Investors Scurry for Protection of Shelters : Receding Tide of Tax Reform Renews Interest

The $200,000-a-year Newport Beach business executive was in a quandary. Since January, he knew he needed to find some tax shelters to cut his anticipated 1985 tax bill, but all the uncertainty about tax reform caused him to wait. And wait. And wait.

Finally, reasoning that any tax-reform bill wouldn’t pass until next year, he took the plunge this month, investing the first $5,000 of an eventual $25,000 in a private equipment-leasing partnership that will give him an investment tax credit this year of as much as $20,000.

“He decided that he’d better do something now rather than waiting,” says Stan Ross, co-managing partner of Kenneth Leventhal & Co., a Los Angeles-based accounting firm that advised the Newport Beach executive.

Looking for deductions and believing that tax reform won’t be passed until next year, if at all, investors are beginning to show renewed interest in tax-shelter-oriented limited partnerships, tax experts say.

Although this mini-revival is not unusual when compared to the year-end tax-shelter stampedes of previous years, it nonetheless is surprising many tax-shelter operators and analysts who earlier this year believed that uncertainty about tax reform would keep many investors and partnership syndicators on the sidelines.

Sales Start to Rebound

Instead, sales of many tax shelters are beginning to rebound, and some syndicators say they may not have enough investments to meet the demand before year-end. Meanwhile, sales of limited partnerships that stress income as well as tax benefits are setting records.

“Over the last month, we have definitely seen a pickup in interest and a pickup in sales,” says Arthur H. Goldberg, president of New York-based Integrated Resources, a major partnership syndicator. A $60-million real estate shelter offered by Integrated Resources earlier this month sold out two months before it was expected to, he says. “As a result, we will have less tax-shelter product to offer in November.”

“As it becomes apparent we will not see a tax bill in 1985, many investors who were delaying making a move earlier in the year are now investing,” says William R. Walker, director of national business relations for Chicago-based Balcor Co., the nation’s largest syndicator of publicly registered partnerships. Sales are so good that the firm is now selling its third public real estate shelter this year; in past years demand was only high enough to sustain two such offerings, Walker says.

“There are an awful lot of people who need a write-off and they need it now,” says William G. Brennan, a Valley Forge, Pa., tax-shelter newsletter publisher.

Much of the year-end resurgence, tax experts say, is coming from high-income individuals most in need of tax shelters because of their high tax brackets, usually at the maximum 50% level. They were most likely to be on the sidelines earlier in the year, waiting for the outcome of the tax debate.

Urged to Invest

But now their tax advisers are urging them to invest, arguing that this year could be the last chance to take advantage of the investment tax credit and faster depreciation schedules.

Both President Reagan’s tax-reform proposal in May and the current plan by the House Ways and Means Committee would eliminate the investment tax credit and require that depreciation deductions be spread over longer periods, thus reducing write-offs in each year. But deals put into place this year are expected to be grandfathered under both House and Reagan proposals, preserving current tax treatment at least for 1985.

Another incentive to invest in shelters now, advisers say, is the prospect that income earned in later years from the deals would be taxed at lower rates--a maximum of 35% instead of the current 50%--proposed by both tax-reform plans.

Accordingly, “people are trying to get as much write-off in 1985” and take income in later years, says Ronald W. Weiss, chairman of the real estate group at Shearson Lehman Bros.

But many high rollers looking for hefty year-end tax dodges may be disappointed, tax experts say. The types of tax-shelter partnerships available today generally are more conservative and offer smaller write-offs, thanks largely to a fundamental restructuring of the limited partnership industry over the past two or three years. Such restructuring has been inspired by tax-law changes and increased scrutiny by the Internal Revenue Service.

To be sure, shelters are still available in a wide variety of investments--ranging from the more conventional deals in apartment and office buildings, equipment leasing and oil and gas, to the more exotic projects such as cattle breeding, hydroelectric plants, movies and cable television.

And they still come in the form of limited partnerships, in which a syndicator pools money from many investors--the limited partners--to invest in projects managed by a general partner who doles out the profits and tax benefits to the limited partners.

These partnerships also still come in two forms, public and private, with the publicly registered deals usually requiring a minimum investment of $5,000 or less while the privately placed deals usually require investors to cough up at least $50,000.

But tougher tax laws and an IRS crackdown have eliminated many abusive, multiple write-off deals. These abusive shelters--lithographic plates, master sound recordings and gold and silver mines were among the most notorious--often offered deductions as high as $10 for every $1 invested by grossly inflating the value of the assets used to generate deductions or by grossly inflating losses.

San Diego Scheme

In one such deal, three San Diego firms pleaded guilty earlier this year for promoting a shelter scheme in which investors paid $6,000 in cash for solar energy equipment but took investment tax credits and depreciation based on a $36,100 value for the equipment.

In another, a Washington businessman pleaded guilty for his role in a scheme which created phony losses on trading in government securities and precious metals futures contracts. Investors in that scheme included such celebrities as Woody Allen and Dick Cavett.

The Tax Reform Act of 1984 provided the IRS with greater powers to wage war against these and other abuses. The 1984 act required that every shelter with more than five investors, more than $250,000 invested or with write-offs of more than $2 for every $1 invested, must be registered with the IRS and given a number. In turn, taxpayers claiming shelter deductions must put that number on their returns.

Access to Lists

The law also gave the IRS the right to obtain lists of shelter investors and to send letters to investors in shelters that the agency deemed abusive. The letters warn the investors that any deductions claimed from abusive shelters will be disallowed and that their returns will be audited.

Since that provision took effect last year, the IRS has sent 16,653 such letters nationwide to individual taxpayers in 60 different shelter projects. Nearly $2 billion in back taxes, penalties and interest was collected by the IRS in 1984 under its crackdown, an estimated 125,000 abusive-shelter investors being slapped with an average assessment of $16,000 each.

“Tax shelters have become such a dirty word” because of the IRS crackdown, says Harry W. Abel, western regional tax director in the Los Angeles office of Seidman & Seidman/BDO, a New York-based accounting firm. “So many people have not received their deductions (that) they’re really scared.”

The IRS crackdown “has had a sobering effect on a number of people,” IRS spokeswoman Lowell Langers acknowledges.

Incentives Reduced

Meanwhile, lower tax rates, down from a maximum rate of 70% in 1981, have reduced incentives for the wealthy to seek multiple write-off deals.

As a result, today’s shelters have lower write-offs and generally “are not as crazy” as deals in the late 1970s and early 1980s, says Arnold G. Rudoff, director of partnership analysis for the accounting firm of Price Waterhouse. That is largely because the shelters have reduced borrowings used to buy assets at a much higher value than the investors’ cash alone could buy. Partnerships with less debt offer reduced interest and depreciation deductions, but also are less risky.

Today, shelters promising write-offs higher than $5 for every $1 invested are hard to find, and even when they are available, “everybody knows the IRS will be looking at them,” newsletter publisher Brennan says.

“The result is that a lot of investors seeking high write-offs may not have their appetites satisfied,” he says.

The shift away from multiple write-off deals has gone so far as to reverse the whole mix of public partnership offerings. Whereas two years ago the majority of public partnerships stressed tax benefits over economic returns, the majority now stress income and capital appreciation.

Economics Is Key

“It’s a whole new marketplace,” Goldberg of Integrated Resources says. He notes that four-fifths of his firm’s public partnership sales this year were in income-oriented products “that did not even exist three years ago.”

“The buzzword in the industry is economics. If you can’t show the investor economics, then there’s no sale,” says Steven R. Narker, manager of the tax-investment department at Merrill Lynch.

Attractive annual yields on many public income-oriented real estate partnerships of as much as 10% in the first year--with the potential to rise up to 20% in later years as rental income increases and the property is sold for a profit--have made real estate partnerships the most popular form of limited partnership. An estimated 600,000 American households are investing in them annually, many through their individual retirement accounts and Keogh plans.

Meanwhile, many partnership syndicators have used more aggressive marketing tactics to sell their deals and have sweetened their terms. They are offering lower fees and pledges to compensate for reductions in investment values should tax legislation be enacted. Syndicators also are offering greater diversity of investments, including partnerships in mobile homes, health-care facilities and hotels.

“Investor awareness and understanding (of limited partnerships) is much higher,” contends William H. Elliott, chairman and chief executive of Angeles Corp., a major Los Angeles-based syndicator.

Big Jump Expected

These and other factors will help boost sales of publicly registered limited partnerships to $11.6 billion this year, up 34% from last year, predicts Robert A. Stanger & Co., a Shrewsbury, N.J.-based partnership research firm. Sales in every category of public partnerships are up, even oil and gas, which, despite the world energy glut and depressed energy prices, is up 0.9% in the first nine months of this year over the same period in 1984.

Even sales of public limited partnerships oriented toward tax benefits are expected to grow this year. Stanger predicts a rise of 15% to $4.47 billion from $3.87 billion in 1984. Some categories are up dramatically so far this year, including research and development partnerships (up 130% through September compared to the like period last year), film tax-shelter partnerships (up 265%) and cable-TV shelters (up 107%), Stanger reports.

Nevertheless, some syndication firms which did not offer income-oriented partnerships are suffering from slumping sales as a result. Oakland-based Equitec Financial Group, for example, says it will report lower quarterly earnings and has initiated a cost-cutting program because of a slump in sales of its leveraged real estate partnerships.

But because public partnerships tend to have lower write-offs than private deals, the small investor looking for some year-end tax relief may have to rely on tax shelters other than limited partnerships, such as IRAs or company savings vehicles commonly known as 401(k) plans.

“There is no place you can get a deal with a substantial write-off with only $5,000,” Brennan says. “I don’t see how you can prudently do it, and I couldn’t find such a product anyway.”

Offer Higher Risks

Small investors willing to take higher risks could find some public oil and gas shelters offering first-year deductions of as much as 75 cents for each $1 invested, Brennan says. Also available for the daring small-time investor are public research and development shelters offering first-year write-offs of as much as 60 cents on the dollar, he says.

But few, if any, public partnerships offer write-offs of more than $1 for every $1 invested, he says.

Thus, the new surge in renewed interest in shelters appears to be centered in private placements. These private deals tend to be the exclusive domain of the wealthy, given their usual minimum investment requirement of $50,000 and a Securities and Exchange Commission requirement that no more than 35 of the investors have net worth of less than $1 million and annual income of less than $200,000.

Goldberg of Integrated Resources reports that his firm’s private placements had been down as much as 30% this year before picking up in recent weeks.

Neil Alexander, a Los Angeles investment adviser, says available multiple write-off private placements include computer equipment leasing deals offering deductions of as much as $4 for every $1 invested. Some real estate shelters offer write-offs of as much as $3 for each $1 invested, he says.

But tax experts warn that getting into a multiple write-off private placement partnership can be risky, particularly as the year draws to a close.

Given high vacancy rates and overbuilding of office buildings in some cities such as Houston, Denver and Atlanta, highly leveraged real estate partnerships--those which generally finance more than 80% of the value of the investment--”are going to have problems if rental rates drop or interest rates rise,” Brennan says.

The buildings owned by the partnership may not generate enough rental income to make payments on the loans, thus causing foreclosure or sale of the property at a distressed price, he says.

Such a potential disaster was illustrated by the recent collapse of Alexandria, Va.-based Equity Programs Investment Corp. Its 341 limited partnership tax shelters failed to make payments on mortgages and mortgage-backed securities in August.

The collapse rocked the mortgage-securities and mortgage-insurance industries and led state authorities to seize control of both EPIC and its parent, Bethesda, Md.-based Community Savings & Loan Assn.

By contrast, unleveraged partnerships which buy their properties with all or nearly all cash may also suffer from lower rents and slower price appreciation, but are not in danger of foreclosure and can wait to sell their holdings under more favorable market conditions.

Another danger of leveraged tax-oriented shelters is that the value of the shelter could decline in later years if tax rates are lowered, says David G. Shulman, director of research planning at TCW Realty Advisers, a Los Angeles real estate investment management firm.

Don’t Wait Too Long

Tax experts also warn investors to beware of last-minute deals put together by disreputable promoters trying to sucker desperate investors willing to do almost anything for a big write-off.

“There is an old brokers’ saying that, ‘If you don’t buy a tax shelter before Thanksgiving you get a turkey,’ ” Balcor’s Walker says. “Right now there’s pretty slim pickings.”

Such warnings, however, don’t appear to be stopping some desperate high-bracket taxpayers, experts say.

Demand for higher write-off deals is at its highest since 1978, Brennan says, citing a flurry of calls that he has received recently from worried taxpayers seeking deals that he calls “preposterous and absurd.”

One such investor wanted a deal with a 7-to-1 write-off, Brennan says. “It’s been a while since we’ve gotten those kinds of calls.”