Sunday, November 27, 2005

Are Trusts Good for a Real Estate Investor's Asset Protection Plan?


Real estate investors seem to have an insatiable curiosity about how to protect their assets. New investors sometimes get so hung up on deciding between the many options they never get around to investing.

No doubt it is a confusing mess. There is a whole alphabet soup of entities to choose between…LLC, LP, FLP, “S” corporation, “C” corporation, trusts, general partnerships…They all sound so official and important.

You could spend many weeks researching all of the different entities, and still not arrive at the best answer. Worse yet, you do not make money as an investor figuring out how to structure your portfolio. You make money negotiating with sellers, lenders, and buyers. Every minute you spend deciding what entity to use and setting up that entity is a minute you have not spent on a money making activity.

I have a set of answers I have put together based upon 15 years as an investor, ten years as a real estate attorney, and many weeks of study of all the alternatives. I share that system which involves corporations and limited partnerships with my students in every seminar and set up clients with the entities they need a few times a week. In this article I want to share with you some of my thoughts on trusts for the real estate investor.

Land trusts are certainly a hot issue in investing. Some national speakers extol their virtues but many investors find when they return home their attorney, insurance agent, title agent, and banker poo-poo the idea of trusts. I generally dislike trusts because they complicate your investing and depending upon which trust you use either cause you to pay high taxes or provide little asset protection.

Background on Trusts.
There are two basic kinds of trusts: revocable; and non-revocable. Revocable trusts are sometimes referred to as “living trusts”, “grantor trusts”, “land trusts”, or “Massachusetts trusts.”

There are three roles to be played with both kinds of trusts – the role of trustor (sometimes “settler”), trustee, and beneficiary.

A quick description of a trust is that a trust is a legal entity where the “trustor” places property with a “trustee” who holds and administers the property for the benefit of the “beneficiary.”
The “trustor” or “settler” is the person who puts the property into trust. The “trustee” is the person who administers the trust including managing the property held in trust, filing tax returns as necessary, and record keeping. The “beneficiary” is entitled to the benefits of ownership (i.e.; the profits). Sometimes all three roles are played by one person which is the proper way to run a revocable trust.

Differences between revocable and non-revocable trusts.

The two kinds of trusts differ in their permanency, tax consequences, and asset protection.
Permanency. Revocable trusts are not necessarily permanent. The settler can “revoke” or cancel the trust by removing the property from the trust. Non-revocable trusts are permanent because the settler cannot readily remove the property from the trust. Sometimes a court order is required to remove the property from a non-rrevocable trust.
Tax Consequences. Revocable trusts do not pay separate federal taxes when the settler is the sole beneficiary and trustee. The trust income is reported on the settlor’s schedule 1040. Non-revocable trusts DO pay their own taxes. The rates vary from time to time and can be very high. Calculating the tax bill for an irrevocable trust can be complicated and the rules are found in subchapter “J” of the Internal Revenue Code in sections 641-692. Tax treatment of trusts under state law varies. In Pennsylvania some trusts are subject to the “Capital Stock Tax” which causes business trusts to pay tax on its income and assets.
Asset protection. Revocable trusts where the settlor is the trustee and beneficiary generally provide little in the way of asset protection. Revocable trusts do provide sturdy asset protection.

Benefits v. Drawbacks.
Benefits. All trusts provide some privacy (the beneficiary is generally private information known only to the trustee). Non-revocable trusts provide strong asset protection. Creditors of the beneficiary cannot take the property held in trust nor can they take the income generated by that property. If you are using a revocable trust you will not pay extra federal tax.
Drawbacks. Practical problems abound when you try to use trusts. Title companies often do not want to insure title, property and risk insurance companies will not offer property and liability insurance, and banks do not want to lend to trusts. If you use a non-revocable trust which provides good asset protection you will pay taxes twice.- first the trust will pay taxes on its income then the beneficiary will pay taxes on the income he receives. If you use a revocable trusts to avoid the taxation then you will not receive good asset protection.
When to Use Trusts.
Trusts are advisable as part of an estate plan developed by a competent attorney and accountant. Trusts are NOT advisable as vehicles to hold real estate investments. There are much better entities to use to hold real property for investment. Generally those entities will be limited liability companies (“LLC”), corporations (sometimes “S” sometimes “C”), or limited partnerships (“LP”). Those entities carry different tax burdens and tax minimization opportunities but all of them provide good asset protection, and are well understood by lenders, title companies, and insurers. In plain English it means you will have the protection you need, will not pay extra taxes, and you will be able to get the insurance and money you need to conduct your business.
I hope this article gives you a better understanding of trusts and when to use them.
Bob Diamond,
Real Estate Investor, Teacher and Attorney at Law
See more info at http://www.bobdiamond.com

Friday, November 18, 2005

New California Anti-Investor Laws

There are new laws being passed in many states including California, Minnesota, Texas, Georgia, and other states.

The laws are deadly serious. One investor was fined and sued for nearly $3,000,000 and despite spending over $400,000 on attorney's fees to defend himself, he lost everything he owned!! He lost his business, his own home, and was enjoined (forbidden) from ever speaking to homeowners in foreclosure!!

As an investor you have to keep up with this dangerous new trend. This commentary is about part of one of the new laws in California. California Civil Code section 1695.

The law deals with "Home Equity Purchasers" who are people that buy houses from homeowners in foreclosure (with some exceptions for people who buy thehouse as a place to live in, as a deed in lieu of foreclosure, or at atrustees foreclosure sale).

The law says that the purchase contract has to contain special language that is different from a regular agreement of sale including a provision allowing the homeowner five days to cancel the contract.

The law also says if the buyer says anything to the homeowner that is misleading or untrue the purchaser can be fined $25,000 and go to jail for a year!!

The law also says the buyer cannot take "unconsionable advantage" of the homeowner (See section 1695.13) . "Unconsionable advantage" is a very loose and uncertain term - as a lawyer I could not tell you if that means you make a 20%profit, a 10% profit or something less. It would probably come down to what judge you happen to get if you are hauled into court on one of these matters.

The law has plenty of other bad news for invetors. For example under section 1695.13 the homeowner may be able to rescind the transaction for two whole years!!

The purchaser is also liable for any representations made by his representative (ie door knockers).

You need to understand the Equity Purchaser law because an investor who violates it can do to jail for a year, be fined $25,000 AND he can be sued by the homeowner! I suggest you get a copy of the law and read it or come to one of my seminars to learn about the new law. Information on my seminars can be found at
http://bobdiamond.com

Next time I will talk about another new California law that is intended to stop homeowners in foreclosure from being defrauded, deceived, harrassed, and dealt with unfairly by"foreclosure consultants."


Bob Diamond
http://bobdiamond.com

Wednesday, November 02, 2005

Big tax law news: Mortgage Interest Deductions!

Holy COW!!! One of the sacred cows of the American system of taxation being discussed as a candidate for slaughter to the cash hungry United States Government...

That sacred cow is the MORTGAGE INTEREST DEDUCTION!!! Almost as sacred as social security, this deduction allows most taxpayors who itemize to deduct the interest paid on first and second homes from their taxes on Schedule "A" of their tax return. There are limits to deductability, but for most Americans the limits do not impact them.

How did this happen?


President Bush appointed a bi-partisan committee to study the tax code and come up with ways to make it "fairer", promote growth, and update the tax system. The committee came up with a proposal to replace the current laws that allow most taxpayors to deduct mortgage interest (as mentioned above- assuming the itemize their deductions) to instead have a tax credit of up to 15% of interest paid on their principal residence. There was a flap and the committee came back with a revised recommendation of allowing deduction of 25% of the interest paid.

The proposal would no longer allow for deduction of home equity loan interest or for second or vacation homes.

The last time there was a major overhaul of the tax code as it affect real estate was in 1987. That overhaul caused the savings and loan crisis, subsequent failure of many savings and loans, and a huge crash in real estate values. The 1987 overhaul had to do with the ability to depreciate properties, not with mortgage interest deductions, but in my opinion this proposal, if it goes through, will have a huge impact on the housing market.

I see high-end houses in high cost areas (ie; South Florida, California, New York, Boston, Washington) going down dramatically in value because the goverment will no longer be effectively subsidizing those huge mortgage payments. I also see the second home market crashing...all those beautiful beach houses and mountain retreats no longer being seen as investments you can use but instead as very expensive ways to vacation.

Additional links:

http://money.cnn.com/2005/10/11/pf/taxes/mortgage_interest/

http://www.csmonitor.com/2005/1018/p09s02-coop.htmlhttp://realtytimes.com/rtapages/20051019_debate.htm

http://www.latimes.com/business/la-fi-taxbreak8oct08,0,1112971.story?coll=la-home-headlines

It is important to understand that good investing practices do not rely on tax treatment. Smart investors invest when the deal stands on its own, not when there is some tax benefit that makes it all work. Smart investors also study the psychology of John Q. Public and act accordingly. John Q. is being told almost daily to look out for a crash in the housing market and if these proposals go through I think John Q. will be told the end has come by the popular press and will quickly turn from real estate to other ways to invest his hard-earned money.

My advice is to keep a careful eye on the tax news as the proposal makes its way around Washington. I would also stay away from investments in high end homes, pre-construction condominiums, or any other pre-construction deal. Those deals depend upon future increases in value and those increases are not going to come.

We are at the end of the expansion in real estate. You should be investing based on using your real estate purchases as profitable rentals (meaning you have cash flow) or by fixing them up and flipping them to a retail buyer. Your profit cannot depend on future appreciation in a market that may go soft or may decline in value. In this kind of market I also like investments in houses priced for first time home-buyers and houses where you can afford to rent them for awhile if you cannot flip them for a profit. There are always first time buyers coming into the market and there are always renters looking for a place to live.

Good investing!
Bob Diamond

http://bobdiamond.com




About Me

Philadelphia, PA, United States
Bob Diamond is a practicing real estate attorney, real estate developer, and published author of three books on foreclosure investing. You may be familiar with Bob from his appearances on FOX, NBC, or CNBC or on his real estate radio show. Inside the investor world, Bob is known as the ‘guru’s guru’ and teaches advanced real estate investing techniques including buying discounted liens, notes and judgments, buying out of bankruptcy, short sales, taking under and subject to, straight equity purchases, multi-units and even condo conversions.