Can a Relative Live in My Rental or Investment Property?

This is actually a fairly common question. Can a taxpayer sell rental or investment property and acquire another rental or investment property through a 1031 tax deferred exchange and still qualify for tax deferred exchange treatment if a relative lives in the newly acquired property? The answer is fairly straight forward.

Treat it as Rental or Investment Property
The key is that the acquired property must be rental or investment property or used in your trade or business in order to qualify as like kind property. So, as long as the related party is paying the taxpayer fair market rent just like any other tenant would pay, it will qualify as like kind replacement property for tax deferred exchange treatment.

Risk of Being Recharacterized as a Second Home
There will be risk that the acquired property would be recharacterized or reclassified as a second home or vacation home instead of rental or investment property if the related party does not pay fair market rent to the taxpayer.

Vacation Property or Second Home
It is possible for a property held and used as your vacation property or your second home to qualify for tax deferred exchange treatment. It depends on a number of factors. The IRS also provided certain "Safe Harbors" for situations like this. I just recently posted a blog on this subject.

Trading Equal or Up in Value in a 1031 Exchange

Reinvest Total Investment Amount
This seems like a relatively straight forward issue, but it can get confusing for many investors. The concept is simple. Congress wants to make sure that investors trade equal or up in value (i.e. they stay fully invested) if they are going to be able to defer the payment of their capital gain taxes.

Most Investors Trade Way Up In Value
The actual required calculation for trading equal or up in value is not generally an issue because most investors are trading significantly up in value. However, some investors are not interested in expanding their real estate holdings, but do want to make sure that they defer all of their income taxes. Other investors are simply misinformed as to what trading equal or up in value means.

It's Not Just Reinvesting Your Equity
First, trading equal or up in value does not mean just reinvesting all of your cash, equity or capital gain in the property. The investor must do that also, but it is based on the net sales price and not just the investor's equity or capital gain in the property.

The two (2) rules are as follows:

1. Trade equal or up in value based upon the net sales price of the relinquished property; and
2. Reinvest 100% of the net cash proceeds from the sale of the relinquished property.

It is technically based on your net sales price, so if you want to cut the reinvestment as close as possible, you can calculate your reinvestment by taking your gross sales price and subtracting your routine closing costs to arrive at your net sales price. The next sales price is the correct amount of value that you must reinvest in your like-kind replacement property.

Backdating the Identification Form in Your 1031 Exchange

You are probably very familiar with the 45 day identification period if you have ever completed a 1031 exchange transaction. The taxpayer must identify in writing the potential replacement properties that they are considering buying as part of their 1031 exchange transaction, and the identification must be made with in 45 calendar days of the closing of the relinquished (sale) property.

45 Day Period Moves Fast
The 45 day identification period moves very quickly. In fact, it is only six weekends, which is not a lot of time to search for suitable like-kind replacement properties for your 1031 exchange. Taxpayers should start looking for replacement property well before they have closed on their relinquished properties to help minimize the stress involved with the 45 day ID period.

It is not surprising that many taxpayers may get a little stressed out during the 45 day identification process and time period. O.K. That might be an understatement in certain cases, especially as the taxpayer gets to the end of his or her identificatio period.

Backdating or Altering the Identification Form
Actually, my favorite question is "what is your position on the 45 day period?" I can't actually say this, but I really want to respond with "Are you kidding me?" The 45 day identification requirement is contained with the Internal Revenue Services, the Treasury Regulations and in numerous IRS rulings and court decisions. I think it is just about as clear as it can be that you must identify no later than midnight of the 45th day. There is no gray area here.

"But, ABC Exchange Company will allow me to backdate my identification form." "Nobody ever gets caught." These are some of my favorate follow-up comments that we get after we inform them that there is no flexibility with the 45 day identification requirement, even though we wish there were.

It's Tax Fraud; Pure and Simple
I realize that the IRS has been very loose in its enforcement of this area, but it will happen at somepoint in time. The act of backdating, altering or amending your identification form after the end of yoru 45 day identification period is tax fraud. There is no gray area.

I don't know about you, but I certainly do not want to be the poster boy for the IRS when they decide to actually prosecute some of these cases.

It is the same as the mortgage fraud was going on for years, which is part of the reason we are n the mess that we are in now. Clients used to respond all the time that no one ever gets caught if they say it was owner occupied when in fact it was rental property. We would still warn them. Well, the FBI is investigating and prosecuting those who lied right now. Its fraud, period.

Do you really want to take the chance that you might be the one that gets caught? More importantly, do you really want to work with a 1031 exchange company that is routinely breaking the law? I would prefer that they be around for a long time so that they are there for me if I get audited. Just my two cents.

Merry Christmas

Twas the night before Christmas and all through the house not a creature was stirring...not even your 1031 exchange Qualified Intermediary!

Have a very Merry Christmas!

Two Party Swaps: Concurrent 1031 Exchanges

These type of 1031 exchanges are not that common, but they do happen on occassion. This post was triggered by a recent call that I received. The caller said that he wanted this other person's investment property and coincidentally the other person wanted an investment property that he had. He wanted to know if they merely "swapped" properties if that would qualify as a tax-deferred exchange.

Classic Two Party Swap

This is a classic two party swap or concurrent 1031 exchange. You might also hear it referred to as a simultaneous 1031 exchange. It is actually the most basic type of tax-deferred exchange or 1031 exchange and is the structure often used years ago before the current delayed exchange was allowed by the courts through the Starker cases.

You have two investors that simply want each other's investment property. This tax-deferred exchange is often over complicated by the parties involved when it should be a relatively straight forward tax-deferred exchange.

Concurrent Recording of Deeds

The procedures to complete this tax-deferred exchange are very simple. The two parties simply draw up deeds for each of their properties granting the property to the other party. The two deeds are then recorded concurrently or simultaneously, and you have accomplished the two party swap.

Property Market Values

This assumes of course that both properties are worth the same amount. One party may owe the other party a cash payment in order to "equalize" the values if the properties are not equal value. The party that receives the cash payment will recognize tax on the cash portion received or he or can set up a delayed tax-deferred exchange with a Qualified Intermediary or Accommodator.

Professional Qualified Intermediary

The use of a professional Qualified Intermediary is not generally needed when you are structuring a classic two party swap. However, you must make sure that everything is structured and recorded concurrently.

Investors often retain a professional Qualified Intermediary in order to make sure that the necessary steps are taken to protect the tax-deferred exchange transaction. This will ensure that the proper tax-deferred exchange documentation is completed accurately and there is no accidental error that could invalidate the tax-deferred exchange.

You might also want to review some of the blog posts on this subject on the Exeter Discussion Board.

Consult with Tax Advisor

Both parties should of course consult their tax advisor before proceeding with a two party swap in order to ensure that the values are correct. Any complication due to property market value or outstanding debt, etc., can be dealt with before recording the deeds.

Does My Vacation Property Qualify for 1031 Exchange Treatment?

I can't tell you how many debates I have listened to or participated in regarding vacation homes or vacation property and whether it does or does not qualify for 1031 exchange treatment. The arguments were always the same. Would the IRS consider the property held for personal use or held for investment?

The more the vacation property or second home is held and used as investment property the better you were, and the more that you used the property for personal use the less likely it was that it would qualify for 1031 exchange treatment.

Moore vs. Commissioner
There was a court decision in Moore vs. Commissioner that held that a vacation home or vacation property must be primarily held for investment and not primarily held for personal use or enjoyment in order to qualify for 1031 exchange treatment.

Revenue Procedure 2008-16
The Internal Revenue Service issued Rev. Proc. 2008-16, which addressed this issue very well. It was in fact a very generous ruling in favor of the taxpayer. We updated our extensive article regarding the qualifications of a vacation property or second home and whether it qualifies for 1031 exchange treatment.

Safe Harbor Ruling
However, the Rev. Proc. only provides certain safe harbors. This means that if you fall within the safe harbors you will qualify for 1031 exchange treatment. But, it also means that if you fall outside of the safe harbors it does NOT mean that you do not qualify. It just means that you can not take advantage of the safe harbor provisions, but you must be extra careful when proceeding with your 1031 exchange going forward.

Strategic Thoughts
Vacation properties or second homes that fall outside of the Rev. Proc. may still qualify for 1031 exchange treatment. Taxpayers merely have to be more diligent in their planning to ensure a successful 1031 exchange.

Here are some thoughts that you may wish to consider:

• Rent out the vacation property or second home as much as possible.
• Put the vacation property or second home in a rental pool.
• Limit your personal use of the property to less than 14 days per year if at all possible.
• Don't use the property for any personal use in the year in which you will sell the property.
• Treat and report the property as investment property for income tax purposes, including depreciation (the IRS will tax you later on deprecation recapture whether you depreciated the property or not).
• Always charge fair market rental rates when you rent the vacation property or second home to your relatives and friends that use the property and make sure that you report this on your income tax return.
• The best of all solutions is to cease all personal use for at least 12 months before the sale and rent the property for 100% of that time. This way it is well documented that you are holding it for investment purposes and are collecting rent and paying taxes as investment property.

You can easily structure the sale of your vacation property or second home so that it will qualify for 1031 tax deferred exchange treatment if you follow the above suggestions and leave plenty of time to do so.

Deferred Sales Trust to the Rescue
However, for those who do not have time to properly structure the sale of your vacation property or second home for 1031 tax deferred exchange treatment, you may wish to consider the Deferred Sales Trust as a tax deferred solution on the sale of your property. Property does not have to be investment property in order to take advantage of the Deferred Sales Trust.

Selling an Easement on Your Property for a Billboard

Sale of an Easement
You own real estate and someone approaches you with a special request. They would like to buy an easement on your property so that they can put up a billboard for advertisements. The offer is attractive, and you really want to accept, but you are worried about the income tax consequences and contact your tax advisor for guidance.

Is It a Sale of a Real Estate Interest?
This is where a little creative thinking can go a long way. The sale of an easement on your real property is generally considered a partial sale of real estate because you are granting a right of way on your real property to someone else. You need to verify that the sale of an easement is considered to be a sale of a real property interest in the state in which the subject property is located.

1031 Tax Deferred Exchange
It is considered to be a sale of real estate in most states, so the sale of the easement can be structured as a sale of real estate and therefore will qualify for 1031 exchange treatment. You can sell the easement or right of way and set-up a 1031 exchange and buy replacement property in order to defer the payment of your captial gain taxes from the sale of the easement.

You might even want to approach one of these outdoor advertising vendors with the idea. It might be a great strategy to generate some liquid cash that can be reinvested tax deferred through a 1031 exchange into investment property that produces monthly cash flow.

Tax Deferred Investment Solutions
The 1031 exchange does, of course, require that you reinvest in replacement property. You may not wish to buy replacement property through a 1031 exchange when you sell an easement to your real property. In this case, you would need to decide if you wish to cash out and pay the taxes in the current year or look for ways to defer the payment of the taxes over a period of time. Certain taxpayers may wish to look at the Deferred Sales Trust as an alternative strategy to the 1031 exchange transaction.

Can I Buy More Than One Property in My 1031 Exchange?

There is a common misconception that taxpayers who are completing a 1031 exchange can only sell one relinquished property and buy one replacement property, and nothing could be further from the truth. One of the benefits of the 1031 exchange is the ability to use the 1031 exchange strategy to diversify or consolidate your investment portfolio.

Diversification Strategy
Generally, younger investors are trying to trade up in value by selling one relinquished property and buy two or more replacement properties. This will usually provide them with more units, more cash flow and better diversification (risk management).

Consolidation Strategy
The opposite of the diversification strategy is the consolidation strategy. This is often implemented by taxpayers that are apporaching retirement or are in retirement and are tired of the property management headaches involved with owning investment property. It is a very effective life simplification strategy by selling more than one relinquished property and buying fewer replacement properties or properties that are easy to maintain and manage.

Tax Deferred Solution
1031 exchanges allow taxpayers to reposition or rebalance their investment portfolios by selling and buying one or more properties without having to pay depreciation recapture taxes and capital gain taxes. The only downside is that it does require that you buy replacement property in order to defer the payment of your income taxes.

Taxpayers that are not interested in buying more investment properties will need to look for other tax deferral solutions. They might want to consider the Deferred Sales Trust.

Can I Change the Property that I have Identified in My 1031 Exchange

The 1031 exchange requires that you sell an exchange property (relinquished property) and acquire other property (replacement property in order to defer the payment of your capital gain taxes.

Replacement Property Identification
The 1031 exchange process requires that you identify the replacement property or properties that yu are going to acquire as your replacement property within your 1031 exchange. The identification must be made within 45 days from the date that you sold and closed on the sale of your exchange or relinquished property.

Changing Identified Property
The question that comes up all the time is can I change the replacement properties that I have already identified as part of my 1031 exchange. The answer is: It depends.

You can change your mind and revoke your identified properties at any time as long as you are still within your 45 calendar day identification period. Simply contact your 1031 exchange Qualified Intermediary and find out how they want you to revoke the identification that you already provided them with. I would recommend that you make a complete revocation of your previous identification even if you do not want to revoke all of the properties and then make a completely new identification on a separate identication form. This keeps the entire process nice and clean.

However, you can not change your mind and revoke your replacement property identification if you are outside of your 45 day identification period. You can only change your mind during the 45 day ID period, but not after the 45 ID period has past.

Beware of Changing Your Mind After the 45 Day Period
There are those 1031 exchange Qualified Intermediaries that allow you to amend, alter or change your identification period after the 45 day period. I get the comment all the time: It doesn't matter; THEY let me do it. Actually, they are allowing YOU to commit TAX FRAUD. I know that it is tempting, but it is tax fraud none the less.

California Land Trust Webinar

Join us for an informative webinar on buying, holding and selling California real estate using the California Title Holding Trust, or also known as the California Land Trust. The benefits and advantages of acquiring, owning and disposing of California real estate or personal property under a Title Holding Trust or California Land Trust will be addressed by William L. Exeter, president and chief executive officer of Exeter Fiduciary Services, LLC.

We will also discuss the ability to defer the payment of your capital gain taxes through the potential benefits of using a Deferred Sales Trust. The Deferred Sales Trust can be a good alternative to the 1031 exchange strategy when an investor does not wish to replace the asset he or she is selling.

This is a complimentary webinar offered through The Exeter Learning Institute.

Land Trust or Title Holding Trust Webinar on 12/1/2008

Title Holding Trust webinar on the benefits and advantages of acquiring, owning and disposing of real estate or personal property under a Title Holding Trust. The potential benefits of using a Deferred Sales Trust™ will also be addressed. You can visit our web site for complete details regarding the upcoming Title Holding Trust webinar.

Title Holding Trust Discussion on Radio Show

Title Holding Trusts on the Air
Buying, holding and selling real property via a Title Holding Trust, especially for the purpose of holding property confidentially and privately, will be presented by Bill Exeter, president/ceo, Exeter Fiduciary Services, LLC on the Financial Advisor's Money Talk Radio Show with its host Aubrey Morrow, president/ceo of Financial Designs, Ltd., on Saturday, November 8, 2008 from 7:00 AM to 9:00 AM PST.

Listen Live on Saturday, November 8, 2008 at 7:00 AM PST
Tune your radio to AM 600 KOGO San Diego to listen to the talk show about Title Holding Trusts, or if you are outside of the Southern California area you can by clicking the Listen Live icon below.


Land Trust Seminars
Exeter Learning Institute provides monthly seminars and webinars on Title Holding Trusts or Land Trusts as well as other topics. You can review its upcoming land trust seminars and webinars on its website for further details.

Listen Live to the Financial Advisors on Saturday Mornings
The Financial Advisors radio series with host Certified Financial Planner® Aubrey Morrow can be heard each and every Saturday morning from 7:00 AM to 9:00 AM PST on News and Talk Radio AM 600 KOGO San Diego. KOGO`s superior signal strength reaches six Southern California Counties, which include Santa Barbara, Ventura, Los Angeles, Orange County, Riverside, San Diego and Tijuana, Mexico.

About Exeter Fiduciary Services, LLC
Exeter Fiduciary Services, LLC delivers specialty fiduciary products and services to real estate investors and property owners throughout California. It is a wholly-owned subsidiary of
The Exeter Group, LLC.

Year-End is Here Again; Let's Revisit 1031 Exchange Year-End Planning Issues

It seems like I was just writing this same 1031 exchange year-end planning post toward the end of 2007. Did twelve months actually just come and go, again?

End of Year Near
Well, here we are once again. We are now just shy of two months before we celebrate the end of 2008 and welcome in the new year of 2009. What a year 2008 has been, and what a year 2009 will be. I'm actually typing this as I'm watching the election results begin to unfold on CNN.

1031 Exchange Year-End Planning
I'm going to ignore the election results right now since the results will not affect our discuss about 1031 exchange year-end tax planning, unless you have a 1031 exchange that fails or will otherwise not qualify for tax-deferred exchange treatment. The capital gain tax rates for 2009 might be substantially higher than what we have been used to over the recent past few years.

1031 Exchange Fails at Year-End
Anyway, ignoring the election for now, it is time to discuss 1031 exchange year-end tax planning for those 1031 exchanges that fail to qualify for tax-deferred exchange treatment. The question is what happens when you begin your 1031 exchange during 2008 and it fails because you were not able to locate and identify suitable like-kind replacement property or you were not able to actually acquire the property identified? The answer may surprise you!

Section 1031 of the Internal Revenue Code Works in Conjunction with Section 453
So, you have a 1031 exchange that started in 2008 and then failed. When do you recognize and pay taxes on the sale? Can you still defer the payment of the capital gains at all? These are all important questions that can have significant income tax consequences. The answer to this question depends on when you have the legal right to receive access to your 1031 exchange funds.

If your 45th day identification period and/or your 180th calendar day exchange period end in the following income tax year and the 1031 Exchange Agreement contains the appropriate language to restrict your right to access the funds, the depreciation recapture would be recognized and taxable in the year you sold your property (2008) and the capital gain would be recognized and taxable in the following year (2009) when you have the legal right to access your 1031 exchange funds.

The failed 1031 exchange works like an installment sale transaction pursuant to Section 453 of the Internal Revenue Code. Your capital gain is not taxed until the following year because you do not have the right to receive the proceeds until the following year provided the 1031 exchange documents are drafted correctly.

Save the Failed 1031 Exchange with a Deferred Sales Trust
You might also qualify for the Deferred Sales Trust™ if your 1031 exchange documentation was properly structured prior to the sale of your relinquished property closing.

Fed Cuts Fed Funds Rate by 0.50%

The Federal Reserve Bank cuts short-term interest rates today by dropping the Fed Funds Rate to 1.00% from 1.50%.

Tax Deferred Exchange Seminar

Intermediate Tax Deferred Exchange Seminar
This 1031 exchange seminar is an intermediate seminar on regular forward, delayed, reverse and improvement (build-to-suit or construction) tax-deferred like-kind exchanges pursuant to Section 1031 of the Tax Code and Section 1.1031 of the IRS Regulations.

Tax Deferred Exchange Seminar Content
This educational tax-deferred exchange program will begin with an introduction to various tax-deferral and tax-exclusion strategies, including combining Section 1031 with Section 121. The discussions will focus on the requirements, structures, processes, strategies, and compliance issues necessary to successfully complete a 1031 exchange transaction.

Should You Attend?
Yes, if you are interested in gaining a deeper understanding of the processes and requirements for completing a successful tax-deferred like-kind exchange transaction, including investment property owners (taxpayers/investors), accountants, attorneys, corporate officers, certified financial planners and real estate agents and brokers (Realtors©).

Registration Required
Click here for more complete details and to reserve your space.

Premier Lending Services on the Big Island of Hawaii

Hawaiian 1031 Exchange Operations

Many of you know that Exeter 1031 Exchange Services, LLC opened a branch office location on Hawaii under the supervision of Mellanese Lofton toward the beginning of 2008. This new 1031 exchange operation was an important move for Exeter so that we can take advantage of the real estate market when it begins to turn around and normalize later next year.

Luxury Home Lending Operation

I would like to introduce everyone to one of our our Hawaiian Island partners - Island Home Capital. Island Home Capital has been instrumental in providing high end lending services on the Big Island of Hawaii since 1997. They are one of Hawaii's leaders in luxury home lending and have recently expanded into the western United States. They can quickly help you decide which mortgage program would suit your needs best and get started with the process right away.

Please feel free to contact Mellanese Lofton, Esq., and Branch Manager of Exeter 1031 Exchange Services, LLC for a personal introduction to Island Home Capital.

Tax Deferred Exchange Seminar in Irvine, California

Intermediate Level Tax Deferred Exchange Workshop

This is an intermediate level workshop on forward, reverse and improvement (build-to-suit or construction) 1031 exchange transactions pursuant to Section 1031 of the Internal Revenue Code and Section 1.1031 of the Treasury Regulations.

Educational Workshop Content

The educational workshop will begin with an introduction to various tax-deferral and tax-exclusion strategies, including combining Section 1031 with Section 121. The discussions will focus on the requirements, structures, processes, strategies, and compliance issues necessary to successfully complete a tax deferred exchange transaction.

We will finish with an explanation of the new fractional ownership opportunities of tenant-in-common property interests (TIC or CORE Interests) used as like-kind replacement property solutions pursuant to Revenue Procedure 2002-22.

There will be plenty of time for open discussions, questions and answers with our 1031 exchange experts. Handout materials will be provided for future reference.

Who Should Attend?

Anyone interested in gaining a more in-depth understanding of the processes and requirements for completing successful 1031 exchange transactions, including investment property owners (taxpayers/investors), accountants, attorneys, corporate officers, certified financial planners and real estate agents and brokers (Realtors©).

Continuing Education Credit (CE Credit)

Two (2) hours of continuing education credit will be provided to:

• California real estate agents/brokers
• Certified Public Accountants (CPAs)
• Certified Financial Planners (CFPs)

Deli Lunch Provided

A deli lunch and drinks will be provided by Exeter 1031 Exchange Services, LLC.

Speakers

William L. Exeter
President and Chief Executive Officer
Exeter 1031 Exchange Services, LLC

Kim Englert, MBA and Paralegal
Business Development Officer
Exeter 1031 Exchange Services, LLC

RSVPs Are Required

Go to our web page at http://www.exeterco.com/1031_Exchange_Seminar_Orange_County_OCAR.aspx for complete details regarding the Tax Deferred Exchange Workshop in Irvine, California and for information on how to RSVP.

The Land Trust in California

Land Trust in California

Title Holding Trusts, often referred to as Illinois Land Trusts, Land Trusts, Holding Trusts or Blind Trusts, has been used in the State of California for numerous decades. I have drafted, created, and administered Title Holding Trusts for real estate investors and homeowners in California since 1986, and I have administered Land Trusts that were originated in the 1930's.

Ways to Own California Real Property

Title Holding Trusts are just not popular methods for buying and holding real property in California. There is a huge void in land trust education in California. Hence this blog. Read about the Eight (8) Common Ways to Hold Title to California Real Estate. I think you will find it very interesting, and a quick summary or cheat sheet on the various methods used to hold legal title to property.

Title Holding Trusts' roots go back to the Illinois Land Trust. The Land trust vehicle are extremely popular and have been used in Illinois for well over a century. The Title Holding Trust or Land Trust is an extremely simple and inexpensive strategy for buying, holding and selling California real property.

I will post a follow-up blog with more information, including the advantages of holding property inside of a Title Holding Trust.

1031 Exchange Workshop in San Diego, California

1031 Exchange Workshop
It's Not Just Another 1031 Exchange Seminar - It's a Workshop!

See all of our 1031 exchange seminar programs.

Intermediate Level 1031 Exchange Workshop

This is an intermediate level workshop on forward, reverse and improvement (build-to-suit or construction) 1031 exchange transactions pursuant to Section 1031 of the Internal Revenue Code and Section 1.1031 of the Treasury Regulations.

1031 Exchange Workshop Content

The educational workshop will begin with an introduction to various tax-deferral and tax-exclusion strategies, including combining Section 1031 with Section 121. The discussions will focus on the requirements, structures, processes, strategies, and compliance issues necessary to successfully complete a 1031 exchange transaction. We will finish with an explanation of the new fractional ownership opportunities of tenant-in-common property interests (TIC or CORE Interests) used as like-kind replacement property solutions pursuant to Revenue Procedure 2002-22.

There will be plenty of time for open discussions, questions and answers with our 1031 exchange experts. Handout materials will be provided for future reference.

Who Should Attend?

Anyone interested in gaining a more in-depth understanding of the processes and requirements for completing successful 1031 exchange transactions, including investment property owners (taxpayers/investors), accountants, attorneys, corporate officers, certified financial planners and real estate agents and brokers (Realtors©).

Continuing Education Credit (CE Credit)

Two (2) hours of continuing education credit will be provided to:
California real estate agents/brokers
Certified Public Accountants (CPAs)
Certified Financial Planners (CFPs).

Refreshments Provided

Refreshments will be provided compliments of Exeter 1031 Exchange Services, LLC.

Speakers

William L. Exeter
President and Chief Executive Officer
Exeter 1031 Exchange Services, LLC

Gary Wildeson
Director, San Diego Region
TREC Investment Realty

Date and Time
Monday, September 22, 2008
11:20 AM Registration
11:30 AM - 2:00 PM Workshop

Learn more about this 1031 exchange workshop, including RSVP infomration and location.

Federal Reserve Leaves Rates Unchanged

The Federal Reserve Bank left short-term interest rates unchanged today at their Federal Open Market Committee (FOMC) meeting. The Federal Funds rate remains at 2.00%.

September 11, 2008: FLY YOUR AMERICAN FLAG

Please join us in this FLY THE FLAG campaign and PLEASE forward this Email immediately to everyone in your address book asking them to also forward it. We have a little less than one week and counting to get the word out all across this great land and into every community in the United States of America. If you forward this email to least 11 people and each of those people do the same ... you get the idea.

THE PROGRAM:

On Thursday, September 11th, 2008, an American flag should be displayed outside every home, apartment, office, and store in the United States. Every individual should make it their duty to display an American flag on this seventh anniversary of one our country's worst tragedies. We do this honor of those who lost their lives on 9/11, their families, and friends and loved ones who continue to endure the pain and those who today are fighting at home and abroad to preserve our cherished freedoms.

In the days, weeks and months following 9/11, our country was bathed in American flags as citizens mourned the incredible losses and stood shoulder-to-shoulder against terrorism. Sadly, those flags have all but disappeared. Our patriotism pulled us through some tough times and it shouldn't take another attack to galvanize us in solidarity. Our American flag is the fabric of our country and together we can prevail over terrorism of all kinds.

ACTION PLAN:

So, here's what we need you to do ..

1) Forward this email to everyone you know (at least 11 people). Please don't be the one to break this chain. Take a moment to think back to how you felt on 9/11 and let those sentiments guide you.

(2) Fly an American flag of any size on 9/11. Honestly, Americans should fly the flag year-round, but if you don't, then at least make it a priority on this day.

Thank you for your participation. God Bless You and God Bless America!

1031 Exchange Class in Long Beach, California

SCI Real Estate Investments and Exeter 1031 Exchange Services cordially invite you to:

Tax Deferral and Replacement Property Solutionsin a 1031 Exchange

Wednesday, September 17, 2008
9:00am - 12:00pmHoliday Inn Long Beach Airport
2640 N. Lakewood Blvd.
Long Beach, CA 90815

This is an intermediate level discussion on Section 1031 Tax-Deferred Exchanges. The program will include the requirements, structures, processes, strategies, and compliance issues necessary to successfully complete a 1031 exchange, including a discussion of Tenant-In-Common (TIC) investment properties as 1031 exchange replacement property solutions. Click here to RSVP.

Can I Cash Out When I 1031 Exchange

I hear clients ask this all the time.

The 1031 Exchange

The client is selling an investment property and structuring a 1031 exchange so that they can defer the payment of their capital gain and depreciation recapture income taxes into another property they intend to acquire through the 1031 exchange.

Cashing Out or Having Your Cake and Eating it Too

But, they would like to pull some cash out of the transaction when the sale of their current investment property closes. The frustrating part is that clients get so many conflicting messages that they are not sure who or what to believe.

The Answer: It Depends

Those who know me and/or my real estate blogs know that my favorite answer is "It depends." In this case, it depends on whether the client wants to defer the payment of all of their income taxes or just some. The client must reinvest 100% of his or her net cash proceeds from the sale of the investment property in order to defer all of their capital gain and depreciation recapture taxes.

Cash Boot

The cash they pull out will be considered "cash boot" and will be taxable. The fact that they are pulling some of the cash out of the sale will not jeopardize their 1031 exchange transaction (contrary to what some tax advisors will say), but it will result in the payment of some taxes.

Don't Pull Too Much Cash Out

It is also important to make sure that the amount that is pulled out does not result in the recognition of all the client's income taxes. It is possible to pull too much out so that the 1031 exchange will actually not defer any taxes. This is a relatively easy computation that you tax advisor can make for you.

Property Acquried Through Sheriff Sale Qualifies for 1031 Exchange

Here is a question that I received today via email.

If I buy a property which is being sold at auction by
the county for defaulting on property taxes, and assuming I meet the deadlines,
can I use this as a replacement property in a deferred 1031 exchange? If the
last owner of record was a defunct corporate entity whose charter was revoked,
who is the party with whom I am exchanging? Is it the county?

Yes, you can acquire this property and it will qualify for your 1031 exchange provided that both properties are held for rental income, investment or are used in your trade or business.

Counties normally have Sheriff Sales to dispost of properties that were taken for unpaid property tax bills. The Sheriff Sale will issue you a deed upon closing and settlement.

However, the challenge is how the 1031 exchange can be structured. The Qualified Intermediary must be assigned into the purchase and sale agreement and any escrow instructions, if any. There are often no agreements at trustee sales or county Sheriff Sales. We would need to contact the department responsible for processing the sale to determine how the transaction is actually settled in order to determine how to structure the actual 1031 exchange. But, it can be done.

Reverse Exchange Pricing

We do a lot of reverse exchange transactions each and every month. In fact, we have seen an increase in reverse exchanges this year compared to what we thought we would see given the real estate market.

How Much is Not Enough and How Much is Too Much

The question we obviously get asked often is how much should we expect to pay for a reverse exchange transaction? Reverse exchange providers are still feeling their way along the pricing models to a certain extent. We see prices that run from $1,800.00 (which should really, really scare you) to well over $25,000.00, which is absolutely rediculous (unless it is a huge transaction).

Complicated Tax Deferred Exchanges

Reverse exchanges are complicated tax-deferred exchange strategies that should not be taken lightly. We have seen many pricing models in the industry, and generally, the lower fees are nightmares waiting to happen, while the really high end fees are taking advantage of the real estate investor.

Competent Reverse Exchange Servicers

Generally, competent reverse exchange servicers are going to be charging somewhere between $5,000.00 and $8,000.00, which should include the reverse exchange services, the documentation, any consulting needed to get the job completed, and the set-up maintenance and dissolution costs and service for the separate LLC that is set-up for each individual reverse 1031 exchange transaction.

Taxpayer Loses Partial Tax Free Exclusion on Sale of Personal Residence

Property owners are in for a surprise if they have used their personal residence in the past for rental or investment purposes. The tax free allowance of $250,000 per person when a property owner sells their personal residence is reduced if the personal residence was a rental or investment property before it was their personal residence.

The changes were included in the Housing Act of 2008 and modify Section 121 of the tax code.

The amount of taxable gain applied toward the time period that the property was held for rent or investment will no longer be tax free. The amount of taxable gain applied toward the time period that the property was held as the property owner's personal residence will still qualify for the tax free deduction.

Learn more about the modifications to Section 121 under the Housing Act of 2008.

President Bush Signs Housing Act of 2008 with Changes to Tax Free Exclusion on Sale of Home

President Bush signed the Housing and Economic Recovery Act of 2008 yesterday, which contained some surprises.

Reduced Tax Free Exclusions on Sale of Home

The Housing Act included provisions that may reduce the amount of the tax free exclusion available to a taxpayer upon the sale of their primary residence if they had also used the home as a vacation home, second home, rental property, investment property or in their trade or business. These uses are referrred to as "non-qualified use."

Section 121 (121 Exclusion)

The current exclusion falls under Section 121 of the Internal Revenue Code. A taxpayer can exclude up to $250,000 in capital gains (per taxpayer; $500,000 for married couple filing jointly) from their taxable income if they have lived in their home as their primary residence for at least a total of 24 months out of the last 60 months.

Changes under the Housing Act of 2008

The Housing Act of 2008 will now prohibit a taxpayer from excluding part of the capital gain based on the number of years (percentage of total use) that the property was used for non-qualified use such as personal vacation usage or if it was held as rental property. These changes are summarized here.

1031 Exchange Workshop in Irvine, California

07/30/2008
11:30 AM — 2:00 PM

1031 exchange workshop on the requirements, structures, processes, strategies, and compliance issues necessary to successfully complete a 1031 exchange. Continuing education credits available for Realtors, CPAs and CFPs. It's NOT just another 1031 exchange seminar.

Learn more

Intermediate Level
Irvine, California

The Fallout From Starbucks!

Those who are familiar with the commercial real estate market, or those who are 1031 exchange investors that acquire triple net leased properties through their 1031 exchanges, have probably heard about the announcement that Starbucks is closing 600 plus stores, and those who are not in real estate may have heard about it on the news.

It was certainly a surprise to hear that, but once you really think about it there is really no surprise at all. It will have some pretty significant consequences for landlords, developers, 1031 exchange investors, brokers and others.

I just read a blog post by Eric Odum entitled Starbucks: Do Not Foresake Me, Oh My Darling! It is a must read

Combined 1031 Exchanges and 121 Exclusions May Be Changed

This should be good news for the 1031 exchange business, but not for taxpayers.

The House of Representatives has passed the Housing Bill, which has now been sent to the U.S. Senate for debate and vote. The Housing Bill contains a provision that will significantly change the structure of a combined 1031 exchange with a 121 exclusion.

Here is the down and dirty. The current language in the Bill says that a taxpayer can not exclude gain from a sale of property for the time that the property was used for non-qualifying uses (i.e. rental, investment, use in a business, etc.).

This means that if a taxpayer 1031 exchanges into property the gain that was deferred from the 1031 exchange could not be excluded under Section 121.

The U.S. Senate has to pass it and then the President must sign it, so a lot can change between now and then. We will keep you updated.

What Is Cost Segregation?

Cost Segregation Tax Savings Benefit Analysis

If you as a commercial real estate investor have completed a 1031 exchange and the replacement property you purchased cost more than the property or properties you sold, you may be eligible for substantial state and federal tax savings that you can only obtain through a cost segregation study.

A cost segregation study is a strategic analysis that allows owners of commercial real estate to increase their cash flow by accelerating depreciation-related tax deductions. To do so, the study identifies, segregates and reclassifies property costs currently being depreciated over the typical 39-year depreciable period to shorter depreciable periods of 15, 10, 7 or even 5 years. This means you can enjoy tax deductions right now that you’d otherwise have to wait years to receive. So you’ll not only increase the net value of current tax savings, but also boost your cash flow.

1031 Exchange Seminar in Torrance, CA on July 23rd

07/23/2008

11:30 AM — 2:30 PM

1031 exchange workshop on the requirements, structures, processes, strategies, and compliance issues necessary to successfully complete a 1031 exchange, including a discussion of Tenant-In-Common (TIC) investment properties as 1031 exchange replacement property solutions. Continuing education credits available for Realtors, CPAs and CFPs.

Learn More

Intermediate Level

Torrance, California

Failed 1031 Exchange Taxation Issues When Qualified Intermediary Fails

I have received numerous calls over the years, and a signficant number of calls after last year's failures of two 1031 exchange Accommodators, asking about the taxation of a failed 1031 exchange once or if the taxpayer's Accommodator fails and files for bankruptcy protection.

It is a very sad and unfortunate event when a taxpayer's 1031 exchange Accommodator fails, and is even more frustrating when it is because of a theft of 1031 exchange funds.

Chief Counsel Issues Letter

We now have some guidance, although it is not binding and is not an IRS Ruling of any sort, but it is guidance non-the-less.

The IRS's Office of Chief Counsel issued an informational letter (INFO Letter No. 2008-0021) regarding the income tax consequences of a failed 1031 exchange transaction due to the failure of the Qualified Intermediary (also referred to as a QI).

The IRS was responding to a inquiry made by Congressman Delahunt of Massachusetts on behalf of his constituents that had lost money through a failed 1031 exchange transaction because their 1031 exchange Qualified Intermediary had failed and filed for bankruptcy law protection.

Options for Partnership Treatment When 1031 Exchanging

Real estate investors often use the 1031 exchange as a strategy to dispost of real estate and acquire replacement real estate without incurring an immediate income tax liability.

Partnership Issues

The issues involved with the disposition of real estate when the property is acquired and held within a partnership, including general partnerships, limited partnerships or multiple member limited liability companies can be extremely complicated.

Read this blog post for more details.

A Guide to 1031 Exchanges

The newly released publication A Guide to 1031 Exchange Services is now available free of charge.

This 21 page guide book to 1031 exchanges provides real estate investors with all of the critical information needed to complete their 1031 exchanges in one easy to use and follow guide book.

You can request and download your copy from the following web page: http://www.exeter1031.com/RequestBrochure.aspx. Keep it at your finger tips for quick reference.

Tax-Deferred, Like-Kind Exchange Seminar in Torrance, CA with CE Credits for Realtors, CPA and CFPs

This is an intermediate level tax-deferred, like-kind exchange seminar on forward, reverse and build-to-suit tax-deferred, like-kind exchanges.

Tax-Deferred, Like-Kind Exchange Seminar Program

This tax-deferred exchange seminar will cover the various tax-deferral and tax-exclusion income tax strategies, including Section 1031 with Section 121 combinations. The topics will focus on the requirements, structures, processes, strategies, and compliance issues necessary to successfully complete a tax-deferred, like-kind exchange transaction.

The program will complete with an discussion of the new fractional ownership opportunities of TIC or CORE investment properties used as like-kind replacement property solutions for tax-deferred, like-kind exchange transactions.

Who Should Attend This Educational Seminar?

Real estate investors that are interested in learning much more on the processes and requirements for completing successful tax-deferred, like kind exchange transactions, including investment property owners, accountants, attorneys, corporate officers, certified financial planners and real estate agents and brokers (Realtors©).

Continuing Education Credit Provided (DRE, CE)

Two (2) hours of continuing education credit will be provided to:

California real estate agents/brokers
Certified Public Accountants (CPAs)
Certified Financial Planners (CFPs)

Deli Style Lunch Provided

Beverages will be provided compliments of Exeter 1031 Exchange Services, LLC and SCI Real Estate Investments.

Reservations Required

You can visit our web page at: http://www.exeter1031.com/1031_exchange_seminar_torrance.aspx to learn more about this tax-deferred, like-kind exchange seminar to be held in Torrance, California.

Introducing Sid Jain with MoneyMallUSA

Real estate investors are always looking for new real estate and investment resources. I would like to make the introduction to Sid Jain.

Biography

Sid’s personal experience in the Financial Services Industry is 18+ years in the USA. Prior to that he worked for four years in India, where he worked with Reliance Industries in their Retail Marketing Division, creating fabric showrooms and handled Financial Instruments, raising money for the company. He holds MA Economics from University of Jabalpur (Now RD University) and BA Economics and Math, from St. Aloysius College. He was educated from Grade K through High School, at one of the finest, private catholic convent schools in India, St. Aloysius School, which is now 137 years old. The motto of his “Alma Mater” was "VIRTUS ARDUO" which means “virtue in hard work”. Sid attended University of Georgia in the PHD Economics program, Athens, Georgia, initially in the USA. Later, in 1989, he transferred to an Ecumenical "Master in Religious Education" Program at Barry Town, New York for personal and spiritual enrichment.

In his spare time, Sid has participated in numerous summer or winter, Inter-Faith, Cultural, Rebuilding and Community Service programs on three Continents, Asia, Europe and United States. On a local basis, Sid volunteers his spare time at a Community Center in Sunnyvale and the local Silicon Valley Real Estate Community. Sid was a Junior Table Tennis and Badminton Champion, has coached and sponsored - Little League Baseball and National Youth Sports Basketball, and enjoys sports. He is married and has two boys. He lives in Monte Sereno (Los Gatos), CA and has been a Northern California bay area resident since 1991. Both, he and his wife became PROUD American Citizens in 2003. Sid is a Freethinker, Free Spirit, and a Registered Independent.

MoneyMallUSA Corporation was founded by Sid Jain in 1999. Currently, their Broker-Dealer is Emerson Equity, LLC, San Mateo. Sid Jain’s current Real Estate Broker is Mr. Joe Atab, First City Bancorp Mortgage, Inc. They are Licensed, Bonded and Insured. Average Financial and Real Estate Industry experience of their 1031 exchange Qualified Intermediaries (a.k.a Accommodators), Registered Representatives and Property Providers a.k.a. Sponsors, Securities Broker-Dealer and Real Estate Broker is at least 10 years each. On a combined experience basis, that experience is well over 500 years, including people in the Sponsor’s home office. They are regulated by Federal and State Securities laws, through SEC, NASD, State Agencies, and in some states through the Department of Real Estate.

Sid is also regulated by the DRE, since he voluntarily obtained the Sales Person License for Real Estate (Non-Securities) transactions. Sid Jain and/or MoneyMallUSA Corporation is a member of NASD (registered rep.), Member of California DRE (as salesperson), Member-Financial Planning Association, past member of NAIFA (National Association of Insurance and Financial Advisors), Member and Sponsor of COIAR (Council of Indian American Realtors), Member-CA Department of Corporations, Member, Nevada Department of Corporations, Member, Tenant In Common Association (TICA), Member, CA Apartment Association, and a member/contributor of numerous environmental, conservation, cultural, service and charitable organizations worldwide.

MoneyMallUSA Corporation is a 1031 exchange, Tenant in Common (replacement) property* Broker. The minimum net worth of any client accepted into the TIC 1031 PROGRAM (considered securities even though it is Real Property) is $1 Million with a minimum investment of $350,000. Each investor or SPE (Special Purpose Entity) has to be an Accredited Investor with net worth for SPE's at $5,000,000. Their Advertisements run in Commercial and Residential Magazine, California Apartment Association website and member magazine, Los Gatos Weekly Times, Saratoga News and online on a weekly basis for 1031 exchange replacement properties. Please visit Item A and Exhibits in the “About Us” section on their website at http://www.mymoneymall.com for additional 1031 information. You can reach them at 408-836-3858 or sidjain@mymoneymall.com.

SID JAIN, President
MONEYMALLUSA CORPORATION
A Financial Services Company
sidjain@mymoneymall.com
(408) 836-3858

The New Sub-Prime

Private Money Lending is "The New Sub-Prime"

By Lance W. Newton
lance@thenewsubprime.com

What follows is a discussion explaining why I think Private Money Lending will become "The New Sub-Prime" for single family residential mortgages in America.

Some History

Historically Private Money Lending was called "Hard Money" or sometimes "Equity Lending". Each loan was made based on a much lower "Loan to Value" (LTV) than "Conventional" loans from a Bank or Savings and Loan. Private Money Loans had a maximum LTV between 50 and 65% of appraised value on each property (the collateral for the loan) and higher fees and interest rates than the loans available to more "credit worthy" borrowers. The pricing of these loans reflected the risk to the lender and often included a risk premium.

Since the real security for each of these loans is in the underlying property value, if the borrower could or would not make the payments, the lender had to come back to the property to recover his investment. The rates, terms and conditions of these types of loans varied widely and there were abuses. In more recent years, limitations were placed on the practices of this type of lender that limited fees and rates within a narrower range. Federal Regulations were implemented, but Private Money Lending remained relatively expensive.

Another innovation in the late 1980's was the creation of tools that enabled Private Money Lenders to pool their loans and thereby spread risk from a single property loan to the pool. These pools are similar to the pooled mortgages we read so much about today, but with major structural differences that will keep them strong and viable for the future. Keep in mind that in a Private Money Pool, the lender thoroughly reviews the capacity of the borrower to repay and the focus of underwriting is on the strength of the collateral!

The failure of so many securitized Sub-Prime Pools in the current market is a result of too much leverage and very high LTV's on poorly underwritten loans in the pools. From day one, this has been a recipe for disaster. There simply was never enough collateral or liquidity to reflect the real risk in many of these pools. When the cycle turned they could not survive the volume of failed loans that occurred. The financial geniuses that created the concepts did the calculations did not foresee the events that have happened.

Because of readily available "Sub-Prime" loans in the marketplace from 1990-2000, Private Money Lenders became to an extent, "lenders of last resort" and the business contracted but did not disappear. Some changed their business model and originated and sold loans just like everyone else. In large part, this was because of the increased use of underwriting standards based on credit scores and mathematical models and the pooling of mortgages with different risk characteristics into securities, theoretically eliminating the risk from Sub-Prime and lower rated borrowers.

Once the system was in place for originators to easily and readily sell off loans to firms that bundled them into securities, the historical checks and balances in mortgage lending (like verification of employment and assets) began to fail, in part because there was minimal risk retained by the originators (or so it was believed) and because the upfront fees and commissions for these loans represented huge short term profits for everyone involved. Mortgage brokers in particular have taken much of the blame for “Agency” issues and once again, there were visible abuses to point at.

Good Private money lenders kept the best performing loans they originated for themselves to the limits of their capital, but they could not compete (and did not want to compete) with a market place awash in capital. The availability of "Liar Loans" with LTV's that went as high as 103% of property values were greeted with scorn and the old timers saw the inevitable collapse as handwriting on the wall.

Supported by the artificially low interest rates that were in place for years, the Boom real estate market expanded and originations of more and more exotic, highly leveraged mortgage instruments increased. Even Private Money Lenders felt the pressure created by the overall easy money environment and many increased the LTV's offered on their loans from historically safe levels of 50-65% to 70% or above, or expanded their offerings to include equity lines at high rates. Many of these lenders have failed or will fail and many were companies that did not have the benefit of long term experience by having survived multiple real estate cycles.

For most, the lure of quick profits overcame common sense and prudent business practices. Going forward it will make even more sense to do business with well known and accomplished survivors.

Fundamentals, like a meaningful correlation between income and the cost of properties were abandoned as the market expanded and prices ballooned. Everything was great until the system reached a tipping point in 2005-2006. As Bennet Sedacca of Atlantic Advisors has said "Debt must be serviced, repaid or refinanced or go into default".

Ignoring the facts has never changed the facts, so here we are today...

The Sub-Prime Market has Turned Full Circle

Who has not heard daily about the Sub-Prime mortgage meltdown? We are bombarded with daily updates on which mortgage company has now closed and which large bank, brokerage house or insurance company is announcing losses of double or triple initial estimates on investments in Sub-Prime mortgages. There is a popular website at www.mlimplode.com that has tracked the failures of more than 256 lenders since late 2006. Some of these lenders were huge.

Many large individual investors in seemingly safe financial institutions have lost their shirt on stocks held for investment or investments in mortgage related securities. A few have profited enormously from the declines of these securities. A top hedge fund manager for a fund betting against various Sub-Prime instruments made a heady $3.7 Billion in personal compensation for 2007. His top fund returned over 500% to individual investors (after costs) for the year. Many hedge funds holding the same securities for the long term lost everything or went bankrupt before losing everything. Several large pension funds held long term positions in the mortgage securities that went down. Only time will show the effects of those losses to pensioners.

The Federal Government has gone to previously unheard of lengths to prevent further damage to the finance/mortgage industry and the interlocked dealings between Wall Street, the Mega Bankers and mortgage originators of every stripe, including opening the discount window to investment banks.

Taxpayers are already on the hook for the Federal $39 Billion dollar, non-recourse loan made to secure the purchase of Bear Stearns at an initial price of $2 per share. Since the stock traded for $30 per share the Friday before the bailout/purchase on the following Monday, this may well represent the deal of the century for the buyers.

Bear Stearns was at the heart of an intricate web of cross collateralized and highly leveraged exotic mortgage instruments whose failures could have collapsed our financial system. If $39 Billion were the true ultimate cost of this bailout, it would be cheap. Now of course, every investment banker that profited from the run up of the bubble sees the Fed (translation=Taxpayers) as the low cost financial solution to a decade of previous highly leveraged financial excess. Why act responsibly when there is no downside, little chance of prosecution for misdeeds and a federal bailout around the corner?

Apparently the Federal bailouts will not extend to individual borrowers who either cynically manipulated an out of control market or who were incapable of understanding the financial commitment they made to a lender and every borrower in between these extremes.

Current political initiatives (like the S 2636 Foreclosure Prevention Act) to help borrowers with Adjustable Rate Mortgages (ARM’s) or Option ARM’s, are a political football and consumer advocates like the "Center for Responsible Lending" are supporting legislation to help a broader cross section of borrowers than earlier anemic initiatives (see the article "Earlier Subprime Rescue Falters" online.wsj.com/public/article/SB120285480915463431.html?mod=yahoo_free). Any such legislation will be gutted before passing or be vetoed by the current administration.

The deep pockets of the financial industry, their lobbyists and the politicians that are beholden to their financial industry patrons, would seem to make meaningful legislation in this area all but impossible. Too much money has been made by too many people for too long with no consequences for any misdeeds and incredible payouts to insiders.

If you listen to talk radio on the topic of borrower bailouts you hear the outraged cries of former mortgage brokers and real estate industry insiders who do not want any kind of bailout for borrowers, in particular the unqualified speculators that abused "Liar Loans" to flip properties and boost the bubble in real estate prices. These callers seem to overlook their own contributions, in league with appraisers and lenders and brokers that contributed greatly to the bubble. I keep thinking of a quote from author Sinclair Lewis who said something like "It’s hard to get a man to understand something when his salary depends on his not understanding it".

These same outraged callers are also forgetting the interlocking relationships between speculators and regular homeowners who qualified for the best financing and put 10% or more down on their properties. If a "free market" approach had been allowed to take place, a real estate crash would have undoubtedly occurred on a scale hard to imagine.

Americans are also incredibly lucky that foreign investors bought so much of our mortgage securities and have sustained the losses related to them. Imagine if all of the $250 Billion of write downs related to Sub-Prime loans (so far) were taken by American financial institutions alone!

Remember that by several estimates there is another $750 billion of bad paper till to be written down. The so called "Secondary Market" for mortgage securities is all but closed for business and may never recover. The ripple effect is already impacting the commercial loan market as well.

As disgusting and one sided (in favor of the financial industry) as the current bailouts seem for many people, they have slowed down the overall rate of foreclosures and may prove to be a brilliant solution to the crisis. Of course history has proven that any market cycle that is artificially extended on the upside, experiences a longer and harsher downturn and resolution on the downside. This market cycle is not immune to history, just different in form.

While there is no doubt that responsible borrowers and savers are adversely affected by the actions of the irresponsible, most Americans simply do not realize the enormity of the problem. A good discussion of the potential mayhem for equity values and eroding tax bases is at: http://www.responsiblelending.org/issues/mortgage/research/subprimespillover.html.

Estimating Long Term Costs

In a 2006 article published online by the Federal Reserve Bank of Chicago, GMACRFC, Americas largest private issuer of mortgage backed securities and a leading warehouse lender, estimated that it loses $50,000 per foreclosed home (a cost that would likely accelerate in a rapid downturn). The entire article can be viewed at: www.chicagofed.org/community_development/files/02_2006_foreclosure_alt.pdf.

The system in place today has created a bias toward foreclosure as the path of least resistance for a servicer or trustee, because of the contractual limitations/difficulties and potential liabilities related to any attempt at modifying terms on any loan in almost any securitized structure. (Email me if you want to read my article on this topic).

The percentage of successful loan modifications is very small as is the percentage of successful short sales by borrowers in trouble. We will see if market conditions force lenders to modify more loans or accept more short sales, but right now foreclosure is the easiest option. There is little doubt that too many foreclosures will force financial institutions to change tactics as many are very thinly capitalized and they do not want to take back properties on a mass scale.

A possible wild card would be mandatory federal guidelines for handling problem loans, but financial institutions are likely to fight the tough measures necessary to resolve the problems mass foreclosures would create and politicians in an election year are hypersensitive to Governmental solutions that would be overtly recognized by voters as taxpayer funded.

Of course for individual borrowers making legal claims against originators that have failed or are in bankruptcy there is little hope of legal remedy and it is likely that their house will be long gone before a class action might produce results.

Everyone needs to realize that the well we all drink from has been thoroughly poisoned. Just how far the poison will spread is the real issue, not whether thousands or even hundreds of thousands of small speculators will be bailed out of ARM type loans and into federally subsidized, fixed rate loans.

Most of these speculators who have not already walked away will be ruined financially even if they are able to negotiate temporary modifications directly with their lender, or if there are more Federal programs to convert their loans from variable to fixed rate loans. Since most paid a speculative premium, the fundamentals are not there to sustain a long term investment.

If the underlying values have dropped sufficiently, these investors are likely to keep only those properties that cash flow enough to make sense as an investment. Just about everyone in America knows that in most areas, speculation on Single Family Residential properties is dead for the foreseeable future.

We are definitely back to basic "buy and hold" fundamental strategies for the average small investor or more bulk purchases for the wealthy like the recent sale of 11,000 new homes in 8 states from a national home builder to various hedge funds at 40 cents on the dollar.

Americans also need to understand the longer term social costs to every taxpayer when borrowers in inner city and lower income neighborhoods who were deceived in this Sub-Prime mess lose their homes as a consequence of the deception. This is due both to the ripple effects on surrounding homes and the long term social costs to the nation in the affected neighborhoods. All borrowers would be well served by a rational and logical bailout of this sector as near term direct costs will be far less than any well structured alternative.

Out of Disaster, a new Opportunity

If you haven't seen the opportunity yet, let me spell it out for you.

It will take years for all of the systemic problems we are seeing to be resolved. In the meantime, existing or new mechanisms must expand to fill the void. It is hard to say how large financial institutions will respond in the future and if securitized structures will be redesigned for sustainability in the mass marketplace. Perhaps the deep thinkers in other countries affected by the same issues, like England, Ireland, France, Germany or Australia will come up with a viable structure, while financial institutions here continue to resist the inevitable changes to an unsustainable system. The demand for loans is still out there and originators can process loans all day and night, but if the loans cannot be sold into a secondary market place, this system is finished as currently structured.

For the foreseeable future, the opportunity is for private investors to begin aggressively funding the Private Mortgage Lenders who underwrite their current loan pools based on low LTV's and the strength of the underlying collateral and with little or no leverage. The low LTV's provide downside protection for investors along with the additional collateral that is often used to secure these loans.

Experienced managers of these types of pools will be able to demonstrate a track
record of limited losses to investors. with excellent potential returns that are secured by realistic valuations of the underlying assets and plenty of liquidity to handle foreclosures in the portfolio.

Of course this type of investment is illiquid by nature and suitable primarily for Qualified Fixed Income investors who need to diversify and find reasonable, secure returns from monies allocated to longer term (5 year) investments.

The Future

Perhaps in the longer run, new methods to meet the basic needs of modern society for mortgage financing will be created. Robert Shiller, the Yale Professor of Economics who helped established the Case-Shiller Home Price Indices now run by Standard & Poors, http://www2.standardandpoors.com/portal/site/sp/en/us/page.topic/indices_csmahp/2,3,4,0,0,0,0,0,0,0,0,0,0,0,0,0.html, has advocated a concept he calls the Continuous Workout Mortgage”. To paraphrase him, this concept would include a mortgage that is “privately issued so that the cost would be priced into the rate. And they would be mortgages that are flexible in the sense that the payout scheme responds to changing economic conditions and changing ability to pay."

We will need to wait and see how the market reacts as future economic conditions unfold. If you wish to share your thoughts and comments, email me at lance@thenewsubprime.com.

Copyright by Lance W. Newton. Republished by permission of Lance W. Newton.