Friday, April 13, 2007

Case Study Of What Not to Do

I recently had a call from a real estate agent who was in a panic. She had an 82 year old client who had called her in tears. Here is what had happened.

The client (I'll call her Susan Seller) had engaged the real estate agent (Rita Realtor) to sell an investment property for her in the Spring of 2006. Rita did exactly this and collected her commission without asking any questions about what Susan would do with the proceeds. Susan had approximately 280K in gains.

Susan took the check from escrow and placed it in a 6 month CD. She had never sold property before and was unaware of the tax consequences.

When the 6 months were nearing an end, Susan called Rita back and asked her to look for another investment property for her that was in the price range of her last sale.

Rita found a property for her in early 2007 and collected another commission, still not ever discussing the funds involved. Susan used the entire amount from the last sale, plus the interest from the CD and about 10K of her savings and purchased the property outright.

The second week of April Susan went to her accountant to do her 2006 tax return. The accountant told Susan she would owe upwards of 80K in capital gains tax, recaptured depreciation and extra income tax from the CD earnings.

Susan didn't believe that was possible because she hadn't spent a penny of the earnings except on the new property. Since she had employed Rita for both the sale and the new purchase, she believed that Rita would have mentioned the tax problems since Rita was aware of what she was doing.

So, Susan was furious and called Rita to see if there was some sort of mistake. Susan no longer had the money to pay the 80K tax bill. It never crossed Rita's mind to talk to her clients about what effect their sales and purchases could have on their taxes. Rita didn't know herself.

I gave Rita the bad news that Susan didn't have any choice but to pay her taxes. She will have to take out a loan either against her personal residence or the rental. This means the rental income that she was counting on to support herself will be used in good part to make payments on the new loan.

The extremely sad part of this story was that all of this could have been totally avoided by either doing a 1031 exchange or structuring the sale to minimize the tax burden. At the very least, Susan could have kept the proceeds in an account until the tax return and paid her tax consequences with the cash on hand.

Rita Realtor just lost herself a client and you can bet Susan Seller will be telling everyone who will listen about her bad experience.

All Rita would have had to do was ask a simple question when helping Susan with her first sale. She could have asked Susan what her plans were after the sale, informed her that she should talk to someone who could explain the tax consequences and options available because they may be significant if not handled properly, and given her the name of someone who could help.

Real estate sales persons and brokers don't have to be tax experts, but if they take that one extra step to show they have their client's best interest at heart, they will earn the respect and appreciation of their clients and never put themselves in the position of having to explain why they never disclosed the tax consequences on a sale.

I guarantee this is a lesson Rita Realtor won't soon forget!

Paula Straub

Fill out a Qualification Questionnaire and see if you qualify to hang onto your capital gains.

Wednesday, April 11, 2007

Is Gifting Real Estate A Good Idea?

I receive a lot of questions regarding gifting real estate as a means to pass along property prior to death and remove it from the estate.

In theory it sounds good, but in many cases it does not accomplish what the giftor intended. Here are some things to consider before taking any action.

  1. When you gift real estate the person receiving the property inherits your tax basis and /or depreciation taken. So, if you paid 100K for the property and it is worth 500K, the recipient will owe taxes on 400K when they sell.
  2. If you are giving the gift to remove property from your estate, you have to realize you may have to pay gift tax. You have a maximum of 1 million dollars to give during the course of your lifetime without paying gift tax. Once that amount is exceeded, it is you who will have to pay the tax on each gift. (There is an annual amount of 12K that can be gifted to any one person without counting against your maximum lifetime gift amount)
  3. If you are trying to remove property from your estate so you will qualify for State or Federal assistance for medical care or a nursing facility, there is now a 5 year look back period. This means that if you didn't give the property away at least 5 years prior to when you need to qualify for assistance, they count it as if you still have the money and you won't qualify. This is to prevent individuals from wiping out their estate for the express purpose of qualifying for government aid.

Of course, there are times when gifting does make sense. It really depends on the individual situation and goals. Before doing anything you might later regret, consult with a professional who can explain the ins and outs. It is very possible the desired results can be attained using a different approach.

Paula Straub 760-917-0858

Fill out a Qualification Questionnaire to see if you qualify to hang onto your capital gains.

Tuesday, April 10, 2007

Red Flags to Beware of From Your Advisors

Tax time is drawing near. Never is the desperation more apparent than this time of year when panic sets in as April 15 (or 17th in 2007) fast approaches.

I estimate 4 of every 5 phone calls and emails are from those filling out tax returns and learning of the exact amount of taxes they have due. Many panic from having had no guidance prior to the sale of their asset in the previous tax year, but just as many are irate due to having had bad counsel.

In almost all cases, the amount they have to pay is much greater than they anticipated or were told. Most don't have the excess funds readily available and are desperately trying to find a way to defer their tax burden now due.

So, I've compiled a list of some of the most frequent scenarios I hear and where the initial problem started, often due to bad or inaccurate advice.

Consider these red flags if you find yourself selling an asset, and at least seek a second opinion before proceeding if you are told something similar.

1. From financial advisors: "Just pay your taxes and give me your proceeds to invest. I'll get you double digit returns and you'll be ahead in no time".

2. From Attorneys: "Let me evaluate the situation. That'll be 10K for my research and recommendation." No doubt the solution will be some sort of expensive trust or other fee for service plan and additional fees will be required to implement it.

3. From CPAs or other Tax Professionals:
  • There is no solution but to pay your taxes
  • You'll only have to pay 5% capital gains tax or at the most 15% so why consider anything else? The tax rates will never be lower (not usually true and due to lack of knowledge on how to calculate capital gains)
  • I don't have time to research that plan. I'm just too busy.

4. From anyone you go to for advice:

  • Either "I know all about that and it's not not a good idea" (without a solid reason why or without being able to explain the strategy in question), or "I've never heard of it so it must be a scam of come sort" (again without being able to explain why)
  • "My Uncle Milt had a bad experience with the IRS. It's better to just take the hit and not have to deal with them down the road" (Problem usually totally unrelated and caused by other source of bad advice)
  • "If you just take the lump sum up front you'll be in control of the money and you can do whatever you want with it. You can take that trip or invest it in the stock market"

5. "Whatever idea someone else presented to you is not right. This (whatever they are selling) is the only way to go. There's no use even discussing it further - you'll be sorry if you don't do what I'm offering you. There is no need for all parties to get together and talk. The other party is full of it"

Now, here are some of the things you want to hear from an advisor:

  1. I haven't heard of this plan, but I'd be interested to know more. If it makes sense and is better for your situation I'm all for it. It may even be something I can use to assist other clients in the same dilemma.
  2. I believe my plan is better for you. Let's set up a conference call with all parties and discuss the advantages of each so you can hear both sides and make an informed decision.
  3. I'm not familiar with this. Do you mind if I contact the other party and find out more about it so we can make an informed decision?
  4. Here are a list of questions I have concerning what you have shown me from the other party. If they can be answered to my satisfaction I will feel comfortable recommending the plan.

It is hard to know who to go to for advice and who to trust. I can usually tell if someone has my best interest at heart by how they answer my questions and how they use facts to support their proposal versus just blowing hot air or invoking fear for no reason.

If a professional has a plan they feel is in the best interest of their client, they will have no problem explaining and comparing the benefits of an alternate proposal. If all parties can hear both sides simultaneously, the party will the superior plan will become apparent.

Everyone can always stand to learn something. Anyone who thinks they know it all is usually the most ignorant. Just my two cents.

Don't let yourself be scrambling before next year's tax return and wishing you had done more before the sale to lessen your tax bill. It will be too late.

Paula Straub


Fill out a Qualification Questionnaire to find out if you qualify to hang onto your capital gains.