Love Austin Homes Investing Blog

Do you ever feel compelled to hold a reno project for a full year so you only have to pay cap gains taxes on the property? Or do you just plow ahead and sell when its finished, incurring taxation as regular income? Anyone have thoughts on this? It appears the difference is so substantial, it’s pushing me towards year long holds, but wondering if there are any problems with this option - other than the fact the market could go down during that time…

Robert

ANSWER

Robert,
Usually the cost of interest payments on the money and/or the real-time value of money (in other words the opportunity to put the money to use on other projects) outweigh the benefits of long-term capital gains vs. short term capital gains (income). I’ve got one huge project that is pushing a year in scope that I may push the close on so that it pushes me over the 1-year mark, but this is just because the project already took 10+ months. If I weren’t right near the 1-year mark anyway, I wouldn’t hold out.

I also consider strategies such as renting a property out and later selling. For sub-$125K ARV renos, I often offer them for sale and for rent, and take whatever comes first. If I rent them, I get long-term financing in place and plan to continue to rent for several years. For >$125K ARV properties, this would usually have negative cash flow, and put my beautiful remodel at risk of being just another used resale down the road, so I don’t bother offering to rent.

Also be aware that depending on how you structure your business and your personal finances, you may be at risk of being classified as a ‘real estate dealer’ by the IRS. I’m getting a little outside of my expertise here, however, my CPA has warned me that this classification would make someone ineligible to claim long-term gains on properties flipped pasted the 1-year mark. You also lose other tax benefits such as the ability to depreciate properties. For this reason, you may want to take steps to avoid this classification.

Phill

Does anyone know what forms I should use for a “subject to”
transaction? Also, in what way do I obtain the deed? Do I have the
homeowner quit claim it to me, or do I write a new warranty deed? If
so, where can I get that form? Answers to any one of these questions
would be helpful. Thanks in advance,
Mark

ANSWER

Mark,
Buying Subject-To is not as simple as just using the correct forms. Most people that do it, like myself, have paid hundred or thousands of dollars to lawyers to develop the contracts or for courses that include the paperwork. Once you obtain a subject-to contract, you need to know what provisions to add and how to handle things like escrow accounts, insurance, and long term access to the loan. You will also need to address liabilities, and may want to include a non-disclaimer. There are many additional optional forms that may be used. Then you will decide how you want to address this with the lender (if at all). Finally, you will need to decide how to hold the deed – for example: in a trust, in an LLC, in a DBA, or in your name. Then where to change the address for the loan to, and how to handle payments, and how to cash refund, escrow, or other checks from the lender. Then there are many other little details like how and if to do title insurance, what to record where and when, how to arrange to ultimately be able to pay off the loan, etc. etc. Oh yeah, and there are several critical things you want to find out about the loan before you take it subject-to… and, I recommend never using quit claims for this…

I don’t mean to say that this is rocket science, but it is advanced real estate investing if you want to do it correctly. If you just jump in and do it, there are many potential gotcha’s. I suggest you buy some books, hire a lawyer, or partner with someone that has experience in this area before just jumping in.

Phill Grove

More bad press for the investor community - the National Consumer Law Center
recently released a report titled “Dreams Foreclosed: The Rampant Theft of
Americans’ Homes Through Equity-Stripping Foreclosure ‘Rescue’ Scams.”

www.consumerlaw.org
www.consumerlaw.org/news/ForeclosureReportFinal.pdf

ANSWER

I found this report quit interesting. (see: http://www.consumerlaw.org/news/ForeclosureReportFinal.pdf)

It is highly worth noting that most of the “Foreclosure Rescue Scams” they write about involve either: 1) clearly illegal activities such as selling services and not actually delivering the services, or 2) deceiving a homeowner into believing in terms that are different than the actual terms in the contracts.

What is distressing are the broad conclusions that therefore virtually any pre-foreclosure deals with investors are probably scams, and need to be regulated. The report goes on to outline suggested regulations on investors involving limiting fees, profits, etc. and giving homeowners rights to pay back or otherwise reverse deals retroactively or be compensated.

Also distressing is the increasing use of the term “equity stripping”. In some contexts equity stripping is already a legally defined term describing an illegal activity in certain real estate transactions. For example, buying a home by assuming a mortgage, and then selling it, with financing, at a profit, but then letting it go into foreclosure anyway by not paying the underlying mortgage despite collecting the new monthly mortgage payments. In other cases, equity stripping just an ominous term, assumed to be illegal or at least highly unethical.

In still other context’s ‘equity stripping’ simply means buying a home with equity (at less than full retail value), and reselling it without equity (at retail value), thus stripping the equity. As investors, we also call that ‘making a profit’. And, as much as I would love to pay everyone full retail for every home I buy, I would be broke, out of business, and facing foreclosure myself quite quickly if I did so.

This report also illustrates examples similar to “I knew I sold my home for $100K, but because I was an idiot or lazy or just needed the money quickly and the investor was smart enough to know that the home was worth $150K, the investor is a crook, and I deserve another $50K…”. This is followed up by commentary from the sympathetic report writer to the tune of “investors are buying properties for less than full value and have the nerve to sell them for profit”… Investors are then referred to as ‘Equity Strippers’, ‘Equity Surplus Purchases’, or ‘Equity Property Purchasers’.

As Capitalists, making a profit is the American way, yet because of the various bad apple amongst us, and no clear way for the public to differentiate among us, there is a growing belief that making a profit as a real estate professional is not a good thing, and something that the government needs to put a stop to – and several states are already doing so.

Hello,
I am trying to purchase a home via a lease option. I understand that in Texas there is not a formalized contract for lease options buying. Is that true or am I just getting false info. Can anyone direct me to where I can get a good lease option contract. I am being told that to get one an attorney will need to draft up the document which will cost upwards of $400. This is prior to the seller even looking at the offer I am proposing. Doesn’t sound right!

I appreciate any help you can give.
Thanks,
Dean

ANSWER

Dean,
Most of the lease option contracts out there came from courses investors bought or lawyer’s investor paid.

All the ones I’ve seen are clearly more favorable to the investor and not necessarily something I would recommend for a purchaser that might have the opportunity to set terms.

Phill

UPDATE: Texas Senate Bill 629 has made lease/options virtually illegal in Texas. I don’t recommend this strategy. If you are going to try this type of transaction, contact me for information on how to do so legally.

Below is an interpretation of the SB629 lease/option law in Texas. This is an “investor interpretation” and not an analysis from a lawyer.

>
> If a lease/option is for 3 years or less, only certain provisions
> of the law
> apply to it. The changes are as follows:
>
> 1. You cannot impose a late fee that exceeds the lesser of :
>
> a. 8% of the monthly payment
>
> b. the actual administrative cost of processing the late payment.
>
> 2. No prepayment penalty for exercising the option early
>
> 3. cannot forfeit option money for a late payment
>
> 4. cannot increase price for requesting repairs
>
> 5. cannot make optionor waive rights to repairs or other liabilities
>
> 6. Tenant/buyer can cancel contract for improper platting and
> landlord/seller will have to give ALL monies back
>
> 7. Landlord Seller cannot have any liens against the property
> except:
> a) a lien due to conduct of tenant/buyer
>
> b) agreed to by tenant/buyer to improve property
>
> c) a lien placed on property prior to lease/option contract,
> only if it
> was used to purchase the property(does this exclude 2nd’s and home
> equityloans taken out prior to lease/option contract?), is
> attached only to the
> property being sold, is less than the amount due by the tenant/buyer
> (throughout the contract), where the lienholder does not prohibit the
> property from being encumbered by an executory contract (does this
> mean if
> they prohibit contract for deeds, I can’t execute a
> lease/option?), and the
> lienholder consents to verify the status of the loan on request of
the
> purchaser and to accept payments directly from the purchase if the
> sellerdefaults on the loan (I guess the means we need to give the
> tenant/buyer a
> signed ATRI form?).
>
> 8. If there is a lien against the property prior to contract, then
> landlord/seller must do the following or give ALL monies back
> (includingrents):
>
> a) 3 days BEFORE the lease/option contract can be signed, notify
> tenant/buyer with a written notice disclosing:
>
> 1) The name, address, and phone number of the lienholder
> or, if
> applicable, servicer of the loan;
>
> 2) The loan number and outstanding balance
>
> 3) monthly payments of the loan and the due date of those
> payments
> 4) in 14 pt. type: If the seller fails to make timely
> payments to
> the lienholder, the lienholder may attempt to collect the debt by
> foreclosing on the lien and selling the property at a foreclosure
> sale.
> b) Place the following covenants in the contract:
>
> 1) A covenant that obligates the seller to make timely
> payments on
> the loan and to give monthly statements to the purchaser
> reflecting the
> amount paid to the lienholder, the date the lienholder receives
> the payment,
> and the information described by the above written disclosure
> statement.
> 2) A covenant that obligates the seller, not later than
> the third
> day the seller receives or has actual knowledge of a document or
> an event
> described in this paragraph, to notify the purchaser in writing in
> 14-pt
> type that the seller has been sent a notice of default, notice of
> acceleration, or notice of foreclosure or has been sued in
> connection with a
> lien on the property and to attach a copy of all related documents
> receivedto the written notice
>
> 3) A covenant that warrants that if the seller does not
> make timely
> payment on the loan or any other indebtedness secured by the
> property, the
> purchase may, without notice, cure any deficiency with a
> lienholder directly
> and deduct form the total outstanding balance owed by the
> purchaser under
> the contract, without the necessity of judicial action, 150% of
> any amount
> paid to the lienholder.
>
> 9. Failure to perform means returning ALL monies paid (including
> rentpayments — tenant/buyer lives for free if you make a
> mistake… i.e. 12
> point type) PLUS the value of any improvements made by the
> tenant/buyer(with or without landlord/seller permission). So if
> your tenant/buyer built
> a fence without you knowing, and you mess up and make one small
> mistake…you just bought a fence!
>
> 10. Seller is not liable if a lien is placed on the property by
> someoneother than seller and seller takes all steps necessary to
> remove the lien
> has the lien removed from the property within 30 days of receiving
> notice of
> the lien.
>
> This applies to any and all contracts executed on or AFTER
> January 1, 2006

These are in effect on ALL lease/options including those less than
three years. If it is more than 3 years, then the entire bill takes effect
which even more bad news for the seller.

In that case, the tenant/buyer would have conversion rights meaning they
could, at any time, request the the lease/option be converted to a 30 year
fixed mortgage simply by delivering a promissory note that has their current
balance (price minus rent credits minus option consideration) amortized at
their current interest rate (0%). That’s right… If your lease/option is
more than 3 years, you just financed a home at 0% interest. You would be
required to give title at that time. If you don’t have title (lease/option
sandwich) then be prepared to pay all monies back. If the owner financed
sale triggers your due on sale clause, then pay off your note, or face
foreclosure (and the subsequent lawsuit and paying back all monies from your
tenant/buyer). Plus, there will be many more reporting requirements, such
as monthly reports showing your tenant/buyer how much interest they have
paid — $0.00. Failure to report is a $250.00 fine per month retroactive to
your last reporting date. So if you go 2 years without giving them a
report, or having a mistake in your report, you now owe your tenant/buyer
all monies paid PLUS you’ll owe the government a $4,800.00 fine. Nice, huh?
There are other reporting requirements, etc.

I guess you could take a home under a lease/option for longer than 3 years
and then take advantage of this law to force your seller into giving you all
your rent back or converting the lease/option into a 30 year fixed at 0%.
Seems pretty unethical, though. I’m sure also you would be tangled in a
legal battle as you are the “expert”.

But I’m pretty sure this law will create incentive for some unethical
investors to take advantage of sellers by signing long-term lease/option
contracts. Seems the legislature forgot that sometimes sellers are the
“consumers” needing protection as well.

Its not so much the reporting requirements that make this really difficult
for me to continue to do lease/options beyond this year, but rather the
problems this will create with the banks. The fact that I have to
essentially put my tenant/buyers in contact with my bank and disclose to the
bank what I am doing is enough to kill it for me. Especially when I own the
home sub2!!!!! I would essentially have to get the previous homeowner…
The person who’s name is on the loan… To sign an authorization to release
information for the tenant/buyer…. And each subsequent tenant/buyer.