What is it

1
What is it?

• Real estate is land and the buildings and
  improvements on land.
• By definition, real estate includes natural
  assets, such as minerals, under the land.
• Because of the obvious limited supply of land,
  especially in desirable locations, real estate
  has long been viewed as an attractive investment
  alternative.
• Real estate can be classified into four major
  categories
• Land
• Residential
• Commercial
• Industrial

2
What is it?

• Land
• Unimproved
• Farm land
• Recreational
• Ranches
• Subdivided lots
• Residential
• Single family dwellings
• Multiple family dwellings
• Apartments and condominiums
• Hotels and motels

3
What is it?

• Commercial
• Residential rental
• Office buildings
• Retail stores
• Shopping centers
• Specialty buildings
• Industrial
• Factories
• Warehouses
• Industrial parks
• Utility facilities

4
When is the use of this tool indicated?

• When an investor desires an investment with tax
  shelter potential
• When a long-term hedge against inflation is
  needed
• When a relatively constant cash flow is required
• When an investor is looking for long-term
  appreciation
• When the investor would like a tangible
  investment
• When the investor wants to make maximum use of
  leverage
• Lenders are willing to advance large sums of
  money on the security of real estate for long
  periods of time at relatively low interest
  because real estate is not only tangible and
  stationary, but is also reasonably stable in value

5
Advantages

• Real estate has numerous different tax related
  advantages
• Expenditures that are considered ordinary and
  necessary in the production or collection of
  income or in the preservation of its value as an
  investment are deductible.
• The cost of supplies, labor, and other components
  necessary to keep the property in good repair can
  be deducted.
• Real estate property taxes are deductible.
• A tenant leasing business property may deduct
  reasonable rental costs.
• Interest on the unpaid balance of the mortgage is
  deductible
• The full cost of buildings and real estate
  improvements is depreciable.

6
Advantages

• Gain on the sale of real estate can be reported
  over more than one tax year.
• This may allow the investor to defer the payment
  of tax until cash proceeds from an installment
  sale of the property are received
• Losses incurred on the sale of real estate are
  deductible.
• One parcel of real estate can be exchanged for
  another without immediate recognition of income.
• Tax-free exchange rules
• Upon the involuntary conversion of real estate,
  the investor does not have to pay any tax upon
  the receipt of cash from insurance or
  condemnation award.
• So long as the cash is reinvested in qualified
  property having equal or greater value

7
Advantages

• Liquidity can be obtained from real estate
  without paying taxes through a mortgage on the
  property.
• The cost of rehabilitating certain buildings or
  structures may qualify for a special investment
  tax credit.
• Passive activity tax rules
• Limit the ability to use real estate losses to
  offset income from other sources

8
Advantages

• Real estate is tangible.
• Real estate has historically proven itself as an
  excellent hedge against inflation.
• It tends to increase in value while prices are
  rising and the value of the dollar is declining.
• Each parcel of real estate is unique.
• Because no two parcels can share the same
  location, no two can be exactly alike.
• The monopoly each real estate owner has on each
  individual location is itself of value.
• Because of its great value as security for a
  loan, real estate enables an investor to obtain
  maximum potential leverage.

9
Disadvantages

• Real estate is almost always relatively illiquid.
• Difficult to convert to cash quickly
• Some degree of management is necessary with all
  real estate investments.
• Typically the investment in real estate is large
  in amount.
• Requires the commitment of investable funds for a
  long period of time.

10
Disadvantages

• Costs related to the purchase or sale of real
  estate reduce its value as an investment that can
  produce a short-term gain.
• Include transfer taxes, title insurance,
  appraisals, financing fees and points, title
  recording and notary fees, and sales commissions
• May run as high as 1015
• Real estate, by definition, cannot be moved.

11
Disadvantages

• Once land has been improved with a building, that
  improvement is often difficult and expensive to
  modify or remove.
• Referred to as fixity of investment.
• It is often difficult or impossible to assess the
  economic risks and projected return on a real
  estate investment with exactness.
• Because the investment return on real estate is
  significantly affected by the available tax
  benefits, such investments are most susceptible
  to the risk of challenge by the IRS.

12
Tax Implications

• All the ordinary and necessary expenses paid or
  incurred by a real estate investor during the
  taxable year in carrying on a trade or business
  are deductible.
• Include costs incurred in the production or the
  collection of investment income, as well as
  expenditures for the management, conservation, or
  maintenance of real estate property held either
  to produce income or for appreciation
• Routine repair and maintenance expenses (those
  that do not appreciably add to the value of the
  property) are deductible in the year the outlay
  is incurred.
• The cost of improvements must be capitalized.
• Added to the investors basis in the property
• Recovered through depreciation deductions

13
Tax Implications

• Amounts paid for real property taxes are
  deductible when paid.
• Construction period taxes must be capitalized and
  then amortized.
• Rental expenses for the use of business property
  are deductible currently.
• Interest paid to finance the purchase of
  investment real estate may be deductible
  currently.
• Rules may limit the deductibility of
• Construction period interest
• Investment interest
• Prepaid interest
• Points
• Passive losses / At risk rules

14
Tax Implications

• Land is not depreciable
• Improvements upon the land are eligible for
  depreciation deductions.
• Tax losses from depreciation deductions are
  subject to the passive activity rules.
• Tax on the gain upon the sale of real estate can
  be deferred.
• Installment sale rules permit an investor to
  delay reporting any gain or paying any tax until
  money is received.
• The law does not set a limit as to how long the
  parties can agree to extend the payment period.
• Tax law expects that the parties will provide for
  interest on the loan inherent in an installment
  sale.

15
Tax Implications

• Losses on the sale of real estate held for
  investment or used in a trade or business are
  generally deductible in the year incurred.
• Losses incurred on the sale of personal use
  realty are not deductible.
• Real estate held purely for investment is treated
  as a capital asset.
• Subject to capital gain / loss rules
• Real property used in a trade or business is not
  a capital asset.
• If held for the long-term holding period before
  being sold, such property is called Section 1231
  Property.
• Capital gain or ordinary loss

16
Tax Implications

• Like-kind exchange
• Under certain circumstances, it is possible for
  an investor to trade/exchange properties with
  another party and postpone all or part of the
  gain that would normally have to be recognized on
  a sale.
• Tax deferral may also be available upon
  involuntary conversion.
• Involuntary conversion is the destruction of
  property by fire or other casualty.
• It may also be caused by the condemnation of
  property by a governmental body utilizing its
  right to take private property and convert it to
  the use of the public.
• Any gain realized can usually be deferred if the
  investor reinvests the full proceeds in similar
  property within three years from the end of the
  year in which the proceeds are received.

17
Tax Implications

• An investor can convert part of the appreciated
  value of property into cash without either
  selling it or otherwise triggering a tax on any
  gain.
• Use property as security for a loan
• The cost of constructing or rehabilitating
  certain building or structures may qualify for a
  special investment credit.
• The properties eligible for this credit include
• Qualified low income housing
• Certified historic structures
• Buildings that were first placed in service
  before 1936

18
Alternatives

• Few investments are comparable to real estate
  because of its unique characteristics, location,
  potential for significant tax shelter benefits
  and relatively constant cash flow, and
  psychological comfort.
• Other investments, such as stocks, do provide a
  long-term hedge against inflation, the
  possibility of substantial appreciation, and the
  potential to maximize the use of leverage.

19
Where and How do I get it?

• An individual will typically purchase real estate
  in his own name directly from the seller or
  through a real estate broker or agent.
• Most real estate acquired for tax shelter
  purposes is acquired by purchasing an interest in
  a partnership or other investment entity.

20
Where and How do I get it?

• Real estate may be held by an investor in any of
  the following forms
• Outright ownership
• General partnership or joint venture
• Limited partnership
• Corporate (C corporation)
• S corporation
• Real estate investment trust (REIT)

21
Where and How do I get it?

• Outright Ownership
• Does not protect the individual investor from
  full personal liability relating to the ownership
  and operation of the property
• Full management responsibility
• All tax benefits and costs are personal to the
  investor
• An outright owner can convey the title to all or
  a portion of the property at any time without
  restriction
• Death results in the termination of the
  individual ownership form
• The property will then pass through the
  investors estate to his heirs or by operation of
  law to his joint owners.

22
Where and How do I get it?

• General Partnership
• Two or more individuals join together for
  investment purposes
• General partner jointly and severally liable for
  all the debts and obligations
• If a partner cannot pay his part of the
  obligation, the remaining partners are liable.
• Usually only a few partners are actively involved
  in operations
• Not taxed as separate entities
• Income, deductions, and credits flow through to
  the partners
• Losses deductible only up to basis in partnership
• Right to transfer interest in property is limited
  to the terms of the partnership agreement
• Death of a partner may cause termination of the
  partnership unless the partnership agreement
  provides otherwise

23
Where and How do I get it?

• Limited Partnership
• Limited liability for limited partners
• Most are heavily leveraged
• Limited partners not at risk may not be able to
  deduct partnership losses
• Limited partners cannot take part in management
• Vested solely in the general partner
• Income, deductions, and credits flow through to
  the partners according to their proportionate
  ownership

24
Where and How do I get it?

• Right to transfer interest in property is limited
  to the terms of the limited partnership agreement
• More restrictive than partnership agreements
• Death of a partner will not cause the termination
• Heirs succeed in interest
• Syndicated partnership
• Syndicator-promoters
• Investors

25
Where and How do I get it?

• Corporations
• Limited liability
• C or S corp
• Full liability stops with the corporation
• Corporate borrowing
• Personal guarantees
• Centralized Management
• Board of directors elected by shareholders
• Does not terminate at death of shareholder
• Indefinite life
• Enhanced transferability
• Shareholder can transfer any number of shares
• Restricted on S corp
• C corporation is a separate legal entity
• Must file its own tax return
• Corporate earnings paid to shareholders taxed
  twice

26
Where and How do I get it?

• S Corporations
• Treated essentially the same as a C corporation
  except for taxation
• Taxed similarly to a partnership
• May not have more than 100 shareholders
• All individuals or trusts
• No nonresident aliens
• Not more than 1 class of stock

27
Where and How do I get it?

• REITs (Real Estate Investment Trust)
• A vehicle specifically designed to facilitate
  large-scale public participation in real estate
  investments.
• Operates similarly to a mutual fund
• Having many investors, each contributing
  relatively small amounts of capital, enables the
  management of the REIT to make diversified and
  large-scale investments on their behalf.

28
What fees or other costs are involved?

• Brokers commissions
• Legal fees
• Title examination and registration fees
• Title insurance
• State and local transfer taxes
• Syndicated real estate venture
• Higher costs of investing than an investment
  where the owner finds, develops, and manages the
  property because these responsibilities are
  assumed by the developer/promoter.
• 16 to 26 of the amount invested
• In a private offering, total costs range from 13
  to 25.

29
How do I select the best of its type?

• Location of the property
• Soundness of construction and appropriateness of
  design for intended use
• Cost of capital
• Financing fees
• The cost of operating and maintaining the
  property
• Organization and offering expenses
• Sales commissions
• Construction costs
• Fees paid to the general partner for managing the
  partnership and the underlying investment
  property
• Projected cash flow and tax results from
  operations

30
Where can I find out more about it?

• Tax Facts on Investments
• Tax-Advantaged Investments
• Tax Planning for Investors
• The real estate industry offers many educational
  programs and courses
• The National Marketing Institute of the National
  Association of Realtors
• The Certified Commercial Investment Member
  designation
• Member of Appraisal Institute
• Farm and Land Institute
• Graduate of Real Estate Institute
• Certified Residential Broker