Be careful how you hold your investment properties; New IRS "high wealth unit"

It was announced last week that the IRS has established a new unit for the purpose of discovering hidden assets and income of wealthy individuals:

The high-wealth unit is focusing on trusts, real estate investments, privately held companies and other business entities controlled by rich individuals.

H/T Reuters

While the announced intention is to focus on international investments and activities, those investors who employ layers of trusts, LLC's and related entities to hold real estate should view the above references ominously.

While use of sophisticated legal structures can be legal, in other instances they "mask aggressive tax strategies," [IRS Commissioner] Shulman said.

And don't waste time wondering if your activities qualify as "high wealth." If you catch the IRS' attention, you will be considered "high wealth" regardless of what you man own or earn.

Read the Reuters article for more information.

Avoiding minefields in the purchase of investment real estate.

I previously wrote about hidden landmines in the purchase of investment properties. Unwary buyers often walk into the middle of legal disputes with existing tenants. These landmines can be avoided by obtaining a few simple representations when closing on an investment property.

Many buyers obtain a copy of the leases at settlement, at which time the seller writes the word "assigned" on a corner of the leases. This practice is insufficient.

A buyer must obtain a complete Assignment of Leases at settlement. This assignment must specify the following:

• The identity and unit number of each tenant.


• The monthly rent for each tenant.


• The expiration date for each lease, including a statement as to whether each lease is month-to-month.


• A representation that there are no disputes between the seller and any of the tenants.


• The amount of each tenant's security deposit (which amount should be specifically credited to the buyer).

The parties should include language that the document "survives closing," so the buyer can enforce it later against the seller. This document will be a starting point to discover and avoid future legal disputes with the tenants. If any of this information is inconsistent with the written leases, the buyer can ask questions before settlement is complete.

• If the seller is crediting the buyer a smaller security deposit than is specified in the lease, the buyer might learn at that time that the seller has already used some of the deposit to repair damage caused by the tenant or offset unpaid rent, none of which the seller has previously reported to the buyer.


• If the name of the tenant on the Assignment is different from the name on the lease, the buyer might discover that the original tenant has moved out, leaving a new tenant with only an oral lease.


• If the rental amount listed on the Assignment is different from the amount specified on the lease, the buyer might discover unwritten oral arrangements between the seller and tenants (or at least that the seller has raised the rent since the lease was signed).


• Before signing the Assignment, the seller often "remembers" that one of the tenants hasn't yet paid this month's rent (yet he will expect to be reimbursed for a pro-rated portion of this month's rent since the buyer will undoubtedly collect it soon).

As I wrote, this document is only a starting point. It helps identify issues that the parties can then resolve prior to completion of settlement. There are additional documents for the tenants to sign, particularly in the case of commercial real estate purchases and particularly in cases where the Assignment of Leases has raised red flags.

Investment properties come with ticking time bombs.

Given the state of the economy, it is more likely than ever before that you will be stuck with bad tenants and pre-existing disputes when you buy an investment property.

• Sellers will fill their properties with bad tenants just to show occupancy in anticipation of a sale.
• Sellers are less likely to evict delinquent tenants when they expect to complete an imminent sale.
• Financially distressed sellers are more likely to commingle and make use of tenant security deposits that should otherwise be segregated and turned over to the buyers and/or returned to the tenants.
• Financially distressed sellers are likely to ignore maintenance issues, thus causing disputes with tenants and local governments.
• Financially distressed sellers are more likely to make oral agreements with tenants for reduced rent in exchange for labor.
• Sellers often have made promises to tenants (especially commercial tenants) regarding lease extensions (or options to purchase) at rates that are well below what the market will bear.

Sellers rarely disclose these issues to buyers unless the buyers exercise due diligence and force the issue. Each of the above issues can create litigation and/or eviction issues for the buyer after settlement. Disgruntled or delinquent tenants are likely to force the new owner to bear the cost of these problems with no consequence to the former owner. (These disputes would be, of course, in addition to problems related to undisclosed defects in the physical condition of the property.) But there are ways to discover and avoid each of these problems by taking action before settlement.

Check back for further updates.

update - 12-11-09 - Click here for solutions to these problems.

The rise of the suburban high rise.

In July, USA Today published an article chronicling the increase in high rise residential complexes in suburban areas throughout the United States. The paper attributed this trend to energy savings, traffic congestion, land prices and the prevalance of Asian investors in the real estate market.

While this trend has not affected the Harrisburg area in recent years, Harrisburg may be ripe for suburban high rise development soon. There are numerous residential high rise developments in the city of Harrisburg, all or most of which have or will face the prospect of increased costs resulting from Harrisburg's ongoing fiscal crisis. City residents and developers already face higher taxes and municipal utility charges than their suburban counterparts. But soon they may face the possibility of even higher city taxes or other fees designed to offset the debt created by the Harrisburg incinerator.

While certain of these fees will have questionable validity, the larger question is whether these fees will be enough to push the investors and developers into moving their high rise operations into the suburbs. A national trend already exists and conditions in Harrisburg already tend to push investors into the suburbs. How much more in taxation and municipal costs will it take for the Harrisburg area to go the way of the communities referenced in July's USA Today article?

Quote of the day - Thomas Sowell - mortgage debt forgiveness

Government pressures on mortgage lenders to accept less than the full amount they are owed may win votes for politicians, since there are far more borrowers than lenders. But how much future lending can be expected when the lenders know that politicians are ready to intervene at any time to prevent them from getting their money back?

Thomas Sowell - 12-1-09