The cliché about partial knowledge often being more dangerous than downright ignorance has proven true in my professional experience. We humans seem to desire absolutes when we learn new things, especially when it comes to investing. Allow me to smash that fantasy once and for all. The old saw sayin’, “The only absolutes are death and taxes” is as real as a heart attach. Ironic, cuz the consequences of behaving as if things are narrowly defined in the Internal Revenue Code as infinitely incontrovertible truths of the universe, impervious to changing facts, are sometimes heart stopping.
Consider the following. I wrote about this earlier this year, but in the last several weeks, there have been similar requested consults. Sadly, a couple of them came to me too late for me to really help much. Pay attention, cuz this particular story gets played out every year across the country. Gettin’ a huge tax bill as a complete and shocking surprise is no fun — I know, I experienced it as a young man. It was gut wrenching to say the least.
This particular story has a pretty happy ending — not always the case, unfortunately. Earlier this year an agent called me out of the blue. I’d never met them, but they’d been reading my stuff here and over at BloodhoundBlog.They had just one question, which led to a boatload more, as usual.
She said — “My client is selling one of their rental properties, a triplex, for a sizable loss — about $50,000 give or take. It’s in escrow and scheduled to close on or before August 5th — next Wednesday.”
Their numbers seemed to jive with the set of facts she then had given me. But hard earned experience has taught me to ask the seemingly unrelated questions, as those answers, if they raise red flags, often lead to a complete change of horses in the middle of the escrow stream.
I asked one question: “Did your client exchange into the property in question?”
She didn’t know. I told her to hang up, get the answer, and call me back with the pertinent facts if the answer was yes. You already know the answer, right? It was indeed acquired through a tax deferred (1031) exchange. In fact, from the facts they passed on to me, the gain deferred back then was well over $200,000 — not including any depreciation recapture — from then or now.
Holy Tax Bill, Batman!
BawldGuy Axiom: It’s not the answers to the questions you ask that get you. It’s the answers to the questions you never knew to ask that can end up haunting you for years. Put another way — You can’t know what you don’t know. Duh
The actual numbers were of course not precise to say the least, but I was able to give her a very rough idea of what the consequences were likely gonna be.
The so called ‘loss’ was gonna disappear in the consuming heat of the earlier deferred gain. The long and short of it is, a tax bill that will surely top $30,000 before any depreciation recapture is added to the mix, which of course it will — and at a higher rate too.
The happy ending? They’re converting the sale into an exchange, which will avoid the very nasty surprise awaiting them. It wasn’t their preference, but they’d much rather do that than write that kinda check. They eschewed the other option of canceling the sale outright, as the buyer had performed as agreed, and as the agent said, the seller told her that wasn’t an option. Good for them.
Over the years, this script, or something similar has played itself out more times than you might expect. Again — you can’t know what you don’t know — which means you can’t get critical answers to questions you simply don’t know to ask. It’s often a tragic Catch 22 for real estate investors.
The solution of course, is to find someone who not only knows the questions, but most of the answers as well. If they know all the answers, run, don’t walk to the nearest exit. Nobody knows all the answers.
Let’s talk and find out if there’s a happy ending in your near future. Call me today at 619 889-7100 and we’ll get started. Have a good one.
Related posts:
- The Facts About a Strategy For Offsetting Capital Gains – Not To Mention Steering Clear of Taxes
- Real Estate Investing — Capital Gains Taxes — The Economy
- Surprise Surprise Surprise — B of A Buys $2Bil of Countrywide
- Real Estate Investors Movin’ Capital From California To Texas
- The Questions Many Real Estate Investors Simply Don’t Know To Ask
About BawldGuy
It really amazes me that people will get into the BUSINESS of real estate investing without establishing the appropriate team to guide them through. These guys got lucky and saved a bundle (for now), but not everyone is so lucky. These are the kinds of lessons that you want to read about instead of experiencing yourself.
To make sure that happens, you must do your due diligence, research, knowledge building, planning, team building, and only when you’ve got ALL of these in place, should you get into the business of real estate.
Nice work saving these guys!
Hey Joshua — And the congregation said Amen!
The unspoken problem with due diligence and so-called research and team building, is of quality.
All CPA’s are not created equal. Research by an ‘investor’ with a couple years experience more likely than not to have more gaps than gold. The proliferation of the ‘information age’ has had a paradoxical affect on those relying on books, internet research, etc.
Your point is well taken. I’d only add that the team building should be the gold standard — not the amateur research, learning curve. More trauma is generated by those equipped with 80% of what they need to know than most realize.
Catch ya later.
Readers: Click on Joshua’s name above his comment and check out an incredible real estate investment blog.
I’m with you 100%. I’ve had experience with team members that weren’t fully equipped to give me the right answers, and it cost me. It isn’t just about building a team, but building one with people who are fully equipped to answer ALL of your questions the right way.
BTW – Thanks for the plug Jeff!
Jeff,
I would love to know your perspective on finding the right team to assemble.
How do you go about determining if a CPA/attorney/real estate professional has the knowledge or experience to keep an investor from these types of pitfalls?
Great post…
Next to developing a plan, building a team has got to the most important.
Regarding finding a specific professional… ask around. Attend local real estate association events and network. Many agents, title attorneys, and lenders can make recommendations.
Jeff,
Now you know the anguish I went through when in the spring of ’06 I weighed the consequences of “cashing out” of a fully depreciated property and a Starker to a sane investment.
Next time I’m not going to let LTV debt go too low.
That example is why Purposeful Planning must be so flexible.
Even if you’d refinanced, it most likely would’ve resulted in being caught in a ‘loan over basis’ situation. Not necessarily terrible, but not something you strive for.