Don’t Carry Non-Paying Tenants
QUESTION: I own a small neighborhood shopping center. One of my tenants, a coffee shop, got behind about six months in rent. When I started eviction, the owner filed bankruptcy on me.
After delay after delay the tenant finally moved out and left owing me 11 months of rent, and I probably won’t get a dollar from the bankruptcy court. I just thought your readers who own rental property should know it doesn’t pay to be nice to tenants because they will take advantage of you like mine did.
ANSWER: I also have learned the hard way that it doesn’t pay to be nice to tenants who can’t pay their rent. The most I let a tenant get behind in rent is 30 days, but usually I begin eviction within 15 days after the rent was due.
Don’t Buy Property on Gross Multiplier Basis
Q: I haven’t bought an apartment building in at least five years. But last week a real estate agent who sold me a building years ago phoned to tell me about a new listing next door to my apartment building. She said the property is for sale at 8.5 times gross income. Is that a good deal?
A: I don’t know. Forget you ever heard those dirty words gross multiplier. The building is priced at 8.5 times its gross rental income. But the flaw is the gross multiplier doesn’t consider the property expenses.
To illustrate, two identical buildings with identical rental income could be priced at 8.5 times the gross rent. However, if one has individual utility meters, but the landlord pays the utilities at the other building, the one where the tenants pay the utilities is obviously the better buy.
Never use the gross multiplier. Instead, buy income property based on its net income. Use the “cap rate” method which capitalizes a building’s net income. The local cap rate is determined by recent sales prices of similar nearby buildings.
Free Management Not Worth Eventual Cost
Q: I own several large apartment buildings. Last week I received a letter from a property management company offering to manage my property for free.
The letter said the management company does not charge to collect rents, but does charge a leasing fee when an apartment becomes vacant. Also, the management company wants the listing if I decide to sell the property. What do you think of an arrangement like this?
A: Not much. I’m sure you will get your money’s worth from the so-called free property management. It is very obvious the management company will earn its profits from the leasing fees and from the sales commission if you decide to sell.
To check out this firm, ask for names of three of its current clients and phone those people to ask if they are satisfied with the company and if they have any complaints.
Delayed Exchange Ideal for This Swap
Q: I own about a dozen small residential properties, mostly four units each. They are a pain to manage. But I have more than $1 million equity in them. It occurred to me I should combine them into one large property which can have a resident manager. Can I do this in a tax-deferred exchange?
A: Yes. You can make tax-deferred exchanges of your properties for one large one. This is an ideal situation for a Starker delayed exchange, authorized by IRC 1031(a)(3), since it is unlikely that you can make a direct trade for a large building.
Don’t Make Offer Unless Serious Buyer
Q: There is a vacant old house near where I live. It is on a large corner lot, which is suitable for a convenience grocery store. I made an offer to buy this property and the seller accepted.
But I only put up a $1,000 earnest money deposit with a 180-day closing period. Do you think I can get out of this deal, since it doesn’t look so good after I investigated the costs and problems closely?
A: Shame on you for making a purchase offer to buy a property you really didn’t want to buy. A better approach would have been to obtain a purchase option.
Now, if you don’t complete the purchase, the seller might sue you for damages, since his property was tied up for six months and he might have lost another profitable opportunity to sell the property.
Depreciation Must Be Taken on Property
Q: I had substantial losses in 1989 in my business, so I do not need any tax loss from the depreciation of several rental houses I own. How should I show on my 1989 income tax returns that I am not deducting any depreciation for 1989?
A: Sorry, but after you acquire depreciable real estate held for use in a trade or business you must keep depreciating it. Although the depreciation won’t save you any income taxes, you must still reduce the basis of your depreciable property every year.
However, you can carry over unused tax losses from your investment properties. Many investors have built up substantial losses, which can either be used in future tax years or you can use them to offset realty sales profits. Please consult your tax adviser for full details.
Fixer-Uppers in City Offer Profit Potential
Q: I believe real estate offers the best long-term investment in growing cities. But I am receiving conflicting advice as to whether to invest in older property, such as a rental house, or a brand-new building that probably won’t need much repairs. What do you advise?
A: Although you will usually have fewer headaches with new buildings, there often isn’t much profit potential in such property. I recommend older structures which can be profitably upgraded to increase their market value by more than the cost of the improvements.
Depreciation Allowed on Straight-Line Basis
Q: Years ago I used to invest in apartment buildings, but I sold them. Now I am thinking of buying investment property again. I recall something about Congress changing the rules on depreciation. Please clarify the choices as to how many years I can use for depreciation?
A: You don’t have any choice. Current law says you must depreciate residential rental property over at least 27.5 years and commercial property over at least 31.5 years. Only straight-line depreciation is available. No more accelerated depreciation. Please consult your tax adviser for more details.
Get Tax Advice Before Abandoning Property
Q: I am a partner in a group that owns an apartment building in Texas. It is now worth less than the mortgage balance. Some of the partners think we should stop making mortgage payments and let the lender foreclose, since we have virtually no chance of selling it for what we owe. It is losing money and we can’t afford the property taxes. Do you think we should abandon the building?
A: Before you decide, please consult your tax adviser. In the situation you describe where you will be receiving mortgage relief, if your depreciated book value for the property is below the mortgage balance, the IRS says you will owe profit tax on the difference.
Lease-Option Buyer Gains Tax Advantage
Q: I am acquiring an apartment building on a 30-year lease with an option to purchase. The reason for not acquiring the title is to avoid having the mortgage lender enforce the due on sale clause on the 7.5% interest rate mortgage.
I will make my payment to the seller who will then pay the mortgage lender. However, the seller says he is entitled to keep the depreciation deduction, since he will still hold the legal title. But my CPA says I should get the depreciation writeoff, since I am the “equitable owner” even though I am not yet the “legal owner.” Who is right?
A: Your CPA is correct. For income tax purposes, the IRS recognizes a lease of 30 years or longer, coupled with an option to purchase, as the equivalent of a sale. Since the IRS recognizes this as a sale, you are entitled to the depreciation tax deduction.
This is much like a land contract or contract for deed where the seller retains the title, but the buyer is the equitable owner entitled to all the income tax ownership benefits.
Incidentally, the way lenders learn about a title transfer is from the new fire insurance policy. You may wish to keep the old fire insurance policy in the seller’s name, but with you added as an additional loss payee.
