Sunday, December 20, 2020

How Many Bedrooms Do They Need?

A while back we wrote about changes in the real estate market brought about by the Chinese flu and the government reaction to it. There are many negative impacts on individuals and businesses, but today we will look at the changes in single family housing that are taking place already.

We noted then that many people were working from home instead of commuting to an urban cube farm. Unless they were already doing a significant amount of work at home, most of these newly confined employees find themselves working from makeshift offices in the corner of a bedroom, dining room, garage or wherever they can find some space and an internet connection.

Another Curve Ball for Construction

As if home builders did not have enough to contend with on the building materials and labor fronts, they are now facing the demand for another bedroom or dedicated office. In some areas, the traditional three bedroom home is being pushed to the side in favor of this extra room.

Because they are still working with the middle class market, not looking for a McMansion and not being able to afford one anyway, they are trying not to bump the price up too much. One builder working in the new construction for rental market recently explained that they were trying to rework their current designs to carve out that extra room with the same footprint – thus minimizing the price impact.

This may mean pulling back from the open concept designs and smaller rooms to avoid adding square feet and pushing the price of the home further out of the reach of many of the people they are building for.

Why Build For Rentals?

Some new developments of single family homes are actually being created for the rental market. A significant segment of this market is occupied by the much maligned millennials. There are many who have not been damaged too severely by their education are working at pursuing the American dream – however they define it.

Many have saddled themselves with excessive college borrowing. Even though some make pretty good income, the education debt stands in the way of a reasonable home loan, or even an unreasonable one. This is one reason many would like to palm their debt off onto the unsuspecting tax payers who have plenty of their own debt to deal with. Because of this, some builders are working to build rentals that provide nice housing at a rental level the market can handle.

Impact on Investors

Many investors working in this same market may well find themselves looking at similar demands from their tenants. When you get into the family market many here are also looking for and extra bedroom or office. Most of the time, expanding the footprint of the home is neither practical or economical. Here is where some creativity will come into play in meeting this demands of the market.

Investors and rehabbers are usually flexible and creative people able to find ways to turn a property into something people will either want to buy or rent. Being aware of this trend will help meet the needs of the market and the profitability of the investor.



Sunday, December 13, 2020

It's Still a Wonderful Life

We are officially in the Christmas and Hanukkah season. For those who chose not to celebrate or offended by this time of year, that is your choice and I respect that but please don't expect the rest of us to forego this inspiring time of year. Every economic slowdown brings with it opportunities, so that even though some are experiencing lack, others seize opportunities that did not exist before. For example, how many people ever used Zoom before they were locked in their homes? How many used carry out and home meal delivery as much as they are doing these days?

The same can be said for the real estate business. Some are prospering and some are barely hanging on. Whether it is real estate, hospitality, food service, or any other business that has been shut down or greatly diminished by the Chinese flu or government edict, there may be a sense of failure like George Bailey experienced in the Christmas classic, It's A Wonderful Life.

It's A Wonderful Life

George Bailey was so distraught over his current circumstances and even worse prospects in the future that he wanted to end his life. But he was stopped by an apprentice angel who showed George what the world would be like without him. Whether you are one who has prospered in these times or suffered financial loss there are lessons that we learn from Clarence, the angel.

We probably will never know all the people's lives we touch as we go about our lives and business. As Clarence said, “One man's life touches so many others, when he's not there it leaves an awfully big hole.” Yes, it is about much more than money – even though it may not feel like it when the unpaid bills are piling up and you can't give the kids the Christmas you want to.

Clarence also told George, “No man is a failure who has friends.” There is a corollary to this as well: no man (or woman) is a success – no matter how much money he has – without friends.

Watch The Movie

Frank Capra mellowed from the madcap comedies he made before the war. His experience filming the horrors of combat during World War II helped him better understand the stress and struggles people are capable of experiencing. Jimmy Stewart (George Bailey) was still working his way through what we would call PTSD today, from his time flying bombers and watching his friends blown out of the sky over Germany during the war. Together they created a masterpiece of inspiration for those who question their circumstances and value.

Today, isolation and financial stress have brought discouragement to many people. It's a Wonderful Life gives a break from self pity and reminds us that circumstances are temporary and can be overcome.

That is the story of Christmas as well... and we even hear that from the likes of Charlie Brown as Linus tells the Christmas story. Take the time to watch some of the Christmas movies – even those like Die Hard and LA Confidential. They also carry the message that good does overcome evil – something we all need to be reminded of these days. Turn off the news and watch Charlie Brown, you will feel a lot better.

What About Hanukkah?

Hanakkuh has it's own story of overcoming and the miraculous. Very, very briefly, in 168 BC, the Syrians, under Antiochus Epiphanes, attacked Jerusalem, killing many people and desecrating the temple with idols of Greek gods and the sacrifice of pigs on the altar. A rebellion ensued and the Jews, led by Judah Maccabee, facing overwhelming odds as they did in the Six Day War, defeated the Syrians and drove them from Jerusalem;

When the temple was being prepared for rededication, it was discovered that there was only enough oil to burn in the menorah lamp for about one day. However, day after day, miraculously, the lamp kept burning for eight days, until they could secure enough oil to keep it burning as tradition required. There is much more to this story than I can recount here. It is worth checking out to remind us that there is hope, no matter what things look like. Just remember we can live several weeks without food, a few days without water and minutes without air and seconds without hope.

The Lesson

Whether it is in personal circumstances or as a nation, when things look the worst, we need to keep moving forward, doing our best and watching for help from unexpected sources. As Winston Churchill once advised, “Never, never, never give up.”

For a boost in your spirits, whether you are experiencing boom or bust, help somebody else. One place I like to help is the Angel Tree program at Prison Fellowship. They see to it that the children of those incarcerated are not forgotten during the holiday season. It doesn't take much to let a child know someone cares about them and make their Christmas.



Sunday, December 6, 2020

Active Income, Passive Income – What's the Difference?

Real estate can be a profitable undertaking. There are various ways to make money. Sometimes it comes in large chunks, and sometimes it comes in regular intervals. Every time though, there is a tax man (or woman) ready to take their portion – whether it is a fair amount or not is open to discussion. There is an old saying that we will consider today, “it's not how much you make, it's how much you keep”.

Since everyone's situation is different, the purpose of this is to help you ask intelligent questions of your tax advisor and plan your business to minimize the April 15 impact. There are carve outs and phaseouts inserted into the tax code at various times with only a tangential nod to uniformity and common sense, so it's as the say. “the devil is in the details”.

I don't make the rules, and the people who made up some of these rules are probably long gone. You will see the term “generally” used quite often in this discussion and that is because the tax code was never designed to be a unified, logical exercise. Each piece came in individually, generated by a committee that was subject to various influences and compromises.

Not All Income Is Equal

Most investors are aware of the fact that long term capital gain is taxed at a lower rate than regular income. But there is more to it than that. While old timers are probably well aware of this, many newcomers are not. In many cases, rental income is taxed differently than fix and flip income. Knowing how the tax code is structured is the first step toward minimizing your “contributions” to the Washington leviathan.

Two Types of Income

There is regular income – the kind you work for. It can be for an employer who gives you a W-2 at the end of the year. It can be from self-employment where you file a Schedule C. It can be from your interest in an LLC or S Corp where the tax liability passes through the business down to the individual owners tax return by way of a K1. These are all taxed at the individual rates, designed to extract the maximum number of dollars from the working taxpayer. There are some exceptions that we will discuss later.

Then there is passive income. Yes, you may have to do some work to get this, but generally your involvement is not as great, and, ironically, you don't pay as much tax on this “mailbox money” income.

Passive Income

We will take a look at passive income first. It is the dream of many to spend their afternoons lounging in a hammock while money rolls in the front door. When you have rental property, this is how the IRS sees you, even though you “materially participate” in the operation of your empire.

That is, they regard pretty much all rental activity as passive even though you take part in deciding rental terms, approving tenants, and making repairs, whether you hire someone or do some yourself.

The same is true if you are an investor in a rehab project and someone else takes care of the work – acting as the general contractor or doing much of the work themselves. Just do not become too involved in the day to day activities. You might say, “couldn't I just lend them the money?” The answer would be no, not if you want the income to be passive. Interest income is generally taxed as regular income.

Truth be told, passive income has the same tax rate as regular income – but – and it's a big one – unlike self employment or regular business income there is no self employment tax. That is a 15.3% savings. That's not 15.3% off your tax bill, that is 15.3% of your profit that you get to keep. Some will say by not paying that you are not putting money away for your retirement. If this bothers you, perhaps passive income isn't for you, but if you think you can do better than the social security people... go for it!

The Caveats

Passive losses generally can only offset passive income, although, under some circumstances, if you qualify, up to $25,000 can be applied to regular income. You can qualify by being actively involved in the business and have at least 10% ownership in the properties. Even that phases out at $150,000 if you are filing a joint return... less if you are single.

On the other hand, if you are considered to be a real estate professional, rental income is no different from any other.

What is a Professional

If you are seriously in the real estate business it is easy to fall into the professional classification. If you spend more than 750 hours in a year in the trades or materially participating in the business or more than half your personal service time in such activity you lose your amateur status.

Qualifying Business Income Deduction

Real estate professionals generally benefit from the Qualifying Business Income deduction, otherwise knows as QBI. With this, you can knock up to 20% of your business profit off your Adjusted Gross Income (AGI). There again, there are limitations you tax advisor can explain in greater detail. You may not benefit from this much in the future unless sanity remains in Washington.

And there is good news for rental owners here too. If they treat it as a serious business, keeping separate records for each property. This includes contemporaneous records of time spent and activities performed in the various aspects of the rental business.

Keep What You Can

Volumes have been written and people have spent years learning the ins and outs of the tax code. This article is just something to get you thinking about the impact of taxes on your financial well being. We have not touched on the benefits of operating through a self-directed IRA. It could be well worth the time of both the serious and casual real estate investors to get to know more about the tax environment. It won't make you more money, but it could save you a boat load if you do it right... but push yourself beyond the law... the IRS can do bad things to people who chisel when they file.