Things That Make Me Go "Huh?"

Sometimes I just have to shake my head and chuckle.

I get alerts for news articles and press releases that concern capital gains so I can keep up on what everyone is doing and publishing.

Today there was a Press Release put out by one of the larger Structured Sales companies. The title had something to do with How Older Women and Widows were now inquiring about the Structured Sales Concept for 1031 Exchanges.

That was confusing enough, as the two are mutually exclusive. Farther down in the article they did mention the Structured Sale was in lieu of further 1031 exchanges.

Then they gave an example. One might think they would use an example of an older woman as the article title implied, but they used a daughter selling her Dad's second home to pay for his medical nursing care.

The daughter was "brought to tears" by the concept of her dad getting 10 years of payments totaling 300K (however, no mention was even made of the amount at time of sale for comparison).

Then came this sentence: "A traditional 1031 exchange would require the capital gains tax be paid in the year of sale."

This is what made me say "Huh?". A traditional 1031 exchange means you get to defer all capital gains taxes until you stop exchanging and sell outright. Is that what they really meant to say? Is it just me they confused?

Besides, the example was for a sale of a "second home" that didn't even qualify for a 1031 exchange in the first place!

I really feel sorry for people who are facing a capital gains tax dilemma for the first time. With so much contradiction in articles, press releases and general information on the subject - how is a novice supposed to know truth from inaccuracy?

When doing research it's a good idea to write down anything you find that is puzzling or contradictory. The correct answer is easy to find if you know where to look and a good advisor can prove their responses without back peddling.

Paula Straub
760-917-0858

Fill out a Qualification Questionnaire to see if you qualify to save capital gains tax.

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
760-917-0858

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

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.

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

760-917-0858

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

Minimizing Sometimes Possible Even After the Sale

Recently, I was presented with a fairly unusual scenario. A man in New York City was paid 500K as a buy out on a rent controlled lease. He'd been there 20 years and was one of only 5 tenants left in a building on prime land where the owners wanted to tear down the building and build a skyscraper.

The buyout was actually considered as a long term capital gain, even though the tenant never owned the real estate. Money had already changed hands, so a taxable event had occurred. It was too late to defer capital gains tax, but not too late to minimize the tax burden due to the best extent possible and still have him meet his goals.

Here was the plan I presented to him. His goal is to use the money to buy a primary residence, and the means is to do a Charitable Installment Bargain Sale using cash.

"If you pay your taxes, you'll owe a little over 25% of 500K or about 125K. So you either start with 375K left over and use that as a down payment on something or strategize for something better. If you put it into real estate, the 375K doesn't earn interest, the equity increases just as it would whether or not the property was financed to a greater extent.

The example attached shows keeping 100K and putting 400K through the public charity in exchange for 507K back over 15 years plus an upfront tax deduction of 216K .

By using the tax deduction, you will reduce your capital gain due by 43% (the 216K deduction) so you will owe about 71K vs 125K. The 100K kept out more than covers your tax bill and leaves you with some to spend. You could use the 29K for a down payment.

The illustration is for 15 years, but can be shorter or longer. Here, you get almost 3K per month for 15 years. This should be enough to pay any mortgage off in the 15 year period if you want to buy a place. This also gives you a mortgage interest deduction to further reduce your taxes and 100K more than you put in back as payments. Most of the payments received will be income tax free, as it is a return of cost basis. Only the interest component is taxable. The funds are also protected from creditors during payout.

You save an immediate 54K in taxes and get basically a rent free place to live that's paid off in 15 years, as well as lower income tax bills and the appreciation which will also be tax free up to 250K.

Let me know if this makes sense to you. I think it really puts you way ahead of paying a lump sum and gives you a steady income stream (mostly tax free) you can depend on and a roof over your head that is basically paid for in total."

The capital gains could have been spread out over the 15 years if a strategy had been put in place prior to sale, but in this case, even after the fact a plan makes a huge difference.

Paula Straub
760-917-0858

Fill out a Qualification Questionnaire to determine how you can save capital gains tax.

Bad Advice Can Really Break You

As I've said before, the calls I dislike the most are from those individuals that have already sold their asset and are desperately trying to figure out a way to reduce their capital gains tax.

My business is not really driven by any particular event, such as tax filing time, but it is from February to April that a lot of people actually realize what their tax consequences are and panic.

In most cases, it is too late to do much but pay the piper. The tragedy is, the money is not always there to cover the bill.

A fellow in Florida sold a rental property last year at a nice profit. He had paid about 70K four years ago and sold for 800K. He owned it with another family member, and both had put quite a bit of money into fixing it up, and had taken out a number of high interest loans to finance it.

His tax preparer had told them they would only owe 5% in capital gains tax, so they each set aside 20K for taxes. After paying off the loans (including a large balloon payment), they each had about 120K left over.

Now with tax deadlines approaching, this same tax preparer has called them back and told them he was wrong in the estimates. What he didn't realize at the time he originally advised them, is that only a small portion was going to be taxed at 5% , and the majority will be taxed at 15%. He also neglected to mention the recaptured depreciation that will also be due, taxed at 25%.

They each will owe more than 40K in additional taxes come April 17. Neither party has this amount left over from their proceeds. They thought they were free to spend the amount left over after they set aside the original 20K. Luckily, they live in a state where there is no state capital gain tax or their problem would be even greater.

They will have to take out loans to pay the tax bill. All this could have been avoided had the right advice been given from the get go. The time to do research and seek specialized counsel is before the sale happens.


Paula Straub
760-917-0858

Fill out a Qualification Questionnaire to find out what options you have to save capital gains tax.

Dismantling a Business Isn't Always Easy

When people come to me to help them minimize their tax burden upon selling a business, they often don't have a clue what tax consequences await them.

Every business is different, but here a some of the factors that determine how much tax will be owed. It can become quite complicated, depending on the business structure, the assets of the business, the parties involved in the sale, etc.

• What entity structure does the business have? C-Corp, Partnership, S-Corp, LLC, Sole Proprietorship, etc. Each entity is taxed differently with different rules
• Who are the owners/partners/shareholders/members, etc. and how is ownership divided?
• What is the sale comprised of? Assets, inventory, real estate, client list, good will, etc.
• Will the entity be shut down on sale or remain intact?
• Do all of the partners agree on sales terms and goals?
• Will the sale be broken down by types of assets, or sold as shares of the company?
• If real estate, when was it purchased, how much debt is there, what is adjusted cost basis, how is the property titled, how much has it been depreciated and by what methods,etc.
• If the sale is within the entity, how do you plan to get the proceeds back to the owners from the entity? Will you get doubly taxed as capital gains and then income tax?

When a business is started and is growing, usually little thought is put into how it will eventually be sold, dismantled and distributed. It can get very complex, but an exit strategy is crucial to maximize return. The sale is often for retirement income, and it can be a very rude awakening to find out when it is too late that the money actually kept will not support you as you had hoped.

This is an area you probably don't want to take upon yourself without help from experienced professionals who can guide you to the best outcome possible.

Paula Straub

760-917-0858

Fill out a Qualification Questionnaire to determine what capital gains tax strategies will help you most.