The real potential issue.

BawldGuy Axiom: In this age of uber-accessible information, finding answers to our questions is, generally speaking, not a major problem. What bites us where we sit are the answers to those questions we never knew to ask. Answers to unasked questions can be deadly.

One of the many ways you can look at your tax return is as a summary of the investment strategy(s) you’ve chosen to execute — purposefully or not. The question beggin’ to be asked is, 

“Is there a strategy that would’ve been far more beneficial for my circumstances?”

Over the years there’ve been countless times, when while perusing an investor’s tax return I’ve been able to pinpoint what appeared at first blush to be a less than optimal approach. Now understand, I don’t pretend to be a tax advisor or anything close, as a CPA is always close at hand when needed. But I do know quite a bit about the IRC as it relates to real estate investing. I’m like the birddog — smokin’ out weak links in an investor’s approach — if one exists. I tend to error on the side of, ‘We need to see what the tax guy has to say’.  There have been many, many times when I’ve literally stopped a tax related move by an investor, so as to prevent catastrophe. Most of the time those stories include botched or misunderstandings about tax deferred exchanges per section 1031 of the IRC.

It’s counterintuitive, but I’ve learned that half or more of the people who come my way either still do their income tax returns themselves, or use a tax preparer undertrained for the job. A surprise to many, I find that a large minority of investors who’ve hired CPAs, are unaware even the CPA isn’t fully cognizant of all the possible arrows available for their tax related quivers. This isn’t to say the CPA in question should know everything in the code. That’s an impossible dream if there ever was one. In fact, I’ll go a step further. I think CPAs as a group are unfairly charged, much like physicians and medicine, with knowing the entire tax code. Doctors don’t know everything about medicine, do they? Of course they don’t. Yet the same guy who wouldn’t dream of asking his buddy’s podiatrist about his shoulder problem, hires a CPA with strength in an area(s) other than real estate.

I have a friend who owns not only a couple retail operations but a nationwide wholesale firm. Wonder if a CPA expertly versed in the ins and outs of real estate tax law would be a solid choice for him? See what I mean?

Put another way, every year I personally witness, first hand, new clients who when introduced to a, you know, real estate savvy CPA, quickly learn they’re owed money from 1-3 past returns. Occasionally there are mistakes found that when rectified are pivotal in avoiding future unwanted IRS attention. Then there are the annual changes to what we think we already know about the tax code itself. Some years the changes are minor, other years they’re significant, and other years they’re literally worthy of front page headlines. Going into the last weeks before the Tax Reform Act of 1986 went into effect, the real estate investment world was almost literally operating a couple sandwiches short of a picnic. It was beyond chaos. More transactions closed in December of 1985 than pretty much any December I can remember.

With that picture in mind, think about all those real estate investors who realized how much better off they woulda been, had they done in 1985 what they’d planned for 1986. What a painful irony it musta been for those who had this epiphany while in their CPA’s office doing 1985′s tax return. I met more than a few of those folks in ’86, and it was indeed a sensitive subject.

I suspect Chuck Perkins might have a few thoughts on this topic. (That was me, not winning the battle to avoid dripping sarcasm.

So, thinkin’ we might put our heads together and improve your retirement plan? Sweet — gimme a call at 619 889-7100 and we’ll get started. I also like gettin’ emails, which is as easy as clicking on the Contact BawldGuy button at the top of the page. Have a good one.

Section 1031 of the Internal Revenue Code is one of the few tax deferral strategies available for real estate investors.  It is basically an “avoid tax on the sale” provision for real estate.  It should go without saying that in order for this provision to apply, the sales proceeds are reinvested in similar or like kind property.  However, reinvestment in like kind property is just part of the qualification for an exchange.  For investors who utilize entities for their property, the knowledge of this has come at inopportune times.  The use of land trusts, limited liability companies, corporations, or other entities may nullify an exchange if you do not have a complete grasp of the requirements under 1031.

Basic Rules For a 1031 Exchange

1. The Property You Are Selling Must Be Held For Investment or Used In Your Trade Or Business.   Investment property is straightforward.  It includes any real estate, improved or unimproved, held for investment or income producing purposes e.g., residential or commercial property, raw land, fractional interests, leasehold interests, easements, water or mineral rights, oil and gas interests, even development rights.  Property used in your trade or business includes real estate and equipment used by your business.  In an exchange this is sometimes referred to as “incidentals” depending on the type of property e.g., dump truck or excavator received to assist with developing the property acquired in the exchange.

2. The Replacement Property Must Be Like Kind.  Like kind does not mean an exact replica of what is exchange, i.e., a 3-bedroom rental for another 3-bedroom rental.  This prong is an intent based requirement and not a physical requirement i.e., if the property you are selling was held for investment then the property you are buying must also be treated the same.For instance:
   

   • An apartment building can be replaced with raw land or vice versa.
   • One rental property can be exchanged for two or more properties or the reverse.
   • A commercial building can be exchanged for land and equipment.

3. Replacement Property Title Must Be Taken In The Same Name as The Relinquished Property Was Titled.  If the property you are selling is owned in your name then the replacement property must be taken in your name. Similarly, if the property is held in a land trust, corporation, LLC or other entity, the replacement property must be taken in the name of the entity.

Planning Considerations for Entity Owned Property

The last rule can prove problematic for investors contemplating a 1031 exchange who currently own property in a land trust or LLC.  If financing will be involved in your acquisition of replacement property you do not want to show up to closing and be told to pull it out.  Your lender is not sensitive to your tax deferral strategy and will not close on the loan unless title is taken in your personal name.  You lender’s insistence on title will implode your exchange if you originally sold property held in an entity.  This is a violation of the 3rd rule “replacement property must be taken in the same name as the relinquished party was titled.”  Unlike other aspects of the tax code the IRS does not grant safe harbors for 1031 exchanges.

Pre-Planning is Your Solution

If you plan on entering into an exchange with property held in an entity and you anticipate acquiring residential real estate with the exchange proceeds, then my recommendation is to deed the property into your personal name prior to listing it for sale.  In so doing, you will ensure that the exchanged property will be sold in your name and acquired in the same. I recommend you adopt this strategy even if you do not plan on using financing for the replacement property to keep your options open.

After your exchange is finalized, you can transfer the property back into your entity.  Many CPAs will recommend you wait until the following tax year to make this transfer.  I disagree with this recommendation if you are transferring the property into a disregarded LLC.

Property Held in an Entity with Other Partners

The above approach is also useful in those situations when you have invested with other individuals and now it is time to sell the investment.  Frequently, one or more of the partners in a partnership desire to take cash when the property is sold rather than roll the proceeds into a replacement property. This presents problems that require careful planning and is not without tax risk.

To preserve your exchange options in a partnership setting, the prudent course of action is for the individual partners to deed the property out of the partnership and into the individual partners names in advance of the sale.  Deeding the property from the partnership to its partners as tenants in common does this.  In doing so, each individual partner is then free to sell or exchange his ownership interest in the real estate.  People familiar with 1031 exchanges will refer to this strategy as a “drop and swap”.

1031 exchanges are a great tool for tax deferral but with everything in real estate investing, it pays to invest in some pre-planning to ensure you are maximizing your benefits.  As I have stated before in previous posts it can be the little things i.e., an afterthought, that can disrupt the entire plan.

As my clients approach the April 15 filing deadline questions are raised as they look at their existing planning after conversing with their CPA. Invariably, a few will ask themselves if tweaks should be implemented for the upcoming year. My answer is always the same; you could, but at what cost?  I am not referring to money, although some changes will definitely cost you, but the cost from a practical investing standpoint.  As an active real estate investor who is currently in the process of closing on three properties in Texas, I am reminded that although asset protection is very important, so is practicality.

Many of my prior posts have discussed the importance of the Limited Liability Company or “LLC” when holding property long term.  The LLC not only provides great asset protection for real estate but can also protect your excess cash that patiently waits on the sidelines for its next deal (Bear in mind that you would never hold your investment cash with real estate. A separate LLC should be used to protect your savings.)  If you have followed some of these exact structuring techniques, how will it affect your future purchases or 1031 exchanges?  Hopefully not at all because simplicity is at the heart of your plan and you conduct your business accordingly.  Here are some ideas to consider when purchasing real estate when you have existing business entities or when you plan to sell via a 1031 exchange..

Preparing to Buy – “KISS Principle”

My axiom – “less is better when acquiring financing.”   I am not referring to the actual investment, but your personal preparation.  Some people make the mistake of standing out in a crowd when they really want to be left alone. When dealing with underwriters your structuring might be the thing screaming to “take a look at you” and from personal experience, this is never to your advantage.  Fact is, the majority of underwriters are not sophisticated investors themselves, so do not try to impress them with your knowledge or the complicated structuring.  It will only backfire.  Your primary purpose should be to obtain financing, so take these early steps to stay out of the way and ensure the process is as smooth as possible.

Here is my short punch list to expedite the financing process:

• Keep your FICO score above 700   You are aware that high credit card debt will negatively affect your FICO score.  High balances is a major contributor in reducing your score.  One solution to this problem is to open up a business credit card and transfer your existing personal balances to the new card.  If you obtain the proper bankcard, this balance will not appear on your credit report, thus improving your personal score.

• Reduce the Number of Personal Credit Cards   Keep fewer than 3 personal credit cards and those that you do hold, it is sound practice to keep your overall credit utilization below 50% on each card.

• Move Money Early     If you are holding your investing funds in a LLC for asset protection you should know that this ideal for asset protection but not so great for obtaining a loan.  When applying for a new loan, your lender will request 3 months of personal bank statements to track available funds.  If your personal account lacks sufficient funds for the purchase because you were planning to transfer money out of your LLC for closing, then “Houston, we have a problem.”

So, do you have a conversation with your underwriter and explain that the money is in your “savings” LLC and these funds will be used for closing? Doubtful, unless you like making life difficult for yourself. The underwriter will not grasp the concept of a savings LLC and will look it as a separate business. Therefore, you will be asked to provide 3 months of bank statements for your savings LLC, plus any tax returns for the LLC.  Guess what?  My LLC is a disregarded entity and it does not prepare tax returns.  Now you have compounded your problems because the underwriter will likely not understand how a LLC can be active and not file a tax return.  (Give him a link to my blog and tell him to get educated)  SOLUTION – Move the investment funds out of your savings LLC and into your personal account 3 months prior to looking for your next deal. Leave any discussion of your savings LLC out of the picture all together.  Less is better.

• Obtain Insurance   Find an insurer in the state where you expect to purchase so you can obtain a quote after your offer is accepted.  When looking for an insurer take the opposite approach when dealing with an underwriter — more is better. The more information you provided an insurer about your structuring the greater the likelihood you will obtain a policy uniquely suited to your needs. For example, you explain to him that you plan to place your investment into a land trust or LLC after closing.  Ask him if this will be a problem with the policy.  Also inquire about an umbrella policy for your various investments.  Each state has different regulations regarding policy issuance but it is possible to acquire this additional protection.  For example, in Washington State, Allstate will allow me to add up to 4 properties under my personal umbrella policy even though the properties are held in separate LLCs.

Working With Your Lender

In my experience, one surefire way to hold up underwriting is by providing too much information either intentionally by talking too much, or unintentionally via your tax return.  I can’t help a chatty Kathy but I can help you with your tax reporting.

The majority of LLCs I create are set up as disregarded entities i.e., the LLC does not file a federal tax return.  This is the ideal entity structure for the real estate investor because everything is reported on his 1040 Schedule E.  To the loan underwriter reviewing such a 1040 return, it will appear as if all of the investor’s rental real estate is held personally and not by a business entity.  (Again, keeping everything simple and practical.)  However, if have a CPA who plays in left field and suggests you to change your tax classification from disregarded to a “Partnership Tax Status” be warned.  I bring this up because I spoke with 2 clients this week who were inclined to do so after meeting with their CPA.

Both clients were told that partnerships have a reduced risk of audit, therefore such a change would be in their best interest.  Most likely the only person to benefit by such a change is the CPA who will obtain additional work through the preparation of 1065 partnership returns. However, regardless my opinion on what the IRS is looking at when it comes to audits, I can confirm that a loan underwriter will scrutinize your 1040 with multiple k-1s resulting from LLC’s that file 1065 partnership returns.  The net effect, each time you apply for a loan you can expect a request for additional documentation on each LLC in which you hold greater than 20% interest.  (Remember more is not better.)

This is the classic conflict between people who invest and those who only work with the investor.  If you aren’t investing, then making recommendations without regard to their practical implications is like instructing my wife on how to get the kids ready for school.  If you aren’t actively involved, you will not understand that the simple things can often pose the greatest hurdles.

After Closing

The deal is done and the property is in your personal name, so what do you do?  If you haven’t done so already, create a land trust and a LLC in the state where the property is located.  Deed the property into the land trust, and then assign the beneficial interest to your LLC.  Do not leave your insurer out of the loop. It is imperative that you have your insurer list your trust and/or LLC as an additional insured under your policy.  From this point on all rents should be paid to your LLC and accounted for accordingly.

Preparing to Sell via a 1031 Exchange

When selling via a 1031 exchange many of the same rules apply but they work a bit differently. Next week I will discuss how to properly structure your exchange when using entities.

BawldGuy again: And now, dear readers, you understand why Clint contributes to this site. The promised topic next week is near and dear to my heart, as lenders often cause problems during tax deferred exchanges when ‘things’ aren’t the plain vanilla to which they’re accustomed.

Welcome back, Clint.

Understanding the rules is important, but I find in many cases investors don’t understand some of the basic tax issues involved in an exchange.

Exchange Value

Some may wrongly assume that the exchange value is the selling price or profit made on the sale. Reality is that the exchange value is the net selling price of the property sold. There are a number of costs incurred in a sale including commissions, closing costs and recording fees.

It can also be said that the exchange value is the total of all cash received in the sale plus the total of all mortgage debt.

Boot

Boot is anything received by the investor that is either cash or some other type of non-qualifying property. Boot is almost always taxable so it is very important to understand what might be treated as boot.

An investor that receives cash in an exchange has received taxable boot. Heavy emphasis on receives.

Boot is more than the cash received though. Boot is also personal property received in an exchange. Personal property includes items like farm equipment received with a farm or say an RV that was left on the property.

Beware of mortgage boot.

One of the most misunderstood examples of boot though is mortgage boot. An investor who exchanges a property, and lowers their overall mortgage debt in the process, will have taxable boot equal to the amount of the mortgage reduction. It is not uncommon for this to come back and haunt investors.

An example

An investor has a single family rental that they would like to exchange for a 4-plex.

Relinquished Property

FMV of the house is 300K
Mortgage 250K
Commissions paid 18K
Closing Costs 7K

Acquired Property

FMV of 4-plex 300K
Mortgage 225K
Closing Costs 5K

Based on this information we know the exchange value of the relinquished property is 275K and the acquired property is 295K.

Taxable boot

There is no cash being received but there is a mortgage reduction of 25K that will be taxable.

BawldGuy Here: Didn’t wanna let this one go ’til I pointed out something about this topic most real estate investors pass over. The $25,000 that’s taxable in the example? You as the exchanger never received that cash in the exchange — but you’ll still owe the taxes.

In a random conversation last year during a break at an outa town conference, an investor came up to ask a question. Bottom line? He was about to incur well over $200,000 in boot directly due to what Chuck wrote about today. After his breathing return to near normal, he excused himself to call his real estate broker. Woulda loved to’ve heard that conversation. Got a call the next day from his wife, who promised me a big hug if we ever met.

There are three basic factors to consider when deciding to sell/trade or keep a local income property.

1. The true quality of it’s location.

2. The true quality of it’s construction.

3. The current age of the property.

Location quality

In my experience, this often morphs into too much of a subjective choice. A little over eight years ago when I decided San Diego income properties were not measuring up, it became imperative to establish a universally objective way to ‘appraise’ location quality. This ‘rule’ had to effectively and accurately assign the level of quality to any particular property in any state/county in the country.

The BawldGuy Mom Rule was born.

Mom turns 81 this spring. If I wouldn’t put her into a property I’m considering for a client, the property is no longer considered. No exceptions, no excuses — next property please. Before the rule was made policy, it was a coin toss as to what I’d find when a team member in another state would tell me it was ‘blue chip’. Or, a ‘slam dunk’ location. Or my favorite, “Jeff, it’s a no-brainer. You don’t even need to fly over to see it Trust me.”

Now? They know what’s comin’. They think twice before tellin’ me they’d put my Mom into this golden location. Funny how puttin’ a face on a policy, along with the the concept of ‘Mom’, changes everything in an instant.

So, back to your local portfolio.

Would you put your mom or grandma into your income properties to live alone? If the answer is an instantaneous and confident ‘yes’, you’re one up in your decision making process.

Construction quality

Let’s not play games with this one, OK? Most of us know quality vs crappola when it comes to construction. Is the foundation solid? How many corners were obviously cut during construction? Remember, you’re not lookin’ at the quality for now. You’re lookin’ at it for 15-30 years down the road. Is the quality of a nature that you wouldn’t mind owning it and possibly managing it in 2025? Ah, that puts a different spin on it, right? Not being straight with yourself on this topic will almost surely bite you in the butt later on. You’ve been warned.

The current age of the property.

The vast majority who call/write me say their properties were built in the 1980s or earlier. If you’re already 40ish, planning to retire at around 60, think. Those properties that’re 35 years old today, are gonna be over half a century old at retirement. Think operating expenses. They’re gonna be measurably more than they are today — duh. That directly impacts your bottom line retirement cash flow negatively. The older the units, the more likely it is you’re dealing with functional obsolescence. It could be floor plan, basic design, unattractive kitchen setup, and that’s just three simple examples. It directly affects both the number and quality of tenants you’ll be attracting.

Expanding operating expenses combined with a decrease in the size of the tenant pie, not to mention tenant quality, ain’t something you wanna generate on purpose. Yet that’s virtually guaranteed to happen in most cases. It’s a downward spiral I’ve not seen reversed in my decades of experience.

A final word

When appraising quality of location, here’s something to consider. Average to below average quality locations tend to go downhill over the long haul. Not always by any means, but more likely than not. Take a look at what were perceived as ‘average’ areas in your town when you were a kid. How are they perceived now? I know where I lived during my last couple years of high school was considered fairly average in the late 1960s. Now? When you say that city’s name, foreheads furrow, and frowns appear.

Neighborhoods that were universally thought of as ‘Average +’ are still considered as at least average if not the same as 30 years ago. If they were considered ‘blue chip’, they still are. Are there exceptions? You bet. But in my experience this has tended to hold true everywhere I’ve been.

What speeds the downturn of an area is when poor quality construction begins to ‘out’ itself. Word gets around, and before ya know it, it’s become common knowledge around the community at large. For the record, that’s never a good thing.

Add functional obsolescence to the equation? Admit defeat and get outa there.

Take a look at your local real estate investments with these three factors in mind. Be brutally honest in your analysis and conclusions. You’ll have a much better idea of what you should keep and what should be sold or exchanged.

Here’s the next thing you might wanna do: Call me. I need a fix — every day. 619 889-7100 will find me. Or, you can opt to click the Contact BawldGuy button up top. Either way, we’ll figure things out together. Have a good one.

Now for some real estate investment info to dazzle ya.

Charles Perkins is workin’ on some killer posts, some of which were by my request. ‘Course, I’ve learned to keep my topic suggestions with him as narrowly defined as possible. He tends to research the livin’ crud out of it, which makes me feel guilty sometimes. This is especially true the last month of the year — which, unfortunately is merely the precursor to ‘tax season’. For CPAs, tax season is that ugly stretch of roughly 105 days, when they sleep at least 3-5 hours a day, no matter what.

• He’s got some killer info on various aspects of depreciation.
• He’ll be listing some of the brand new surprises the IRS has for us — most if not all of which went into effect last Sunday.
• I’m makin’ a topic list for him. (Hope he doesn’t read this.)

John Park will be providing his usual stellar posts on self-directed IRAs/401Ks. The guy is always comin’ up with solid info. The clients who’ve used him, now swear by him. He’s the real deal.

David Shafer is by far the most knowledgeable pro I’ve ever met, when it comes to EIULs. He’s a wizard when it comes to EIUL structuring, which is the most crucial factor. I’m big time OldSchool, but Dave sometimes makes even me roll my eyes.

My first post this year will be on the topic of tax deferred exchanges. In fact, I may do a series on all the different strategies for which it can be incorporated into a well thought out Purposeful Plan.

Meanwhile, back at BawldGuy Ranch, operators are waiting to hear from you. Seriously, I need a fix. Call me at 619 889-7100 — OR — click the Contact BawldGuy button up top and gimme your story. I wanna hear it. Have a good one.

The landscaping is pretty cool, isn’t it? It’s not the norm in San Diego as many might think, but it’s not rare either. Makes for pretty good curb appeal, that’s for sure. Anywho, let’s get started.

A note here, for those readers who might think, even a little bit, that I picked this duplex for it’s crummy location etc. Not hardly, as I’d easily apply the BawldGuy Mom Rule to this property without the slightest hesitation. I know this area like the back of my hand, having lived in or nearby the neighborhood since 1967 when I was 16. What’s the BawldGuy Mom Rule for Heaven’s sake?

BawldGuy Mom Rule: Brown and Brown Investment Properties policy is that no client shall be advised to invest in real estate in which I wouldn’t put my 80 year old mom to live alone. Period, over ‘n out, no exceptions. Hence the name of the rule.

The numbers tell the story 

Here are the assumptions used:

• They owe $100,000 on existing loan.
• This is the only property they own other than their home.
• Sales/Exchange costs will run around 10%. (We’re in termite country.)
• The investor is 50 years old.

At $470,000 +/-, the net proceeds from a sale would be approximately $323,000. They’d be moved directly from escrow to the Accommodator used in the exchange. (Another post altogether.) It’s from that account the second half of the exchange will be executed.

Maintaining the Status Quo

Having reduced the loan to $100,000, and if he’s like most investors, he’s already done the math figuring out the income this duplex will provide in retirement, sans debt. It’s even money it’ll be less than his projected Social Security check. In this case, $1,455/mo., not even $18,000 yearly. Sadly, he’s probably better off than most of his family and friends. But for fun, let’s say it’s $20,000.

His net worth, (only this duplex) is $470,000.

If he exchanges to a superior market

Here are the assumptions used:

• He’ll be puttin’ 25-30% down on any property acquired in exchange.
• All loans obtained will be 30 year, fixed rate, at 5%.
• His ‘depreciable base’ will be increased by roughly $700,000 or so.
• All retirement income/net worth numbers will be those at acquisition — no value appreciation or increase in Net Operating Income (NOI) will be applied, as per my policy.

I’d trade his equity (tax deferred, per IRC Section 1031) into four small income properties. The cost would average out to about $255,000 apiece. Three of ‘em would be with 25% down payments. The fourth would be using, give or take, 40% down.

The NOI for each would be a bit over $19,000. But we’ll be happy with the $19,000 for this example. Using the BawldGuy Domino Strategy he’ll have eliminated debt from all four properties in time for his 65th birthday/retirement party.

His two retirement scenarios in a nutshell

Status Quo — $20,000 a year in retirement income. Little if any of it tax sheltered. The property is now 80 years old, which virtually always means higher expenses than significantly younger buildings. Duh. We have a longstanding joke about old buildings. It’s possible the only reason they’re still standing is cuz the termites have agreed to keep holding hands. Bada boom!

His net worth, as noted earlier, is $470,000 — a kindness I extend to the elderly as policy.

Exchange scenario: $76,000 a year in retirement income. Roughly a third of which would be tax sheltered for around 12 years or so into retirement. Better than a kick in the head, right? The buildings would be only 15 years old, about broken in. They’re family sized units (3 bedrooms/2 baths with 2-car attached garages for each unit.) so over time they would’ve had less tenants in each one. This results in less wear ‘n tear, and therefore lowered expenses overall.

His net worth in this scenario would be in excess of $1 million.

Income/Net Worth if he stays the current course — $20,000/yr — $470,000.

Income/Net Worth using my suggested strategy — $76,000/yr — over $1 million.

When I constantly beat the Get Outa Dodge drums, it’s cuz it’s a no-brainer. This guy would almost quadruple his retirement income while more than doubling his investment property net worth if he opted for the exchange route.

It ain’t rocket science by any stretch.

Hey! You don’t need rocket science to find me. Call 619 889-7100 and we’ll be chattin’ before ya know it. Or, if you like, click on the Contact BawldGuy button at the top of the page. Together we’ll figure things out and make it happen. Have a good one.

Today, it is easy to place too much trust in the tools we have at our disposal. I say this because it is far easier than many might realize to miskey and assume that our software will properly calculate, store and report on the information we put in.

What does this have to do with anything you say? Well, I find that many times people don’t realize a mistake has been made because they don’t have a clue of what the expected outcome should look like.

The Point

I know, I know. Get to the point. The point is income tax law can be quite complicated. Hear me out, I know you might be looking for Captain Obvious as the BawldGuy likes to say. Captain Obvious is close by, but I find that our reliance on software can lead to mistakes big and small.
It is easy for tax preparers and others to think that inputting all of your financial data into a program like TurboTax and carefully answering all of the questions will lead to a tax return that is correctly stated and report the least that should be paid to the IRS.

When returns get complicated

When taxpayers are strictly employees and have but a few deductions, then tax returns are pretty straight forward. It is when individuals get into businesses and investing activities that returns can become complicated. Real estate investors can have some very complicated returns.

One aspect far more complicated than some might realize is how gains and losses in real estate are netted and interact with gains and losses of other investment activities. There can be loss carry forwards, lookback rules, at risk limitations and differing treatments for similar property classed under different IRS code sections.

Tax software can make some of these things seem deceptively easy. Knowing that the various transactions have been treated properly is often the real problem. It is all about recognizing that the answer given resembles something that makes sense and recognizing when something is clearly not right.

While I hear some of you saying to yourself “Garbage in, garbage out,” it really isn’t that simple. You can have good information that is incomplete or mislabeled. Recognizing what the outcome should look like helps.

I was reminded about the complexities of the tax code as I helped a student this week review capital gains rules. It is not that most investors can’t find the answers. Instead, it is much like BawldGuy often laments — you can’t find answers to questions you do not even know to ask. For example, re: capital gains, what’s the adjusted basis? Is there any loan over basis? (A very important question when executing a tax deferred exchange.) Are there any losses you might be able to use in offsetting any gain? What schedule/strategy was used for depreciation? And on and on and on.

Knowing what your answer(s) should look like gives you an incredible edge over most who’re using software to get the job done. Garbage in, garbage out is bad enough. But when the taxpayer is literally unaware of data/answers they should be inputting, but can’t, therein lies the real reason so many out there aren’t getting what they think they paid for.

Anywho, I wrote about an ongoing case study over there this morning. It’s about combining several strategies dynamically to improve your end game results, which is spelled — Retirement Income.

BawldGuy Heads Up: Tomorrow (Wednesday) I’ll be out of touch with the world completely. Gettin’ some dental work done, and they wanna knock me out to do it. Works for me.

I’ll be available for calls beginning at noon Thursday. ‘Course by then I’ll be Jonesin’ for a fix. You can help me with that by callin’ me at 619 889-7100. Or you can, if you prefer, send me a note using the Contact BawldGuy button up top. Have a good one.

It talks about a couple guys who came into my office quite some time ago. Real folks, in the flesh, with real agendas and money to back ‘em. A father and his son — from different schools. I learned much about human nature from those two.

Anywho, here’s what I really think of cash flow vs capital growth — read and enjoy. I hope ya like it. Better yet, I hope it helps in some small way.

I’d love to talk with you about your retirement goals. Call me at 619 889-7100 — let’s put our heads together. Or, if you’d rather write me first, click on Contact BawldGuy up top, and we’ll start that way. Either way, do it quickly, cuz I need a fix. Have a good one.