Guidelines for Picking Property Manager
QUESTION: I recently inherited a 44-unit apartment building from my late aunt. It is professionally managed, or I should say mismanaged, by a large, well-known property management company, which charges me 7% of the gross rents. The woman in charge of my property is a Certified Property Manager but she does not seem very competent. All the company does is deposit the rents collected by the resident manager, who calls a plumber or handyman if something is wrong. How can I find a truly professional management company that will do a good job of keeping the building full and well-maintained as well as giving me prompt monthly financial reports?
ANSWER: In my opinion, the most thankless job in the world is being a professional property manager. This person is caught between the landlord who wants to maximize net income and the tenants who think the rents are too high and the service level is too low. As you discovered, a Certified Property Manager with extensive professional training is not always a top quality manager. However, that CPM designation is usually indicative of a well-qualified property manager.
To find a professional property manager who is competent and who you like, I suggest (1) if you are a member (and you should be), consult the local apartment owner’s association for recommendations, (2) ask fellow apartment investors for their recommendations, and (3) interview some of the property managers listed in the phone book yellow pages. Of course, before hiring a new management company, be sure to verify the manager’s recommendations from current clients.
How to Allocate Land Value for Depreciation
Q: I recently bought my first investment property, a six-story building. For income tax purposes, I want to allocate the purchase price between nondepreciable land value and the depreciable building value. My CPA says to use the local property tax assessor’s land-to-building ratio. However, this is about 85% for land value and only 15% for building value, due to its being in a commercial area. A friend told me he used the building’s replacement cost as determined by his insurance agent and had no trouble when he was audited by the IRS. Do you agree?
A: Yes. Most tax assessors could care less about the ratio between land-and-building values. Although using this ratio is an audit-proof method, it is often very unfavorable. Any other rational method of making the allocation is usually acceptable to the IRS, such as a professional appraisal or the building’s replacement cost for insurance purposes.
Similar Properties for Tax-Deferred Trade
Q: We are selling a rental house and buying a larger house, which we would like to use as our personal residence some day. Our tax adviser told us to trade the rental house for the house we are acquiring. But she is uncertain how long it must be rented after the tax-deferred exchange?
A: Nobody knows the answer to your question. You can make a tax-deferred IRC 1031 exchange of the rental house for a larger rental house with equal or greater equity. Of course, you cannot take any “boot,” such as cash or net mortgage relief out of the exchange.
Both properties must be “like kind.” That means they must be held for investment or use in a trade or business. Virtually any property can qualify except your personal residence or “dealer property,” such as a home builder’s inventory of new houses.
Most CPAs and tax advisers recommend renting the acquired property at least six to 12 months before converting it to personal use. However, your tax adviser is correct the tax law gives no specific guidance on this issue.
Why Price Left Off in Tax-Deferred Exchange
Q: I owned a vacant lot that fronts on a busy highway. An investor asked if I would like to sell my lot. I said no. Then he asked if I might like to trade for some apartments that would provide me with income. More important, I decided to move my son in as the manager to give him something to do. We traded my free-and-clear lot for the apartments and, I assumed the existing mortgage. But prices were never put on either property. Now I am wondering if I have any tax to pay on my lot. It only cost me about $7,000 many years ago and is now worth over $250,000. Do I owe tax?
A: If you did not receive any taxable “boot,” such as cash or net mortgage relief, you do not owe any tax on the tax-deferred exchange. Prices are often left off the properties in tax-deferred exchanges. This way each trader thinks he got a good price. As long as you trade up to a more valuable property and trade equal or up on the equity, no boot was received. Please consult your tax adviser for further details.
Severance Damages in Eminent Domain
Q: I own a small neighborhood shopping center. The city may widen the street and take part of my parking lot. They have made me a fair offer for the square footage, which will be taken by eminent domain condemnation. However, instead of being able to park two rows of cars, now only one row will be able to park, thus hurting the volume of my shopping center. Is there some way I can be compensated for the diminished value of my shopping center since I will now have much less parking?
A: Yes. When part of a property is condemned by eminent domain, the award should also include severance damages to the remainder of the property that wasn’t condemned but is diminished in value. Consult an attorney experienced in condemnation matters because you need professional help to pursue your damage claim with the city.
Leases Usually Benefit Tenant, Not Landlord
Q: A few months ago my wife and I bought a six-unit apartment building. Our first vacancy will be coming up next month. We are discussing whether to offer the new tenant a one-year lease or if we should go month-to-month. Which is best for us?
A. Many tenants prefer one-year leases because the rent cannot be raised during the term of the lease. Most landlords think a one-year lease protects them from the tenant moving out during the year. However, experienced landlords know that a tenant who wants to move is going to move whether or not there is a lease in effect.
Personally, I don’t care if the tenant wants a one-year lease or a month-to-month rental. I let the tenant decide. Most select the one-year lease, but after the lease expires, then my lease terms provide it automatically converts into a month-to-month rental agreement. Please consult a real estate attorney for further details.
Be Wary of Real Estate Syndications
Q: I have a large trust account at a major bank. The trust officer sent me a prospectus on an out-of-town apartment building limited partnership offered by an unknown syndicator. I can invest $25,000 or $50,000 and the yield is projected at 16%, but the syndicator will take half. What do you think of this 10-year investment?
A: Not much. Frankly I am very surprised a bank trust officer would recommend such a highly speculative investment far from your home at such a low yield of 8%. You can do better than that in a bank CD.
The days of real estate limited partnerships were killed by the 1986 Tax Reform Act, so such investments are rarely offered today. But perhaps you are a very wealthy man who can afford to lose $25,000 or $50,000 petty cash. If so, don’t say I didn’t warn you about the very high risk.
How to Convert Home Into Income Property
Q: Several weeks ago you told another reader she could make a tax-deferred exchange of her rental house for an apartment building. As I have about $100,000 equity in my home, I would like to make a similar exchange without having to pay tax on my profit. However, you said a personal residence is not eligible for tax-deferred exchanges. If I move out of my house and rent it to tenants, would it then be eligible for a tax-deferred exchange?
A: Yes. You’ve got the right idea. However, nobody knows for sure how long your house must be rented to a tenant before it is eligible for a tax-deferred exchange. Most tax advisers suggest at least six to 12 months before trading your rental house for other “like kind” investment or business property. Please consult your tax adviser for more information.
