From: mproozee@hotmail.com
Newsgroups: misc.invest.real-estate  misc.legal  misc.taxes
Subject: Real Estate Investment Tax Question
Date: Mon, 26 Nov 2007 15:43:09 -0800 (PST)
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I apologize for cross-posting if any of the above newsgroups are
inapplicable.

A friend asked me about the legal (tax) implications if he:

1) Receives a $1M loan to buy a rental property
2) Uses the $1M to purchase a rental property, A
3) Uses A as 100%+ collateral for a $750K loan
4) Uses the $750K loan to purchase a second rental property, B
5) Uses B as 100%+ collateral for a $500K loan
Wash.  Rinse.  Repeat.

He then rents out all of the properties for the same monthly payment
as the loans used to purchase them plus any property taxes.  So the
rent from A is used to pay off the loan and property taxes on property
A, the rent from B is used to pay off the loan and property taxes on
property B, etc.  All of this seems to be legal at this point.

The plan is to claim no profit and thus pay no tax on the rental
properties.  He claims that he has nothing to tax until he has a
capitalization event.  I am neither a real estate expert nor a tax
attorney but this doesn't make sense to me as the rental income is
still income and the "loss" due to loan repayment and property tax is
not the type of "loss" referred to in the tax code.  My assumption is
that this is tax fraud and that he is responsible for paying income
tax on all rents received but I haven't been able to find any
California statute or case law that is sufficiently on point to
convince him.  This would not be the owner's primary residence or
anything like that... strictly investment property.

Is there a name for this type of scheme and does anyone know what the
typical penalty (in California) would be?

If anyone has any information, please forward it to my email address:
mproozee@hotmail.com

Thanks in advance,

- Matt