Benefits of Real Estate Investing

May 23, 2019 by Client Manager Leave a Comment

The Opportunity Zone

Qualified Opportunity Zones

Established by the IRS to incentivize investment in low-income areas, the Opportunity Zone program is relatively new, and many investors are still unfamiliar with the benefits it provides. As of April 2018, the IRS offers tax benefits on long-term real estate investments purchased within Qualified Opportunity Zones. So what does this mean for long-term investors? Today we dive into the basics of Opportunity Zones and their three major draws.

What’s an Opportunity Zone?

Qualified Opportunity Zones or QOZ are economically distressed areas in which the government has designated certain tax incentives for investors. Typically, this means a capital gains investment is tax-deferred and the deferred gain is eligible for a partial exemption after five years or more. As described on IRS.gov website:

An Opportunity Zone is an economically-distressed community where new investments, under certain conditions, may be eligible for preferential tax treatment. Localities qualify as Opportunity Zones if they have been nominated for that designation by the state and that nomination has been certified by the Secretary of the U.S. Treasury via his delegation of authority to the Internal Revenue Service.”
https://www.irs.gov/newsroom/opportunity-zones-frequently-asked-questions

See a map of Qualified Opportunity Zones

The preferential tax treatment described above only applies to purchases made with capital gains, and only for investment properties. In other words, homebuyers who plan on living in the house are ineligible for preferential tax treatment even if it is within an Opportunity Zone.

In order to establish an investment in an Opportunity Zone, investors must establish a Qualified Opportunity Fund (QOF) as a vehicle for investment property funds.

EIG.org provides a great resource for understanding Opportunity Zones.

Why invest in an Opportunity Zone?

1. Deferred tax

Okay, this one is obvious. After all, deferred tax is the primary incentive to investors, and is effective immediately upon investing.

Investors can defer tax on any prior gains invested in a Qualified Opportunity Fund (QOF) until the earlier of the date on which the investment in a QOF is sold or exchanged, or December 31, 2026.”
https://www.irs.gov/newsroom/opportunity-zones-frequently-asked-questions

This means that the investor has seven full years to defer on the reinvested gains before tax is owed. An investor may be able to defer taxes further with a 1031 exchange before the 2026 deadline.

2. Tax exemptions

In addition to deferring taxes, Opportunity Zones incentivize long-term investments by adjusting the basis on which tax is owed:

If the QOF investment is held for longer than 5 years, there is a 10% exclusion of the deferred gain. If held for more than 7 years, the 10% becomes 15%. Second, if the investor holds the investment in the Opportunity Fund for at least ten years, the investor is eligible for an increase in basis of the QOF investment equal to its fair market value on the date that the QOF investment is sold or exchanged.”
https://www.irs.gov/newsroom/opportunity-zones-frequently-asked-questions

This is where things get good. The tax-deferred gains you invested are eligible for 15% exclusion after seven years, meaning you only owe tax on 85%. Additionally, if the investment is held for ten years, it is eligible for a step-up in basis to the fair market value. If the property was sold shortly after the ten-year mark, the investor would be paying no capital gains tax on appreciation. This is a huge incentive for someone already interested in long-term investment.

3. Economically growing areas

Opportunity Zones were designed to help boost economically distressed areas by incentivizing long-term investors with tax benefits. The first zones were designated on April 9, 2018, so we must wait to see if they will offer the long-term economic development expected.

However, what is expected through the program is that the influx of new investments will drive an increase in property value throughout the zone. Investors realize the greatest gain if they establish funds early and stay invested long-term while the property values continue to increase. It is almost a self-fulfilling prediction, but one that benefits the early investors most.

Find a Real Estate Expert

Now that you know more about Opportunity Zones and the advantages they can provide, you are well on your way to making an informed and financially successful investment. Having a knowledgeable agent to assist you will make your process smooth and your returns as high as possible.

To reach Peter Maclennan please call 925.385.8798 or email at peter@maclennaninvestments.com.

This post is for informational purposes only. Contact a tax professional prior to making investment decisions.

August 20, 2015 by Peter Maclennan Leave a Comment

Using a 1031 Exchange to Upgrade Properties

Using a Section 1031 Exchange to trade from one property to another is a common event. Most of the time owners are seeking higher returns. In the case below, my clients were looking to go from a tired property to a much nicer property.

A Tired Duplex in Concord

Rear Unit of a Duplex in Concord, CA

I was contacted to list a property in Concord for a client. The property was a 2 unit property with great access to Concord BART. The property was not in the best of shape. It had been a rental for 30+ years and some of the tenants had beaten the property up. While listing the property we learned that one of the tenants was going to be an issue and had to process an eviction in the midst of trying to sell the property.

To complicate the matter, the owners had performed a 1031 exchange in the 1980’s when they bought the property. I advised them to consult with their CPA regarding their potential tax liability if the property was sold and not exchanged. After forwarding the estimated sales price to their CPA, she determined that the owners would likely have to pay nearly 50% of the sales proceeds in taxes. It immediately became clear that we should perform a 1031 exchange to preserve that equity to pass on to their heirs.

When we listed the property we got a significant amount of interest. We parlayed that interest into multiple offers and almost $30,000 above asking price sale.

Since a 1031 exchange has strict timing guidelines, I recommended to my clients that we include a provision that extended the amount of time we had to close the “down-leg” of their transaction.

A Nicer Single-Family Home

Rental House in Concord, CA

My clients determined that they wanted an easy-to-own rental property that was going to attract a high caliber of renters. Their plan was to pass this asset along to their heirs. Consequently, they don’t want something that is going to be high maintenance.

Thankfully, we negotiated for more time in the contract as the market was thin on investment properties. The first property we pursued was snapped up from under our noses.

Finally, after submitting offers on a couple of places my clients got into contract on a home in Concord. Using the 1031 Exchange funds and additional capital we were able to secure a purchase with an all cash 14-day closing. This appealed to the sellers as they were in contract on another home to buy. This property is a nice 3-bedroom 2-bath home with granite countertops and a killer kitchen. My clients were more than pleased with the purchase.

Transaction Recap

My clients were able to accomplish their goal of selling a property that was causing headaches and transferring the equity into another more attractive property. This transaction allowed them to accomplish their goal of deferring capital gains tax and to provide their heirs with a more attractive investment property.

It is important to have an agent that can help you navigate the 1031 Exchange Process. If you or someone you know is thinking of selling an investment property, have them give me a call for a no obligation consultation at 925.385.8798.

June 3, 2014 by Peter Maclennan Leave a Comment

Generational Wealth

Bank of America just released the results of their latest Merrill Edge Report. In it they surveyed the “mass affluent”, those with between $50,000 and $250,000 of investable household assets. According to the survey, the Mass Affluent were more afraid of not having enough money throughout their retirement, than they were of losing their job, public speaking, or of going to the dentist.

These families are fearful that they will not have enough assets to last their lifetime. They are not able to even consider the lifetime of their children.

Wealth that Lasts

A good man leaves an inheritance to his children’s children, but the sinner’s wealth is laid up for the righteous. – Proverbs 13:22

Can you imagine creating an inheritance that will endure past your lifetime, past the lifetime of your children, and onto that of your grandchildren? How do we create something of lasting value that will transfer from our children along to our grandchildren?

Leverage Helps

While perusing the list of billionaires over at Forbes.com I noticed that 9 out of the 10 wealthiest individuals had started or grown companies. The lone exception was Christy Walton whose father-in-law Sam Walton founded Wal-Mart.

Unfortunately, for most of us “working stiffs” we are trading our labor or time for money. The problem with this model is that we only have a limited amount of time and labor. I have not figured out how to be in two places at once. I cannot simultaneously sit at my office computer and show property to clients across town. I am limited in my abilities, my time, and in my knowledge.

In one of his books, Robert Kioysaki expresses the idea of leverage. Leverage is using the efforts, time, or money of someone else to advance your cause. A non-profit can leverage connections in the community to advance their cause. An entrepreneur can leverage the time of his employees to solve people’s problems. A real estate investor can leverage a bank’s money to buy a bigger property.

Entrepreneurs and business owners leverage the skills, knowledge, and time of their employees to create a product or service that benefits more customers than the entrepreneur could benefit on his or her own. Collectively the entrepreneur’s business is better able to bless more people than they would if they were a disjointed entity.

Real Estate Leverage

One of the tools at the disposal of a real estate investor is leverage through the prudent use of debt. Many banks and individuals will lend money to an investor if the loan is adequately secured by real estate. A real estate investor can take a much smaller investment of say $100,000 and leverage that into the purchase of a property of $400,000. This can benefit an investor if the property appreciates. A 5% growth in value on a $400,000 property is $20,000. This means that the investor’s equity just grew by 20% ($20,000/$100,000 = 20%).

Warning: Leverage is a two-edged sword and can multiply losses as well. Be careful.

Principal reduction on the mortgage is a benefit received by the investor when the tenant’s rent helps to pay the monthly mortgage payment. Each month a small portion of the mortgage balance is paid down building up the investor’s equity regardless of what the market value of the property does.

Passive Income

Because rent is earned regardless of whether the landlord/investor is at the property, it allows an investor to generate “passive” income. (Real estate is rarely truly passive income. Work needs to be done to maintain a property.) As long as the tenant occupies the property or is bound by the lease, the investor is entitled to rental income.

Creation of Generational Wealth

Leverage and passive income allow an investor to build wealth that is exponentially greater than their individual earning capacity. Real estate assets purchased with debt, build equity as the mortgage is repaid with tenant rents. Rental income allows the investor to have multiple streams of income without cloning himself. Whether the income comes from a business or from real estate rents, it allows the investor to build wealth that can be passed along to their heirs.

To start building wealth with real estate that can outlast you and be passed along to your children, please give me a call at (925) 385-8798.

February 13, 2013 by Peter Maclennan Leave a Comment

Commercial Real Estate & Inflation (Part 2)

Recently I wrote a post detailing what inflation was and that a hedge fund manager had recommended commercial real estate as a potential hedge against inflation. I realized that I hadn’t explained why commercial real estate acts as a hedge against inflation and a store of value.

Inflation Erodes Purchasing Power

In the previous post I shared that inflation makes money purchase less goods and services. The downside of this is that it can affect the lifestyle of anyone with a fixed income. A set income of $6,000 per month will by fewer services, fewer goods, and less entertainment as prices rise.

How Commercial Real Estate Can Protect Against Inflation

Commercial real estate investments that adjusts with inflation can work to protect the investor against the effects of inflation through income protection and wealth preservation.

Income Protection

The income from commercial real estate is tied to rent. Rent can be adjusted periodically to keep up with inflation.

Rents tied to short term leases, as in apartment properties, are easily adjusted on a regular basis (yearly) to account for the effects of inflation. Self-storage properties are another type of commercial real estate that generally have short term contracts/leases that can be adjusted as inflation takes effect.

As inflation occurs, rents can be increased to track inflation. The increased income can help the investor to maintain the level of lifestyle that they previously enjoyed.

Wealth Preservation

Commercial real estate also works to preserve wealth because it is a hard asset. The nominal price of a piece of real estate will rise as inflation rises.

If the purchasing power of a dollar is cut in half over a period of time, it stands to reason that twice as many dollars will be needed to buy commercial property over that same time period. In this hypothetical situation, the commercial real estate investor has not lost any of their wealth over the inflationary period, because the market value of his building has risen in step with inflation.

Long Term Fixed-Rate Financing

Investment real estate that is prudently leveraged with long term fixed-rate financing has an even greater potential to protect the investor from inflation.

Long term fixed-rate debt provides the investor with the opportunity to buy a larger property than they have the cash for and to maintain a consistent payment until the loan pays off. A fixed-rate protects the borrower from the risks of inflation affecting interest rates and increasing refinancing risk.

The rental income should cover the debt payments for the life of the loan. Each payment reduces the loan amount and increases the owner’s equity in the property, slowly building wealth over time.

If an investor borrows 50% of the purchase price and inflation cuts the purchasing power of a dollar in half over the life of the loan, it stands to reason that the investor’s investment has increased by four times.

For Example:

Purchase Price =$2,000,000
Initial Loan = $1,000,000
Initial Investment = $1,000,000
Market Value (with inflation) = $4,000,000
$4,000,000 Market Value/ $1,000,000 Initial Investment = 4x Return On Investment

In Closing…

You can see the benefits that commercial real estate (and investment real estate) offers to protect owners from the effects of inflation. To begin investing in commercial real estate, please feel free to reach out to me at (925) 385-8798.

February 11, 2013 by Peter Maclennan Leave a Comment

Commercial Real Estate & Inflation

Many in the media and financial world are predicting Inflation. Because the Fed is devaluing the U.S. currency, many assume that inflation will come.

Inflation

What is Inflation? I am glad you asked.

Inflation is the gradual or rapid loss of purchasing power. Many of us have seen this at the grocery store or gas pump. When I first started driving, gas only cost $0.99 per gallon. I recently filled up at over $4.00 per gallon. I used to be able to buy a candy bar at the checkout counter with 2 quarters. Today it will likely cost you closer to $1.00.

In both of the examples above one dollar ($1) lost it’s ability to purchase an item. One dollar used to purchase a whole gallon of gasoline, now it only buys 1/4 of a gallon. A dollar used to buy 2 candy bars, now it only buys you one.

Inflation occurs when an abundance of money chases after scarce resources.

Effects of Inflation on Wealth

Inflation can ravage the wealth of an individual. If an individuals portfolio does not grow at a rate faster than inflation, the portfolio is actually losing the ability to buy services, food, and shelter.

In the example above a $1,000,000 portfolio used to buy 2,000,000 candy bars. Now it can only purchase 1,000,000 candy bars. If the rate of inflation remains the same, the same portfolio may only buy 500,000 candy bars in the near future.

Exchange the candy bar for bread, water, electricity, or healthcare and you can see the devastating effects that inflation can have on the wealth of an individual.

Protecting Against Inflation

Kyle Bass is the founder of Hayman Capital, a hedge fund. He made quite the fortune by short selling the sub-prime mortgage market. He spoke to a CNBC reporter after a conference about his thoughts on inflation. A link to the video is below.

In the video Mr. Bass says at the 2:05 minute mark that he expects inflation. At the 2:22 mark he suggests owning productive assets (apartment buildings). At the 2:35 minute mark he also recommends securing long-term fixed rate financing on those assets.

http://video.cnbc.com/gallery/?video=3000143907

If you want to learn more about purchasing hard assets to protect your wealth, please contact Peter at 925.385.8798.

925.385.8798

The Opportunity Zone

What’s an Opportunity Zone?