. We are not mainstream America by any means. COVID Relocation Practices In watching real estate transactions, I learned that local residential mortgage requirements actually added in new COVID relocation practices, requesting remote employees purchasing homes in a new location to receive written approval from their employer, confirming that the employee’s job was indeed an approved offsite employment contract. We have seen companies require employees to return to the brick-and-mortar office buildings for onsite duties. Some have adopted a varied schedule or went completely to a 5-day work week in the office. The fear for the mortgage holder was that once the employer realized the employee had moved, perhaps their job would be in jeopardy for this new relocation destination when the return to the office policy would be reinstated, creating an uptick in foreclosed properties. Let’s look at the effects relocation has had on rental real estate. My brother recently moved from New York to South Carolina. He is recently divorced and decided to put his assets in a trust for his children. When he purchased his house, the taxes were estimated at $8,300 annually. After the closing documents and deed were recorded, the county billed the taxes for the new year at $25,830 under the assumption this was now a rental property due to the trust name on the deed. What factors from the county contribute to over a 300%+ markup on real estate taxes? It is not like rental properties have added families with nine school aged children and feel it is justified in this tax allocation. If we review the 5% overlay state limitation in tax allocations in Maine, this would not be an allowable assessment. There is an ever-increasing need for housing and rental properties, which will make it nearly impossible to forecast the demand. Municipalities should not be able to have fluctuating tax rates as part of the real estate property town revenues. We would not be able to meet the overlay stipulation with this assessment practice. As a landlord, rental fees include the monthly real estate tax as a pass through to the tenant, in all markets. Ultimately, the state’s assessment practices are the cause for rental properties becoming out of reach for certain tenants. The investors are constantly held accountable for gobbling up the available assets across the country, in front of first-time home buyers. There is a significant, purposeful rental engagement with many younger tenants. They are attracted to the flexibility of living wherever and whenever they want. Additionally, the population transitioning to the retirement aged scenarios have also decided they prefer renting vs owning. They have moved closer to their grandchildren and want the flexibility to pursue different locations and lifestyles, on a more flexible basis. We need to stop the perpetual demonization of real estate investors. They are providing valuable housing services to towns and communities across the country.

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Ten Tax Mistakes to Avoid

Tax Planning Gives You Control of Your Outcome By Teresa Bilsky Most all investors, business owners, and even individual taxpayers have experienced that sinking feeling of receiving a letter from the Internal Revenue Service or reviewing their tax return with different results than they expected. Your rental property lost money, so why aren’t you seeing the savings in taxes? Or perhaps you received a penalty letter citing some obscure tax code that you were expected to know! Though there is a wealth of information available (some accurate, some that could land you in jail, some that used to be accurate but is no longer so, and some that is comprised of lots of half-truths), the bottom line is that you are expected to know and understand the laws. Penalties sting, but the real issue that taxpayers are wasting millions of dollars on are missed opportunities. So, where do you begin? Begin with the basics. 1. Missing Filing Deadlines Filing deadlines are absolute. Missing them creates penalties that may not be deductible as an expense. For example, 1099-NECs are required to be filed by Jan. 31 regardless of submission method. Penalties range from $50 to $290 per form. Though there is not a deadline for obtaining the W-9 tax information needed to complete the 1099-NEC in a timely manner, we recommend that businesses obtain a completed W-9 prior to any contractor payments. 2. Federal Tax Extensions Extensions are available to allow for the accurate reporting of tax transactions as well as required disclosures. However, money is due when money is due. Extensions do not apply to the payment of tax. Avoid costly penalties and interest by knowing how much you owe by the due date. The failure to file/failure to pay penalty is the federal short-term rate plus 3%, compounded daily. 3. Estimated Tax Payments These payments are due in April, June, September, and January and should equal 25% of the required minimum amount. You often hear these payments referred to as quarterly tax payments though there is humor in that Congress apparently cannot count in threes. The time between Jan. 16 and April 15 is used to complete the calculation of the actual tax due. Payments are due with the return or extension filing by April 15. Business owners receiving a W-2 from their entity may meet this requirement with withholding regardless of the when, or how many times a payroll is received during the year. The law treats W-2s as having been paid equally throughout the year. Missing those due dates by even one day subjects that portion of the tax to the failure to file/failure to pay penalty. This is such a common penalty and common waste of money that there is a box for it on the personal tax return, form 1040. 4. Tax Liability The IRS announced that beginning in October 2023, the interest rate for underpayment or late payment of tax will increase to 8% in addition to the 5%-10% late payment penalty. Generally, the required minimum tax is either 100% of your tax liability from your prior year return or 90% of the current year liability. For an Adjusted Gross Income over $150,000, you need to pay 110% of the prior year or 100% of the current year to reach Safe Harbor. The Safe Harbor date is Jan. 15. Safe Harbor means meeting this required prepayment which grants you the January to April time frame to complete your total tax estimate. Many states follow the same time frame and concept. 5. Holding Period Oh, what a difference a day can make. Closing on a sale held 365 days or less is taxed as ordinary income. The 2023 highest rate is 37%. For long term capital gain treatment, the holding period is a year and a day. Capital gains are taxed between 0%-20%. The additional 17% in tax for that one day is a lot of your money. 6. Real Estate Professional Rules The “Good” and the “Bad.” The Good — Real Estate Professionals are not subject to passive activity loss limitations (PAL) on their rental activities. Nor are they subject to the 3.8% Net Investment Income Tax. The Bad— they are subject to the 15.3% Self-Employment Tax on rental activity profits. You must understand the annual election rules. To qualify, 750 hours must be dedicated to real estate activities AND more than 50% of service income must derive from those activities. Paying off the mortgage on a rental property may cost you more than you think you are saving. 7. Tracking Business Activities Accounting for income and expenses is essential to saving on taxes and for avoiding or repeating costly mistakes. Many business owners use personal money which is never visible and rarely remembered when recapping activates, once a year. With the top tax rate at 37% and the Self-Employment Tax at 15.3% for a total of 52.3%, EVERY dollar matters. Tracking expenses goes beyond saving taxes, it also provides feedback on areas where you may be bleeding money in small amounts that add up but are not easily felt during your day-to-day activity. Properly accounting for your expenses includes recording non-cash transactions such as depreciation, recording deductible portions of mortgage payments and so on. Some transactions should be tracked even though the tax benefit is limited or disallowed in order to have a complete understanding of how your business is performing. 8. Use Entities There are over one-million words in the US Tax Code. Use them all Entity structures are designed to help with various issues including taxes. Understand the differences and optimize the opportunities to report the very same activities and very same numbers on different pieces of paper for very different outcomes. Also understand when the entity is completely ignored by the IRS. Most importantly, using an entity goes beyond forming it. A business entity must have its own ID and its own bank account. Track and report its own specific transactions. Treat them as a separate person. This is

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Capital Gains Challenges Ahead for Landlords

Creative Investors Could Hold the Key to the Solution & Incredible Returns by Carole VanSickle Ellis When Eddie Speed encounters a challenging situation, the 40-year veteran of the performing and non-performing note space has a history of tackling the problem with a combination of creativity and determination—and he usually is able to work out a winning solution. Speed has never seen anything quite like the financial challenge coming down the pipeline for investors facing capital gains taxes in 2021, however. Changes in Capital Gains “The current presidential administration is getting ready to disrupt the real estate investing business in ways most people cannot yet imagine,” Speed warned. “They are basically planning to double capital gains very, very soon.” He is referring to President Biden’s much-touted campaign promise to change the capital gains taxing process in order to tax the nation’s highest earners at a rate of nearly 50 percent. Currently, these individuals pay about 24 percent in long-term capital gains, and White House officials say that the country’s top tax bracket is still “able to manipulate the tax system in their favor.” The change to capital gains is allegedly designed to “level the playing field” while increasing federal tax revenue by raising taxes for households making more than $400,000 a year. This policy, if it passes into law, could disproportionately affect individual real estate investors who tend to generate the majority of their returns (and income) through the sale of property rather than via a more traditional, annual salary. In particular, landlords hoping to liquidate their portfolios will suffer, and Speed says the only solution he can see at present is to act quickly and creatively to get ahead of the looming problem. “According to the Urban Institute, about half of all individual landlords’ properties are currently free and clear, meaning there is no mortgage on those rental properties,” Speed said. Historically, this would have been an ideal position for a mom-and-pop landlord planning to use the income from rental properties along with some liquidation to support themselves in retirement. Thanks to the proposed capital gains policies, however, the tax burden associated with selling free-and-clear properties could soon be crippling. Speed believes that the pending hit to returns that landlords can generate upon sale of a property combined with the after-effects of the COVID-19 pandemic that have left more than 10 million tenants owing more than $6,000 in rents each could spur many landlords to sell now— if they can do so in a way that protects the returns they have been cultivating throughout the life of the investment. That is good news, he insists. The Strategy “With this policy, the president has done the biggest favor in his political career for investors using seller financing,” Speed said. “This is the least-understood market niche in real estate, but investors willing to work in this space have about six months to act on this incredible opportunity and help a lot of burned-out landlords in the process.” Seller financing involves the owner of a property holding a private note on that property in order to make a sale. The note, like any other property-backed loan, is legal and binding, but the current owner of the property holds the note instead of sending the buyer to another party in order to borrow money for the purchase. Seller-financed loans can have down-payments, creative terms, and interest rates that are set or variable just like “conventional” bank loans. They have been popular with creative real estate investors for years because they permit vast flexibility in pricing, purchase terms, and, crucially for Speed’s strategy, payment schedules.  “If a landlord has a rental property that they acquired for $100,000 and now it is worth $250,000, [upon selling that property] that landlord would have a capital gain of $150,000. However, if the landlord were to sell the property using seller financing and collect payments over the next 15 years, they would pay one-fifteenth of the capital gains every year for the next 15 years,” Speed explained. He added, “This option frees up landlords who would like to sell right now to do so. The key is that real estate investors who want to buy these properties do not have very much time in which to reach these landlords, explain the strategy, and transact the deals.”  Speed, of course, already has that process in place and in action. His company is working with partners to reach landlords on a scale and at a pace seldom seen even in creative real estate. “Thanks to our partnerships and business relationships, we can work quickly to reach landlords and then explain in a compelling, persuasive way exactly what we are offering to do,” he said. Over the course of his career, Speed has shown real estate investors how to create investment-grade notes for many purposes, including acquiring those notes and recapitalization. Through NoteSchool, his training program for investors who want to create note transactions and create investment-grade seller-financed notes, Speed is helping other investors refine the process of reaching sellers and explaining this limited-time strategy to them. “The current environment is perfect for seller-financing because there is a sound, easy-to-explain reason that a landlord-seller should seriously consider carrying a note not just one year or five years but long-term,” Speed explained. “For the deal maker real estate investor targeting the small-time landlord, this can create huge savings on interest for investors buying these properties, increase their volume of acquisitions, help investors develop strategies that create more favorable terms than what a bank or mortgage company might be able to agree to, and solve a huge, life-altering problem for landlords who might otherwise find their real estateportfolios decimated by these new guidelines on capital gains.”

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