Bob Weaver-The Real Estate and Business Tax Guru

I visited with a client of mine yesterday.  He’s about one year into “asset protection mode.”  He has several problem properties teetering on the edge, where the personal guarantees could bankrupt him.   Creditors are circling, but have not yet pounced.  It’s a Kabuki dance, will they or won’t they.  This client wants to be sure if they do pounce, they can’t wipe him out, like they did in the 90′s.

Since I am not an attorney, I can only assume the following that he told me is correct, but I cannot be sure.  This is what I learned.

1.   Get your money out of California bank accounts!  A creditor can walk into a judge the day you default and get a pre-judgment lien on your bank accounts.  Day 1.  A California judge cannot give a creditor such a lien on an account in Wyoming.

2.  Hold your properties in an LLC, preferably an LLC with members not involved in the day-to-day workings of your real estate enterprise. It is much harder for a creditor to get a hold on your assets in an LLC (vs. a corporation or no entity at all).

3.  Be out-of-town on the day of default (so you can’t be served).

4.  Begin squirreling away money into bank accounts that won’t honor a California judgment.  Many foreign jurisdictions, including plenty of ones where it is safe to keep your money,  will not do so.  I knew better than to ask where he was putting his.

5. Pay your federal taxes, file your returns, report your foreign bank accounts and keep on VERY good terms with the IRS.  Chances are, with all the real estate losses floating around, the IRS is not very high on any real estate investor’s creditor list.  The IRS has a worldwide power to collect, unlike the State of CA, and most people are unwilling to stomach the measures necessary to defy that power.

On that cheery note, if you have potential net worth-ending creditor problems and you have not done any bona fide asset protection, you are  a year behind the smart ones who learned their lessons in the 90′s.

I have said this to my clients many times.  Don’t let the tax man drive the bus.   What this means is don’t let the tax implications be the driving force for ANY financial decision.  “But Bob” you say “You’re a tax guy.  How can you say that?”  Sure I am a tax guy, but before I got my MS in Tax I got my degree in finance and was a few classes short of another degree in economics. 

People want to pay less tax, for sure.  But the answer to the question of “Hey Bob, should I buy a new truck?” is ALWAYS, do you need a new truck.   The main deciding factor in any business decision should ALWAYS be determined by the underlying economics, not the tax effect.  If you don’t need a new truck, don’t just do it because you get a tax break.  Don’t spend a dollar to save forty cents.  Now if you are thinking you MIGHT need that new truck, that is the perfect time to call, and we’ll go through the economics first, come up with an answer and maybe, just maybe, we’ll let the tax rules affect the answer.

And “Don’t Let The Tax Man Drive The Bus” is the foremost thing I would tell the tax policy makers in Washington.  In general, as of this minute, my business clients are not enticed in the new tax breaks for hiring new employees or for investing in new equipment.  They will tell you as far as their little corner of the economy is concerned, these moves will not stimulate job or business growth, because they do not make decisions about the economics of their business based merely on tax incentives.  To do so would allow the tax man to get be hind the wheel of the bus.

I took my car in to fix a problem this morning.  The mechanic called me a few minutes ago to say it was fixed, and it didn’t cost quite as much as the estimate.  When was the last time our federal government was able to say that? 

Why does our Federal government estimate  how much a program will cost, be it a military program or social program, only to have it NEVER come in under budget? Even when they seem to not care about how much it costs, with a “do it at any price” mentality; why do they feel it necessary to lowball the estimates of how much it costs? If they were honest, it would come in under budjet one time, over the next.

If you hired a contractor, and they lowballed the cost of the job, you’d expect them to eat the difference, right?  Or at the very worst, if they became beligerent, you might pay them the full price and never hire them back.  Right? 

Well Congress is always beligerent and never backs down and we always pay full price, even if they were totally dishonest when asked how much does it really cost.  Why do we hire them back?

Oh, and don’t get me started about Congress not living up to the part about ”everything’s fixed.” I mean, the recession is over, right?

Whoa Nelly, I didn’t mean no new taxes ever. Just no new taxes for 2010.  The Obama administration may be a lot of things, but stupid is not one of them, at least not on raising taxes.  The administration knows that raising taxes during an economic crisis is unwise.  Yoo hoo, Arnold and Company under the dome in Sacramento, are you listening? 

The new taxes will be coming in 2011 and to a certain extent you could argue they are not new.  The Obama administration plans to return to the top rates of 39.6% and 36% established during the Clinton administration.   Capital gains will go up 5% for those folks as well.  If they are included as part of a new budget, these provisions will fly through Congress. 

Less certain is a new proposed limitation on itemized deductions for those in brackets above 28%.  First it was going to be a limitation on charitable deductions, then they changed it to a limit on mortgage interest.  The charity community went nuts and then the real estate and banking communities went nuts.  So instead, they are trying this generic limitation on itemized deductions.  It’s still a tax increase, and it will effectively limit charitable contributions and mortgage interest deduction.  So its just a wolf in sheeps clothing.   Its disguised as a mere tax on the wealthy. 

The latter is what I call a dishonest tax increase, or a stab me in the back tax increase.  The rate increase is an honest, stab me in the front tax increase.  Like them or hate them, rate increases representation honest taxation.  Do you want tax simplification?  Start with elimination dishonest tax increases.

$270.5 billion commercial property loans are expected to come due this year. How many of those will be able to get refinanced?

But why worry, its only $270 billion. Just add it on the the $1.8 trillion budget deficit. Who’s gonna notice?

But it’s not just the loans coming due.  Retail and office vacancies are on the rise.  The defaults are coming and it’s going to be ugly.

Hold onto your wallets, its going to be TARP II – the commercial side.

My late friend’s widow was in today.  I am helping her put together the taxes for 2008, the year her husband, my friend, died.  He was 49 years old.  When he was alive, he would brag to people that he didn’t need life insurance, that the equity in their home would take care of things.

Needless to say, the widow and her two daughters don’t want to sell the family home and move.  On top of that, the real estate market is really depressed right now.  That equity he bragged about disappeared almost as quickly as he did. And without a job, nobody is going to make the widow a loan on the equity that still exists.

The eldest daughter is bright and looking forward to going to a good school, but the college money is what they are living on and mom says to daughter you are going to need to live at home and go to community college.  With their dad’s passing, they might be able to get scholarships and financial aid to go to a good school, but mom can’t afford to support them living away from home.

And speaking of mom, a formerly stay-at-home mom, she’s having to look for a job during the worst job market maybe in her lifetime. She told me she can’t get a job as a waitress or a bartender, apparently something she did years ago in her single life.  The closest she has to a job offer is selling via telemarketing on a commission only basis.  The eldest daughter is chipping in, working as a bagger in a supermarket.

So if I could go back in time and tell my friend one thing, it would be “get life insurance, stupid.”  Nobody wants to by it, but the value of your life insurance does not does not crap out in a bad economy.  It’s there when your loved ones need it .

Today I met with a client who had to go bankrupt 8-9 years ago.   He is an honest man, but he had a penchant for living above his means.  As an MD, he had what most of us would consider a terrific income and a fat retirement.  As a big spender, however,  that income disappeared pretty fast and he never did salt enough away in his retirement account.  When he retired, it finally dawned on him that his retirement money would be gone in a few short years.  He tried to cut back, but he had a great difficulty in cutting back far enough and fast enough.

The good doctor said he didn’t have the heart to admit to his wife that they couldn’t afford the things they used to. So the debt piled up,and finally all the credit cards and home equity line reached their limits.

This isn’t some morality play about living within your means.  It is what he did next that constitutes the biggest no-no from a CPA’s view.   He cashed out what was left in his retirement account (about 70k) and tried to keep his debt current and managed to make it another year before he lost his house and had to file bankruptcy.  What he did by doing that was to commit tax suicide.  Cashing out his retirement constituted not one but two giant mistakes.

The first mistake was that the retirement funds could have remained outside the hands of the creditors.  The bankruptcy court would not make him forfeit his retirement.  Had he kept his money in the retirement account and filed bankruptcy, those funds would remain to be drawn on post-bankruptcy.  What a waste!

It gets worse.  Taking a retirement distribution is a taxable event.  So did he think of holding back some of that retirement account to pay off his tax debt?  Of course not.  So when he had spent all his retirement money and filed bankruptcy, what was the one debt they didn’t discharge?  It was the tax debt created by the $70k retirement distribution.

Sadly, I didn’t find out about all this until after it happened, when he moved to California to live with his kids because they took his house.  He also had to get work again at age 73 to pay the bills. His daughter in law referred him to me, but it was too late to do anything other than work out a payment plan with the IRS after the fact.  We couldn’t negotiate the bill down because he had a decent job again and had the ability to pay.

So if money is so tight and the debts have piled up so high you are thinking about bankruptcy, you would be wise to spend a few bucks and buy some professional time, to avoid repeating the good doctor’s mistakes.  As a general rule, if you are considering bankruptcy, do not take money out of your retirement accounts to try and save yourself, at least not without getting professional advice first.

With the printing of a trillion dollars of “extra” cash by the US Treasury, many economists fear a return of high inflation.  If you got crushed in the stock market and now you have what’s left in CDs, you could be in for another crushing.  It’s a common misnomer that if you have your money in a CD, you can’t lose money.  Well be warned, inflation will destroy the value of that CD.  That which your CD proceeds will buy today will not buy tomorrow if the price has risen due to inflation.

Right now, you can get single family houses that will cash flow as a rental at cost of less than half of what a new one will cost you to build.  Unless you expect a huge drop in construction costs (already depressed), the theory goes, the price of those homes will rise.

Warren Buffett, the billionaire investor, said March 9 on the CNBC television network that efforts to stimulate a recovery may lead to inflation rates exceeding those in the 1970s.   I would add that it will definitely lead to inflation at some level. 

I was in college getting a degree in finance and economics in the 1970s and I believe government interference in the free market was the key source of inflation.  Some observers blame the oild embargo and rising gas prices.  I believe those were only the spark, the government policies starting with President Nixon (price controls and other counter productive Keynsian economic policies) that were added to and augmented by Ford and Carter were like squirting on lighter fluid. 

The Reagan administration and it’s followers of the Milton Friedman money supply wing of the economics took over, and like them or not for what they did or didn’t do, you have to give them credit for getting inflation under wraps and Presidents GHW Bush and Clinton continued on.  GW Bush seemed to not care about deficits what with increasing spending whilst issuing tax cuts (economic suicide) and now the current administration isgoing into what I call turbo-spending. 

At the Treaty of Versaille after WWI, the Germans were ordered to pay reparations.  With their war torn economy, the Weimar Republic’s only means of paying offf their debt was to print money.  The good news is that it worked.  The bad news is that the visual of the man pushing the wheelbarrow full of money to the store to buy a loaf of bread came from a political cartoon in Germany from that time period.  That visual illustrates the very definition of inflation, too much money chasing too few goods.  It crushed an already bad economy and impoverished its citizens and the disgruntled populous turned to the Nazis to save them frum further economic catastrophy.

Is that where we are headed too?  We are piling up too much debt on an ailing economy?  Will we be forced to print money like the Weimar Republic?  Anybody got a wheelbarrow I can borrow?