March '07

THE ESCROW RECOVERY PROGRAM

CAN HELP DURING A COLLAPSING REAL ESTATE MARKET

In today's collapsing real estate market property sellers need all the help they can get in order to retain as much of their hard earned equity (profit) as they can. Unfortunately, this declining market is expected to worsen over the next 12 months while the market attempts to stabilize.

However, it is interesting to note that real estate IS selling in almost every market, but those properties that are selling are those that are "priced right" for the market they are in. In a "down market" such as the one we are in, having your property priced to sell (priced right) will make the difference between selling and not selling.

OK, now that we have stated the obvious, lets discuss what can be done to overcome these problems and effectuate a profitable sale. Some people have resorted to the use of what is called a 1031 exchange. This is a suitable alternative should you NOT need to receive any funds from the sale of your property and you don't have a problem with the process requiring you to purchase another "like-kind" property through a disinterested third party who you MUST use to handle your transaction within a very narrow time frame. However, this tax deferral program will catch up to every participant when they stop trading one property for another and want some cash from the sale of their property. At that time, ALL the taxes that would have been paid on each sale (transfer) are combined into one giant tax bill that in many cases becomes far more onerous than if you had paid the taxes on each sale (transfer).

There is another little known and much misunderstood alternative that most CPAs and other professionals have overlooked for years. That is an Internal Revenue Code Section 351 transfer. Like a 1031 exchange, it is a tax deferral process but one that can and will eliminate much of the cumbersome aspects inherent in 1031 exchanges.

In the 351 process you need not purchase a "like-kind" property, don't need third parties to officiate the transaction, can defer (and possible eliminate) all taxability related to the sale of the property and the 351 exchange WILL allow program participants to receive cash from the sale without penalty.

How a 351 exchange works: The 351 exchange is a process whereby a property owner creates a specially crafted C-Corporation and exchanges the "basis" they currently have in their property for the stock of the corporation. When exchanged, the stock becomes "valued" at the "basis" that the property was valued at. Then, when the corporation sells the property, the Internal Revenue Code considers the income as the "ordinary income" of the corporation and not as a capital gain to the corporation. Thus, eliminating federal capital gains taxes all together. Additionally, by incorporating the corporation in a tax-free jurisdiction such as Nevada, you WILL eliminate state taxes as well.

OK, so what's the big deal about ordinary income? Ordinary income is the income generated in the ordinary course of the business of a company. For example, a new car dealership purchases cars to sell. These cars are considered inventory in the Internal Revenue Code. When a car is sold, the income derived in commingled with the income derived from servicing the cars and the parts the dealership sells for the cars. This income is never considered capital gains. This is a very important concept to understand. People think that real estate is always a capital asset. That is not true. Should your corporation be in the real estate business you are selling "inventory" and not a capital assets. Hence, capital gains are eliminated.

Now, if this income is ordinary to the business then it stands to reason that that same business can "write-off" its ordinary business expenses that relate to the acquisition of that income as well as the costs associated with making those sales.

In the real estate business what could those deductible expenses be? Travel to view properties that you might want as inventory or as rental property. Vehicles, office space (could be in your home) computers, telephones, health insurance, life insurance, retirement plans, the purchase of more "inventory", consulting fees, club dues, entertainment and a host of additional items.

Better still, all these expenses are paid with pre-tax dollars not after tax dollars, as they are when you sell property or conduct the business of real estate through any other process.

Here is a truism the reader should understand:

Individuals receive income, pay taxes and then buy things with the "after tax" money. Conversely, "C"-Corporations receive income, buy things with "pre-tax" dollars and then pay taxes on any money left over.

So, the bottom line is this. In a "down market" the property seller must become very competitive in their pricing if they want to sell their property. If you as the seller continue to try to sell using those outmoded methods (selling a property titled in your name or undertaking a 1031 exchange) you will face the maximum in taxability and thereby needlessly loose far to much of your hard earned equity (profits). Should you undertake our 351-exchange program you will receive 15% to 45% more net income at the closing of the escrow from the sale of you property. This extra cash can afford you the ability to reduce your sale price making your property more appealing while at the same time not affecting your net income at the close of the escrow.

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