Emailer Asks About 'Boot'

Recent email from a Cash On Cash reader -- "What is Boot?

Section 1031 of the Internal Revenue Service code offers an excellent opportunity for real estate investors by means of deferred tax exchanges. But investors also need to be very careful about getting into a 1031 exchange boot. If they do, they might still end up with a tax bill that they were trying to defer. Here is why. Under current IRS 1031 exchange rules, only "like-kind" property held for business or investment purposes qualifies for a 1031 exchange. There are a number of things, however, that if included as a part of the exchange, can trigger a capital gain tax bill on the portion of the exchange that they represent. These examples are called a 1031 exchange boot. A 1031 exchange boot can include any item in the trade that is not of the "like kind" as defined under section 1031 of the IRS tax code. Quite often people mistakenly get these boots included in their 1031 exchange, and they unfortunately will end up with a capital gain tax bill.

The two most common types of boots that a real estate investor come across are a Mortgage boot and Cash boot. There are also many other types of boots like personal residence boot, and personal property boot, etc.

A mortgage boot on your 1031 exchange takes place when the investment property you buy has a mortgage debt of lesser value than the mortgage debt on the property you happen to sell. It is strongly advised that the real estate property you buy should have a mortgage debt equal to, or greater than the property you are selling. In the rare case that the real estate property you buy has a lesser mortgage debt amount than the property sold, the difference in the mortgage value will be taxable to the investor.

To avoid a 1031 mortgage boot, you have two choices -- 1) If the seller of the property refinanced the property and you happen to assume the new higher debt, you are allowed to finance it through a new loan or a "land sale" contract. 2) Simply add cash to the deal and the cash added into the deal offsets the debt relief on the property sold by you.

Let's switch to a cash boot discussion. By definition any cash or other cash equivalent value received ex. (promissory note) in a 1031 exchange is also not included in the "like-kind" property and is considered as a cash boot. On any such income from capital gain taxes are applicable or if the cash amount is a composite amount of principal and interest, the capital gain taxes are always charged on the principal amount. If this cash happens to be held for a longer period and you earn any interest payment from that, those interest payments will also be taxable as regular income. Keep in mind, if the seller is paying cash for any repair charges that are required by the buyer then the amount paid by the seller towards the repair charges are considered as a cash boot and then it would also be taxable.

Thanks to "Luke" for the great question!

Central Bank Drops Interest Rate 1/4 Point

The Federal Reserve today announced it was dropping a key short term interest rate to 4.5 percent. The one-quarter percent cut is designed to stimulate the sluggish housing market. And of course, lower interest rates are always good news for real estate investors. This is the second time the Fed has cut rates this year.

Fed May Cut Interest Rate Again Tomorrow.

This isn't real estate information, but it is information that affects real estate.

The Federal Reserve is widely expected to further slice interest rates on Wednesday, but a second reduction in two months has economists split on the potential result. It might help boost lagging real estate sales (the commercial/investment market is strong, the residential market is weak). Others, however, are looking for a rate cut to help boost other sectors of the economy, particularly holiday sales.

NAR Report Backs Up This Author's Predictions

I'm no Uri Gellar, but basic fundamentals are basic fundamentals. Early last spring I predicted multifamily would continue to strengthen due to the looming credit crisis. Specifically, my belief was, and continues to be, that as credit for risky borrowers became more difficult to obtain, people who were planning to buy houses would continue to stay in apartments. I also stated that many people losing their homes would turn to apartments for living space.

I caught a lot of flak from people within this industry for being "negative." I wasn't being negative, I was looking ahead on behalf of my clients. Well here we are. The market stayed strong. The National Association of Realtors' latest Commercial Real Estate Outlook says the following: ". . . Potential first-time home buyers are hesitant and staying in the rental market, supporting multifamily fundamentals until the lure of home ownership returns, the housing cycle changes and more buyers enter the housing market." Interestingly, the report also notes that there has been a slight impact on multifamily from an unforseen growth of single family homes offered for rent due to their owners being unable to get them sold.

Co-Star Q3 Report Shows Drop in Office Absorption

The national office market posted net absorption of 18.9 million square feet in the third quarter, the second-lowest quarterly net absorption in the last 3 1/2 years, according to CoStar Group's Third Quarter 2007 Office and Industrial Report. Only the first quarter of this year posted a lower net absorption figure. Good reading. Check it out!

Merrill News Latest Example of 'Paper' Investments

Let me say this as plainly as I can . . . when you purchase stocks, you are purchasing paper. You own nothing tangible. Stocks may provide a dividend -- or they may not. You gamble that they will go up in value.

When you acquire investment real estate, you have relatively steady income, you have incredible tax writeoffs, and you can defer any capital gains by trading your property for other investment real estate. See below. How a company like this didn't see it coming, I still don't understand.

From Bloomberg News Service -- Oct. 24, 2007 -- Merrill Lynch & Co. reported the biggest quarterly loss in its 93-year history after $8.4 billion of writedowns, the most by any securities firm. The third-quarter loss of $2.24 billion, or $2.82 a share, was about six times higher than the New York-based firm estimated on Oct. 5. Merrill wrote down the value of subprime mortgages, asset-backed bonds and loans to finance leveraged buyouts, and Chief Executive Officer Stanley O'Neal said in a statement today that he is "working to resolve the remaining impact from our positions.''

"Merrill fell as much as 3.1 percent in New York trading and is now performing worse than any of its four largest rivals, after O'Neal misjudged the severity of the decline in the credit markets since July. Investors who lauded the 56-year-old CEO for chasing higher returns now question whether he policed the risks as he pushed the firm to become the biggest underwriter of debt securities backed by subprime loans.

"We're very disappointed,'' said Rose Grant, who helps manage about $2 billion at Eastern Investment Advisors in Boston, including Merrill shares. "I don't think Stan O'Neal will step down, but you do have to look at top management and wonder why they didn't know the extent of this loss.'' Click here for the full text of this story from Bloomberg News Service.

Some Great Books To Consider

I thought I would pass along some ideas for books to consider. These are all very good resources for better understanding investment real estate, and how it can impact an individual's financial planning. There are many books out there on getting rich quick; these publications are about building wealth. There is a difference.

Pick up a copy and see what you think!

"Exchanging Up," by Gary Gorman

"The Millionaire Real Estate Investor" by Gary Keller

"Real Estate Riches: Using Your Bankers Money" by Dolf de Roos

"Commercial Real Estate Investing: 12 Easy Steps To Getting Started" by Jack Cummings