A question was posed to me and I thought it would make great blog discussion.  Here is the question and my response is posted below.  What do you think?

Q- The second loan on top of the original mortgage wiped out most of the equity long before the condominium was listed for sale three months ago.  Recent price reductions reduce what little equity was remaining, yet the drop from $500,000 to $460,000 still has not attracted buyers.  The monthly loan payments are difficult for the owner who is convinced she should walk away, giving the property back to the bank.  What would you tell her?  What are the tax, financial, and personal implications of defaulting on the loans?

A- Walking away is certainly an option but not one that I would necessarily recommend. From a tax perspective, should the lender agree to a short sale, any “forgiven” loan amounts could be reported as taxable income to the IRS on a 1099, resulting in a large tax liability (with some exceptions; consult your tax advisor for more details and guidance); a foreclosure is more damaging to a personal credit profile than a short sale (neither of which are particularly good), so exploring a short sale would be worthwhile, provided it could be made to work for all parties.

The damage to the seller’s personal credit report would follow her for a number of years, although some mortgage lenders would potentially look past it in a couple to a few years’ time depending on other credit factors. 

Obviously, the best solution would be to sell the property as listed and try to extricate the owner from the situation. A short sale or a foreclosure should be the last resort for any seller. In some cases, selling to a “fast cash” type of organization may be an option, but any sale would likely be far below market value and the seller may walk away without any profit (but this would still be better than a foreclosure or a short sale in most cases). 

Any discussion about a short sale or foreclosure should be handled by an agent or broker with knowledge of the ramifications from a real estate perspective, and clients should be strongly advised to seek competent tax and/or legal advice for ramifications involving either or both areas.

Many people who sell an investment property believe that federal capital gains from that sale must always be handed over to the IRS.  This is not always the case.  IRS Code Section 1031 offers investors the opportunity to reinvest federal capital gains from a sale if you swap that property for another…and it does not always have to be for ‘like property’ either!  Instead, as an investor, you could have that money work for you rather than end up in the hands of the IRS. Further, you do not have to sell your property for the exact same type of property either!

The 1031 Code indicates that no gains or losses will be recognized on the exchange of any type of business use or investment property for any other business use or investment property.

So what does this mean?  How can this help you?

If you own a business or an investment property you should consider a 1031 exchange.   You would be able to defer 100% of both federal and state capital gains tax.  1031 Exchanges in essence become interest free loans; where the principal may increase through future exchanges allowing the Exchanger to never pay back, if the transactions are planned well.  Along with the guidance of an experienced realtor, www.michaeltrustrealty.com this can be one of the most profitable ventures you will ever enter into.

Are you apprehensive about the 1031 Exchanges?  Here are some interesting facts, which will make the decision easier.

1) At one time, exchanges were only done to switch like investment properties to the same person swapping for your own, but this is not the case anymore.  In fact, you can sell your own property to someone who does not have a relationship to the person from whom they are purchasing the replacement property.

2) It is important to know that like-properties once met the same, condo for condo, empty lot for empty lot but that is also no longer the case.  If you have invested your money in an empty lot but wish to exchange for an apartment building, this too is possible and again, no taxes would be paid for the sale of the vacant land when following the guidelines of the 1031 exchange. In fact, the owner of the empty lot can even sell that one lot and then purchase several others or just buy one and then sell others. Note, 1031 Exchanges only apply to investment properties and not residences.

3)  Many believe only investors of large commercial properties can utilize a 1031. One of the greatest features about a 1031 Exchange is that it applies to all investment properties, large and very small. 1031 Exchange works the same way for a corporation selling a large shopping mall as it would for an individual selling a single-family property used for rental or held for investment in a resort area.

4) Many believe 1031 Exchanges are very complicated and not worth investigating. Consider working with a qualified Realtor and Broker who can offer you professional advice and direction.  1031 Exchanges is a relatively smooth process and definitely worth considering but sound advice from an experienced realtor is the key to profitability.

5) The Exchanger can acquire a replacement property with greater income potential. For example, raw land can be sold to acquire income-producing property or a larger or more ideally located property.  A duplex rental property can be exchanged for a 4-family investment property offering greater income.

Should you wish to increase your buying flow due to greater cash flow, exchange investment or rental property for that with a greater income, acquire investment property that is easier to finance, or should you have the need to relocate or the desire to increase your current business or investment space for a larger area, the 1031 Exchange can accomplish any or all of these goals.

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Michael Trust is a native Angeleno having been born, raised, and educated in Los Angeles.  A homeowner himself, Michael is familiar with the challenges of buying, selling and owning real estate in the Greater Los Angeles area.

His background is unusual in Realtor® circles. With a baccalaureate degree from California State University, Long Beach, and a Master’s Degree in Management from the University of Southern California (USC), Michael offers 15-years of corporate management experience in Fortune 500 organizations, Michael Trust can help you look at your real estate transaction from a broader business perspective.

Not only is Michael a Realtor® but he is also a California Real Estate Broker/Officer. Many Realtors® work under the umbrella of a large real estate organization and are obliged to follow the dictates of that organization. As a Real Estate Broker, Michael does not have to answer to a large corporation. He is free to make decisions based entirely on your best interests.

As a member of the National Association of Realtors®, the California Association of Realtors®, the Southland Regional Association of Realtors® (CRISNET Multiple Listing Service), and the Simi Valley/Moorpark Association of Realtors®, as well as the Combined Los Angeles/Westside Multiple Listing Service, he keeps abreast of legal and market changes through daily communications from these organizations. Michael fully subscribes to and abides by the high ethical standards required of their members.  Michael is also a volunteer member of the Southland Regional Association's Multiple Listing Service Committee, and Regional User's Group Committee.

Michael and his Team specialize in residential, residential income, and commercial sale and lease properties. Michael and his Team are well versed in 1031 Exchanges as well.  Michael and his Team are backed up by a staff of assistants with specialties in marketing, transaction management, and general administrative support so that you can receive the best possible service.  Michael Trust Realty uses technology to the fullest to make your experience a smooth one. For more information, please contact Michael through www.michaeltrustrealty.com