Monday, Feb 02, 2015

Planning Lessons from the Real Estate Industry

Planning Lessons

I work with real estate developers, investors, and Realtors on nearly a daily basis, and I am always impressed by the transformation newcomers to the industry undergo from the time they start their first project to when their business is thriving. These professionals learn many lessons the hard way. Some seek counsel from the start, and others wait until they can “afford” professional advice from attorneys and accountants. The fact is, most investors on a budget can’t afford not to obtain professional advice!

Furthermore, even those who seek professional advice sometimes do not get what they bargained for. For example, I recently received an email from a “business coach” who is assisting one of my growing developer clients. This person was questioning the requirement for depreciation of the developer’s property based on a review of IRS publications. Now, the first red flag is that we have a business coach reading the IRS publications, which are useless for all but a cursory (and often confusing) overview of the subject matter. Simply stated, depreciation is not optional. You can choose whether to take a deduction, but your property depreciates, and your adjusted basis continues to decrease, regardless. I did not charge my client to set the issue straight, but had he listened to his business coach, it would have cost him tens of thousands of dollars per year.

The lesson here is to always make certain you are receiving quality advice in real estate endeavors and that your advisors have the credentials to support what they charge. Too often, entrepreneurs (and occasionally very experienced investors) make grave mistakes because they did not seek the counsel of a qualified attorney or accountant. To help you avoid these mistakes, here are a few pointers to keep in mind for every real estate deal.

  • Always discuss the project with your attorney and accountant well in advance of the anticipated closing – preferably at least 30 days prior (more for larger projects). Although it may be an extraordinary transaction for you, remember that your attorney sees these deals on a regular basis. If there are no red flags, you may only need a short phone call.
  • Make sure you understand all of the immediate tax consequences and how they will play out over the long-term. Make a plan and project the tax consequences and cash flows for at least 10 years, preferably longer. Ask yourself these questions: Will there be taxable income? Will the property generate a tax loss? Is this loss deductible?
  • Make sure you understand what will happen when or if you sell the property. Will there be a capital gain or capital loss? What about depreciation recapture?
  • What happens if you are incapacitated or die? Can the project function without you? Who will take over the management? Are there any tax consequences (estate taxes, basis step-up) or will your partners have any right to buy your interest? If your partners can (or are required to) buy you out, what is the price and how will it be calculated? Should your spouse be in this deal with your partners? Is this fair to everyone?
  • Have an exit strategy and understand the tax and financial implications.
  • Plan for contingencies. What happens if the property doesn’t sell? What if the tenants move out? What if rental rates drop or interest rates increase dramatically? Can you bring on a partner if needed or engage in a cash-out refinancing?

Speaking to an attorney or accountant who is well-versed in tax law will help you make the right decisions for your business and personal real estate investments. To learn more, please visit our Estate Planning & Administration page, or call Chuck McWilliams at (703) 680-4664.