New tax deal... What does it mean to you?

President Barack Obama Monday evening announced a tentative tax deal with Republican leaders that would usher in a wave of tax changes, business write-offs and benefits for the unemployed that would last from one to two years.

While a final deal has yet to be agreed to, here is a cheat sheet to help wade through the debate.

 

Taxes

• The core of the proposal is a two-year, across-the-board extension of tax cuts enacted under former President George W. Bush. Mr. Obama said in his remarks Monday evening that he didn't favor extending tax cuts for top earners, but compromised to keep tax breaks for the middle class.

• A 2% rollback of individuals' payroll taxes that are used to fund Social Security. The White House said the cost of this one-year measure is $120 billion and that it wouldn't affect Social Security's solvency.

• The pact also includes a child tax credit, earned income tax credit and a credit to help students afford college. These are aimed at the middle class and favored by the White House.

• The estate tax would be reinstated for two years at 35% only for estates over $5 million. This provision is favored by Republicans. Obama called the provision more generous than is "wise or warranted."

Unemployment

• The pact would preserve extended jobless benefits, also known as unemployment insurance, for 13 months. It is something Obama said he fought hard for. The White House estimates a 13-month extension would cost $56 billion. Republicans had balked at extending jobless benefits, saying they wanted it to be paid for either through costs cuts or new tax revenue. The White House has said paying for the unemployment-insurance extension, rather than borrowing the money for it, would limit its impact.

Business Benefits

• The pact would allow all businesses to expense 100% of their investments in 2011. The write-off would be retroactive to September 2010, when Mr. Obama originally made the proposals to help shore up support from the private sector. The U.S. Treasury Department has said this expensing provision could generate more than $50 billion in additional investment in the U.S. in 2011.

• The agreement includes a 2-year extension of the research-and-development tax credit and other tax incentives to support business expansion.

Costs/Unknowns

• Senior Obama administration officials said in conference call with reporters Monday that they didn't know the overall cost of the package. The White House has said the provisions in the deal wouldn't worsen the medium and long-term deficit. In the short term, the plan is likely to increase the deficit.

• The unemployment insurance and payroll tax holiday, when combined, would cost an estimated $176 billion.

• A two-year extension of the Bush-era tax cuts would cost $314.9 billion, according to a Dec. 3 study from the nonpartisan Congressional Research Service, which does studies for lawmakers.

• It is unclear if a final deal will include other tax incentives and credits, such as an ethanol tax credit.

Not Included

• Senior administration officials said the deal didn't settle all Republican-White House disputes. The two sides still need to resolve disagreements over an arms-reduction treaty with Russia, called START, and the military's "don't ask, don't tell" policy

The Bush Tax Cuts

The "Bush tax cuts" refers to legislation enacted in 2001 and 2003. The cuts lowered tax rates on income, dividends, and capital gains; eliminated the estate tax; lowered burdens on married couples, parents, and the working poor; and increased tax credits for education and retirement savings.

What happens if the Bush tax cuts Expire?

It kind of depends on whether they expire for everybody or just the top 2% of Americans. Many would argue that they need to expire for the top 2% in order to avoid more deficits in the future, i.e.. , without the income from the increased taxes on the richest Americans, the government will have huge spending shortages. Others argue the tax cuts have worked by creating a trickle down stimulus and they should continue. That argument makes little sense to me when you look at our current economic picture.

I believe that if the cuts are to continue for the wealthiest Americans, the loss in revenue can only be justified with an equal cuts in programming. That would take a joint effort on the part of Congress, and would require huge cuts in one of our largest budgetary items...DEFENSE. So if the Republican's want the wealthiest Americans to continue to get the cuts, they need to agree on cuts to defense spending. Education, Social Services, (excluding social security, which nobody can touch), and various other governmental programs don't compare to the money spent on Defense.

Both Republicans and Democrats favor an extension of the tax cuts for the middle class. Where they differ is whether to extend the cuts for Americans in the top 2% of taxpayers.

Among other things, if the Bush tax cuts were allowed to expire, the following would take place:

1. Tax brackets would change, from 10%, 15%, 25%, 28%, 33%, and 35% to 15%, 28%, 31%, 36%, and 39.6%.

2. Long-term capital gain tax rates would rise from 15% to a maximum of 20%.

3. The child tax credit would be lowered.

4. The alternative minimum tax would cease to be indexed for inflation.

5. The marriage penalty would be reinstated

Thus, there is a lot at stake here. Whatever is decided, it must be tied in to lowering governmental spending. Otherwise, we will create an even greater deficit for the next generation.

IRS Sunset Provision

The real estate market and general economy have been the subject of a great deal of negative news lately. While a tax increase is never good news it may cause a little run in the markets this fall. There may be an increase in the year end transactions this year due to the year end sunset provisions in the law that lowered capital gains to 15% back in 2000. In 2011, the federal capital gain rate will increase to 20% automatically if Congress takes no action to extend the 15% rate decrease. It seems unlikely that Congress will do so. In addition, in 2013, there will be a new tax of 3.8% on unearned income, which will include income from the sale of real estate that will be imposed on those individuals with a gross income of more than $200,000, or married couples with an aggregate gross income of $250,000.00. Therefore, by 2003, most middle and high income earners will pay a 23.8% federal capital gains rate for sale of investment property. Combined with many state taxes, the rate will clearly be above 25% for many taxpayers in most places.



With tax increases looming, it is more important than ever to seek advice from your tax advisor long before you sell investment property. Our company engages in many of these discussions with accountants and attorneys that are trying to help their clients make thoughtful decisions. In fact, in a recent case, we were able to help a client find a way to avoid a large capital gains tax, and even help them with some retirement planning issues in the process. .



Mr. and Mrs. Marks approached one of our attorney clients in 2002 about selling a long term vacation property that had primarily been used as a second home. The property would sell for about 2.6 million, and since the basis in the property was under $200,000.00, the combined state and federal taxes would have been over $500,000. The couple was not thrilled about paying the tax, because after paying off some other debts with proceeds of the sale; they would not have had enough money left to retire on, along with their other assets. That attorney contacted us to ask some questions, which led to a meeting with the parties. In that meeting, we helped construct a plan that involved, converting the property to a full time rental for at least 3-5 years. The parties enlisted a realtor who was easily able to rent the property at a rate that nearly covered their yearly real estate taxes and carrying costs. Also, as suggested, they also refinanced the property in order to consolidate some unrelated debt. This would also benefit them 8 years later when they did the 1031 exchange.



Due to the changes in the real estate economy, the couple decided to hold off on selling the property in 2007, because the market had changed for the worse. This year, they listed the property, and got a strong offer of 2.5 million. Our company was able to introduce them to a commercial realtor who specializes in triple net lease commercial properties, and through that realtor’s efforts, they found a very strong, stable triple net lease property. They were able to do a 1031 exchange into the building by using the majority of the exchange proceeds, and now they have an investment property that is throwing off $105,000.00 of rental income and will not only help fund their retirement, but will also be left to their children when they pass on.

Misc IRA questions.

I got a call today from a client that is about to have his IRA buy a piece of land and lease the mineral rights. This is a hot area in some parts of the country. His first question was whether a lender would lend him funds for the purchase. I gave him the name of an IRA lender but informed him that it seemed unlikely since the lease payments on the mineral rights were not substantial unless the gas company actually chose to drill at some point and therefore the land was not income producing. Since and IRA loan is non-recourse, the lender would either have to see substantial assets in the IRA, or there would have to be an income producing property involved.

My clients next question was about when was the earliest that he could take distribution on a ROTH IRA. The answer is two fold. 1. The age of 59 ½ or before that if he is ”eligible.” Eligible (tax and penalty free) distributions of earnings must fulfill two requirements. First, the seasoning period of five years must have elapsed, and secondly a justification must exist such as retirement or disability. The simplest justification is reaching 59.5 years of age, at which point qualified withdrawals may be made in any amount on any schedule. Becoming disabled or being a "first time" home buyer can provide justification for limited qualified withdrawals. Finally, although he could take distributions from a Roth IRA under the substantially equal periodic payments (SEPP) rule without paying a 10% penalty, any interest earned in the IRA will be subject to tax at a substantial penalty.

Guidant?

I was speaking with a new prospect the other day, and he asked me if we were the same as Guidant Financial. That is a tough question, because I have never had a clear picture of what the company actually does? They are obviously one of the best internet marketing companies in the Self Directed IRA area. They are great self promoters, as well. But when I have spoken to people about Guidant’s services, what I am told is that they charged huge fees to set up LLC’s for their self directed IRAs, and then turned them over to a custodian to handle the administration of their IRA accounts. Guidant seems to be a successful marketing company for other custodians, and they get a big fee to set up the intital documents. If you read their site and their blog, they call themselves a “facilitator”. In their Blog they talk about how they lend money for small business. The truth is that I tell my prospects that if they are going to go to a competitor, they should compare fees and services. Guidant is an internet marketing company, and a very good one. But I don’t think they act as an IRA custodian or administrator.

Delaware Statutory Trust

I just read this article about DST’s. They are a new 1031 replacement property vehicle not too different from a TIC, except for one thing. The up front costs of acquisition are much lower. I pulled a few paragraphs from the article below. It was published in the New England Real Estate Investor.

“Financing problems have plagued commercial real estate since 2008. But problems for existing real estate owners have brought the best buying opportunities of our lifetimes. Institutional real estate owners have been forced to liquidate some of their real estate portfolio at bargain-basement prices in order to raise money to refinance expiring debt. More debt is coming due over the next two years that has to be paid off - creating more buying opportunities for cash-rich purchasers. A number of institutional real estate offerings are now available. They have long-term NNN leases and are large enough to attract institutional investors. Economies of scale enable a $20 million property to be a better value than a $2 million property. How can someone with only $1 million afford to invest in such high-quality real estate? The solution is called a Delaware Statutory Trust (DST).

Institutional-grade real estate offers the best prospects to investors, as it provides income as well as excellent capital gain potential. Investors can join forces to purchase Institutional-quality real estate today at bargain prices through a DST, which have been eligible for 1031 exchanges since 2004. In a 1031 exchange, the investor sells investment real estate but pays no immediate taxes on the sale. The basis and gain are 'exchanged' into a new property. DSTs are private placements and only eligible to accredited investors (those with a net-worth over $1 million not counting their principal residence according to a provision of the new 2010 financial reform bill).

Several property types are available as DSTs - although retail and multi-tenant (apartments) seem to be the best value today. Apartment buildings in growing areas which are located near major highways and shopping areas are among the safest investments today. These types of institutional multi-family properties pay investors about a 6% cash flow. Financing is readily available for multi-family offerings on the institutional level. Financing for other property types, however, is more difficult today. Thus retail DSTs pay from 7-8%, but most are cash deals and may not be appropriate for your 1031 exchange if your replaced property contained a lot of debt.

DSTs are a big improvement for investors than Tenant-In-Common vehicles, which have a huge load upfront as the sponsoring company can't make a profit on the back end due to 1031 regulations. DSTs, however, allow investors to "invest with the sponsor" - aligning the interests of the DST sponsor and their investors. DST sponsors indeed make money with the investors on the ultimate sale in 3-7 years (depending on the offering and market conditions). Since the real estate is being acquired at today's low rates - not only do they offer solid income, but investors enjoy excellent growth potential as well.”

Dockominium

A prospective client called yesterday and wanted to know if they could invest IRA
funds in a “dockominium”. Not being exactly sure what that was, I proceeded to let the prospect educate me about Seaview Marina, in Ocean City, NJ. At Seaview, the marina slips are sold in the same fashion as a condominium operates in the state. There is an association, and dues, and there is a deed to the slip. Slips run from $90,000 to as much as $200,000.00 depending on the size and depth of the slip. Many of these dockominiums are rented for the season at very nice rental amounts. My response was that it was indeed a viable investment for the client as long as he did not store his own boat there and collected rent to the user of the slip. It actually makes a great IRA investment since the Dock Association maintains all the slips and the IRA would just simply pay a monthly maintenance fee. The only issue, of course, is making sure that there is sufficient cash flow from the rental to pay the Association fee.

Incidentally, the client believed the return on these slips was about 7%, and that they have appreciated nicely in good real estate markets. He thinks he is getting it at a very low price.