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Silver Lining of Real Estate Market Correction Hiding In Plain Sight

Gonna be down and dirty today with a strategy real estate investors aren’t using nearly as much as they should. I wrote a post on the subject on my own turf, but thought it important and valuable enough to give it some visibility here. The results this strategy can potentially produce are, in my experience, sometimes pivotal in getting retirement goals back on track, or even more dramatically, raising them from the dead.

So many real estate investors own many properties. They’re located in different areas. sometimes different parts of the country. Some were acquired long ago, some, not so long ago. Some in areas blessed with ungodly appreciation — some that dropped like the anchor on the USS Ronald Reagan 20 minutes after escrow closed.

Earlier this week I spoke to an investor wanting to know how to get out from under some losing income properties. They were worth less than he paid for them, but there was still some equity there if he were to sell them. Further questioning revealed his portfolio also had some long term winners that had increased in value impressively over the years, even after nearly four years of the current brutal market correction.

This is one of those silver lining strategies that should really be looked at as the perfect silver lining storm.

Told this investor he should sell ‘em all this year, and to get started around 4:30 yesterday afternoon. Now, of course that doesn’t mean everyone should take that route, but the strategy is as follows.

Long term capital losses (held more than a year) offset long term capital gains. Simple as that. If, for example, you own a couple props bought with bad timing, that will produce losses, those losses will offset the gains on your gold medal props. This approach will yield many different very positive results — the escape from capital gains taxes being just one — and sans the use of a tax deferred exchange. How cool is that? The various perks are listed in the linked post. Not all of the cool potential results are listed, as some will accrue only to certain taxpayers. But the best rewards — especially the avoidance of capital gains taxes virtually universal.

Anyway, hope this helps. Have a good one.

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  • 13 comments

    13 Comments so far

    1. Shannon Ensor January 9th, 2009 5:25 pm

      Wow – what a great solution to your client’s problem!! Thank you for sharing your strategy & I will be sure to keep this in mind if any of my clients have the same issue.

    2. sumter January 10th, 2009 12:09 am

      I told a client a while back “well look at the bright side, you are selling the property and you don’t have to worry about capital gains and paying taxes” needless to say offering up that strategy didn’t go over too well

    3. Jeff Brown January 10th, 2009 9:22 am

      Sumter — I feel their pain, as I’ve been there. It’s also a great reason to review a client’s entire portfolio including non-real estate investments. Much of the IRC rules allow crossover offsets. That includes long vs short term gains and losses.

      I wonder if your client had another piece of real estate they could’ve sold tax free?

    4. Dan Connolly January 10th, 2009 10:26 am

      So could a loss in the stock market offset a gain in Real Estate? (if so it would have been nice to know that last year!)

    5. Jeff Brown January 10th, 2009 10:41 am

      Dan — I’m not positive, but I don’t think the IRC makes the distinction between stocks/real estate. They’re more concerned with long vs short term gains.

      Here’s a ‘pecking order’ for you.

      • Short-term losses counterbalance those expensive short-term gains. What’s left at the end of Section I of Schedule D is the net short-term capital gain or loss. If there were no gains, then obviously the net would equal the total loss.
      • Long-term losses are applied to long-term gains. The result, at the end of Section II of Schedule D, is the net long-term capital gain or loss. Again, if you only have a loss, then the net is a negative number.
      • Next, you combine the short-term and long-term results. At this point, a loss in one section can offset a gain in the other section. For example, if you have a net short-term loss of $1,000 and a net long-term gain of $1,200, then you’ll pay tax on only $200.
      • If the total is a gain, you’ll be paying taxes on that.
      • If there’s still a loss, you can deduct up to $3,000 from other income.
      • If you had a really bad year and ended up with a net loss of more than $3,000, you can carry forward the leftover portion to next year’s taxes. The unused loss can be applied to next year’s gains, as well as up to $3,000 of earned income. A big loss can be used as a deduction indefinitely — another important reason to keep good records.

    6. Shelley Gross January 10th, 2009 10:55 pm

      I understand what you mean by sell yesterday. But, it really depends on where they bought. I know some of my later investments which were purchased toward the end of 2007 which I hope to flip and couldn’t I turned into section 8 properties. I am more than happy about keeping those properties. The investor has to way all the pro and cons and not immediately take a hit. If they are not negative each month I feel it should be kept. Unfortunately, so many guru’s like Robert Allen suggested using hard money lenders and were caught in a must sell scenario.I was purchasing out of my home state. There are still areas that you can flip property but they are rare.

    7. Robert Kerr January 11th, 2009 1:48 am

      But the best rewards — especially the avoidance of capital gains taxes virtually universal.

      I don’t think I’d call the avoidance of capital gains – which is the way your client is avoiding capital gains taxes – a reward.

    8. Brian Brady January 11th, 2009 9:02 am

      “I don’t think I’d call the avoidance of capital gains – which is the way your client is avoiding capital gains taxes – a reward.”

      I think that’s a bit pedantic, Robert.

      This is a time-tested strategy that takes advantage of market fluctuations to avoid taxes. I used similar strategies when peddling bonds. If a client owned a AAA-rated muni, at a 5% loss (due to rate fluctuations), we might “swap” him into a different AAA-rated muni, of similar YTM and term.

      When you’re fairly certain of the long-term direction of a market (which you admit,is up, in the 24th comment):
      http://www.bloodhoundrealty.com/BloodhoundBlog/?p=2831

      repositioning assets to capitalize on tax laws, while preserving the long-term integrity of your investments, is a very savvy strategy.

      The only way this doesn’t make sense is if you think that real estate is not a good investment. Do you believe that prudently leveraged, residential real estate is an appropriate long-term investment, Robert?

    9. Roxanne Ardary January 11th, 2009 9:15 am

      Interesting suggestions and input. I’m going to check with my accountant on a couple of the suggestions you’ve made. Thanks

    10. Robert Kerr January 11th, 2009 10:55 am

      This is a time-tested strategy that takes advantage of market fluctuations to avoid taxes.

      Come on, Brian, this isn’t some brilliant, new tax strategy, it’s not having to pay gains taxes because you didn’t have any gains.

      On what planet is not having any gains a “reward?”

      Can’t we call this what it is: bad investments and bad investment advice? It happens. Move on.

      Using “Newspeak,” where losses are a reward, doesn’t help anyone and it certainly doesn’t help the public feel any better about the trustworthiness or knowledge or candor of the profession.

    11. Brian Brady January 11th, 2009 12:41 pm

      “Can’t we call this what it is: bad investments and bad investment advice? It happens. Move on.”

      That presupposes that investing in real estate is a bad investment. Buying real estate, for a long-term investment, is NOT, in my opinion, bad investment advice. Would you agree?

      “Using “Newspeak,” where losses are a reward, doesn’t help anyone and it certainly doesn’t help the public feel any better about the trustworthiness or knowledge or candor of the profession.”

      This is not “newspeak” whatsover. This strategy has been used for generations in securities investments. It rarely applied to real estate because we’ve haven’t seen such a volatile and steep decline.

      Jeff’s advice is relevant, timely, appropriate, and will probably result in a higher, after-tax return for clients who invest for the long-term.

      Portfolio management requires constant thinking, Robert not dwelling upon events out of your control….

      …but you know that already.

    12. Jeff Brown January 11th, 2009 4:36 pm

      Shelley — Obviously specific circumstances for each investor will dictate any final decision. Given that fact, If you would’ve been able to report a capital loss on your attempted flip AND you had a solid gain available to offset AND you had somewhere to invest that gain, THEN that would’ve been just as viable as keepin’ the flip property as you did. Or not as your circumstances dictated.

      Keepin’ a property merely because it’s ‘not negative’ while ignoring what may be superior options isn’t the way to go in my view. That factor alone just isn’t persuasive enough. There are always other attending factors — though agreed, they may not uncover a superior option.

      In San Diego we’re workin’ with a client whose purchase of a fix ‘n flip SFR went awry. He’s been renting it now for 14 months. It clears about $50/mo. If he sells it now he’ll have a capital loss. If he sells another ‘loser’ condo he bought (both buys before he knew us btw) He’ll have upwards of $90,000 in combined capital losses. But since he owns a property owned for much longer, he has the option of selling all three properties and owing taxes on what now looks to be a net capital gain of just over $25,000. This approach will get him out of San Diego and into what he thinks (me too) as a more promising region. He won’t then be waiting for SD to bounce back. He’ll also not be managing two properties taking him nowhere fast.

      Again, the circumstances must also match up with the investor’s tax position and ultimate investment agenda.

      Hope your flip turns out well for you.

    13. Jeff Brown January 11th, 2009 4:49 pm

      Brian — I’ll assume our experience with investors dealing with capital losses is more or less the same. Though they want to move on, they’d just as soon try to make lemonade out of lemons if the tax code allows it. Of course, I understand if there are those wishing to pay the taxes, and/or eat the loss without making use of the tools available in the IRC.

      As you put it, “…repositioning assets to capitalize on tax laws, while preserving the long-term integrity of your investments, is a very savvy strategy.”

      May I add a resounding ‘Duh’ to that? :)