From: mproozee@hotmail.com
Newsgroups: misc.invest.real-estate misc.legal misc.taxes
Subject: Re: Real Estate Investment Tax Question
Date: Wed, 28 Nov 2007 13:27:22 -0800 (PST)
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I didn't realize at the time but my first post might be misleading; so
I'll try to clarify...
The original $1M came from an investment pool (as opposed to a loan
from a bank). Going to several non-institutional investors, my friend
raised money for precisely this purpose. The intention is to take
this $1M (basically cash), purchase property A outright (whose market
value is $1M) and use it to secure the $750K loan from a bank. The
idea is that the bank sees the $1M property securing the loan and
provides the $750K (again, essentially cash) which is then used to buy
another property outright, etc.
I don't know if this makes much difference, but if it does, I'd
appreciate any added advice.
My problem is that it seems like he is building equity (which feels
like income) and doesn't owe tax on it until capitalization.
Thanks,
Matt
On Nov 26, 4:29 pm, Deadrat wrote:
> mproo...@hotmail.com wrote in news:6c398b03-ea09-44ab-9cf9-9fb80f4ecf98
> @s36g2000prg.googlegroups.com:
>
> > 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 notaxon the rental
> > properties. He claims that he has nothing totaxuntil he has a
> > capitalization event. I am neither arealestateexpert nor atax
> > attorney but this doesn't make sense to me as the rental income is
> > still income and the "loss" due to loan repayment and propertytaxis
> > not the type of "loss" referred to in thetaxcode. My assumption is
> > that this istaxfraudand that he is responsible for paying income
> >taxon 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.
>
> Your friend apparently would have active income from the rents and
> therefore could offset that income by using the investment interest
> deduction (up to the amount of that income). Assuming that deductible
> expenses for the rental property amounted to at least as much as the
> rental income, then your friend would owe no taxes. I'm not sure what
> you mean by "loss"; interest and taxes are expenses, and within the
> rules, offset income. If your friend shows a net loss on hisrealestate
> business as a whole, then he probably won't owe income taxes from the
> business.
>
> The problem is that in practice, your friend will not be able to find
> properties or lenders to finance his scheme. Step 2 assumes that he can
> buy a property worth $1.75M for $1M. Remember that he doesn't really own
> property A outright -- he owes $1M on it, and that $1M is not available
> as collateral for the loan on property B. Assuming that your friend
> properly discloses everything about hisrealestateinvestments -- and it
> constitutes bankfraudto do otherwise -- how is he going to convince a
> bank that he has $750K equity in building A available as collateral for a
> loan? If the building is really worth $1.75M, how did he convince the
> original owner to let it go for $1M?
>
> > Is there a name for this type of scheme
>
> Yes, the technical name is "pipe dream." Or maybe in your friend's case
> "California dreamin'."
>
> > and does anyone know what the typical penalty (in California) would be?
>
> Cluelessness is its own penalty.
>
> > If anyone has any information, please forward it to my email address:
> > mproo...@hotmail.com
>
> > Thanks in advance,
>
> > - Matt
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