patrick.net

Glen,

Claire and I have despaired over the lack of ETF options in company sponsored plans. It's just plain wrong. They make so much more sense for so many people. Especially that lifetime employment is no longer a given. PLEASE bring it up at every opportunity!

"But Glen, we're here to discuss our health benefits, not retirement benefits!"

Well, yeah I know but I just wanted to let you know how we felt about ETF's!

If we all keep plugging away we can make a dent in this thing!

DinOR,

Side deals which are in consideration for a deal constitute various forms of fraud if not properly reported and accounted for. This could be very bad for any companies selling homes. Even for private folks selling & buying, they may be committing tax evasion & fraud, sometimes unknowingly. For example, if you get a car as an incentive for buying a home, that has to be fairly valued and included in the basis, or else the seller is under reporting the sales price and the buyer will under report the cost basis when she sells later. The IRS may not be capable of catching most of this fraud currently.

I fully expect there to be some scandals related to this within the next year or so. Probably from the direction of some big public home builder not properly recognizing revenues & expenses properly vis-a-vis GAAP. But who knows, maybe they are keeping track of all these HDTVs and accounting for them correctly, even if they know the buyer won't.

Glen,

I'm of two minds when it comes to managing tax-deferred retirement portfolio. Folks like DinOR do this for a living and are probably more help.

For me, I do a little bit of a kind of "macro sentiment timing". That is, if I feel that emerging markets are becoming overvalued and not factoring in risk, then I'll pull some out of there.

But the basis of my strategy is a very long-term, patient global diversification. I let the diversification hedge the recessions and booms. I won't retire with that extra 30% this way, but I will still retire with plenty and be able to sleep at night.

This is not investment advice and should not be taken as such. I can't emphasize this enough -- I'm poor!

DinOR,

Thanks for the tip. There's much to be said for holding cash, even in a period of high inflation. Right now I'm just so paranoid. The US market looks bad, I refuse to touch the emerging markets, and Euro/OZ/Canada already ran up a lot. I'm tempted to go with cash, commodities, and ETF in equal proportions until the dust settles a bit.

That's why I'd be against buying RE right now, even if we go through a period of high inflation. Even in that scenario, there will still be a lot of people squeezed out at the margins in the short and medium run, and provide good entry points for a cash flush home buyer.

Conor,

The only way the US government can prop up the homeowners is if they start printing a lot more money and create 10-15% inflation for a number of years. Anything short of that will not solve the underlying problem of overleveraged RE purchases. As it is, we're lucky that much of the mortgage bonds are held by foreign hands.

Restricting sales operates better as a break on the way up than on the way down.

Randy H,

Thanks for the input. It's a fairly recent development so we will have to wait to see how this plays out. I'd once heard that the IRS had gone after people that qualified for frequent flyer miles. Their interpretation was that it was "income". It was a real stink as I recall but I just can't see myself walking away from a real estate closing with more prizes than "The Price is Right" and believing in my heart that they are gratuities and mine to keep without consequence?

I give out clients the "Stock Traders Almanac" (cost? about $15) when ordered in bulk. Somehow I'm too worried about that. I guess I never thought about giving away big screen TV's and timeshares though?

DinOR,

$15 gifts would fall under de minimis exception for gifts, you're probably in the clear.

Randy,

The whole gift idea is just so idiotic from both an economic perspective and a tax perspective. The builders do this so they can pretend like the prices have not dropped, so they won't have angry former buyers or potential buyers with cold feet from a real price drop.

I predict it'll all go away once people move out of denial about the RE bubble burst. For anyone who buys homes for their usage value, the contract price should be the only thing to matter.

DinOR,

Believe me, I'm pushing. Even if ETFs are not available, I would settle for a better fund company with decent no-load options like Vanguard or Fidelity. Hopefully we will implement a change before '07. (By the way, it looks like Lehman's fund, FMAAX, is a decent fund but I'm allergic to loads. I'll need to read more to see if I could replicate his strategy.)

Randy,

Not a bad way to go. If I was smart, I would probably just put 60% in global stock index fund, 40% in a global bond index and stop worrying about it. Anybody know a good global bond index fund or ETF (preferably with no dollar hedging)?

DinOR

The IRS is quirky. Predicting what they'll go after is dangerous.

I'd guess that little, inconsequential stuff included in home-deals no one cares about. That might include things like a free toaster, or maybe even a HDTV. But big things worth tens of thousands they might start to notice.

I'm thinking more about the public home builders. I don't know the actual structure of how these homes are legally transferred, but if the home builders directly are selling to buyers, and there is consideration in those deals, then there is a library of FASB rules for recognizing revenues and expenses. It's highly likley they're not following those rules. In fact, it's very hard for even honest companies (not that homebuilders aren't honest) to follow those rules at times.

One last thought that comes to mind is about the obligation to report. Do either homebuilders or existing home sellers have an obligation to report the side deal as a 1099, etc? They might be on the hook for unpaid taxes if the IRS decides they failed to properly report the txn so that the IRS knows about the receiver.

Glen,

I use http://www.financialengines.com and have recommended it to some friends and family. (I have no connection or interest in this company). There are others. They can do good old fashioned mean-variance opt and Monte Carlo sim to create a nice risk-adjusted portfolio from your available products.

I don't understand the motivation for these side deals from the buyer's perspective... It is kind of like a negative down payment (and we thought they couldn't do better than "$0 down!")

So your house is worth $350K, but you "pay" $400K and get $50K in cash and incentives. So at the end of the day, you have a $400K mortgage and a $350K asset. Negative equity from day one. I don't get it. Unless, of course, you can use the $50K in cash to flip 5 more LV condos, since real estate always goes up.

I've wondered this also. I get the psychological candy that a free car offers. Lots of people go for the "but wait, there's more..." ploy.

But the cash should flow the other direction, no? Taxes are high enough with bubble valuations that many folks should be willing to brave tax evasion to wiggle out of thousands a year in property taxes.

Since we've already established that there enough sleazy sophisticated debtor FB's out there that "buy" a new home before their former (and now in arrears) home is sold how big a leap is it to the "Price is Right" fandango?

So; if I'm an FB (already flailing to keep just a few months behind) and somone offers me a big screen, pre-paid car lease, timeshare AND cash, well who am I to refuse? What a country!

Imagine further that FB NEVER makes payment one, keeps Bob Barker's goodies and skips town. I realize I've worded this to the extreme but to the boys up in Jackson Hole this situation has GOT to be embarrassing!

One last thought that comes to mind is about the obligation to report. Do either homebuilders or existing home sellers have an obligation to report the side deal as a 1099, etc? They might be on the hook for unpaid taxes if the IRS decides they failed to properly report the txn so that the IRS knows about the receiver.

I think the public homebuilders have tended to offer incentives like pools and upgrades, which I don't think would need to be separately reported. I have noticed some much fishier deals on Craigslist, like $50K cash back from the seller. Not sure why deals are structured this way, but here is my best guess of a possible scenario:

Flipper: Flipper bought house in 2003 for $200K, now appraised at $400K, but can only be sold for $350K. Wants to cash out $200K in gain using the cap gains exemption for home sales. The cap gains offset flipper's loss on three other flips. Knows that buyer can get an appraisal for $400K on POS house, even though house won't sell for more than $350K. Knows lender will lend FB the money. If he lowers his price, then he must report a $150K gain, not enough to offset the $200K in losses on his other flips. He will have $50K in losses, which will need to be written off over a 17 year period. Instead, decides to offer buyer $50K under the table, report a $200K gain to offset his $200K losses. Walks away and hopes the IRS doesn't notice that he really sold his house for $350K.

Buyer: Duh, free money! I'm gonna get me an H2! Buyer is penalized by getting a higher tax basis ($400K instead of $350K), but is none the wiser. When he eventually goes into foreclosure and the house is sold for $250K, Buyer will owe taxes on $150K (instead of $100K) of debt forgiveness income.

What should the tax treatment be if the IRS recharacterizes? Should be a sale for $350K. Flipper should not be able to offset his losses and Buyer should get a lower tax basis.

It will take a long time and a lot of accountants and attorneys to unwind all of these shenanigans.

Glen,

I think the homebuilder/seller industry needs to experience their own SOP 97-2, FAS 48 scrutiny.

So; if I’m an FB (already flailing to keep just a few months behind) and somone offers me a big screen, pre-paid car lease, timeshare AND cash, well who am I to refuse? What a country!

Imagine further that FB NEVER makes payment one, keeps Bob Barker’s goodies and skips town. I realize I’ve worded this to the extreme but to the boys up in Jackson Hole this situation has GOT to be embarrassing!

Seems plausible. Especially if the FB doesn't already own any real estate. If the FB is a renter FB who has credit cards, car debt, etc. up the wazoo, he/she can rationalize the purchase by saying "wow....now I paid off all my debts and I'm a homeowner!" In a weird way, this might even make sense (leaving aside the fraud aspect). If the buyer has $50K of credit card debt at 22%, which can be rolled into a first mortgage at 6.5% and a second at 9%, why not?

Yes, this is clearly mortgage fraud. The first lender, who supposedly has an $80K equity cushion, actually has only a $30K cushion. The second lender is virtually unsecured, and should be getting 22% instead of 9%.

A follow up to my last post....

A lot of flippers and other FBs will be in for a rude awakening when they finally head to bankruptcy court. If a lender can prove fraud, you can not discharge your debt to them. Ouch. Time to make a living from something more respectable that you can hide from the IRS...like prostitution... or dealing drugs.

spike66,

Well I for ONE think you're a financial genius!

This is a solid path you're on, take some pride in it. You're starting a "vulture fund" for one! With cash in hand, sterling credit and unbelievable DTI ratio you're going to be smelling pretty good to any rational lender when the chips are down.

If your stock positions are troubling you that much either put in a stop loss order or move to cash. All of us are going to have to be a lot more "nimble" over the next two quarters but you're up to it.

We've looked at what's at the opposite end of the spectrum and decided we'd rather hang out with you!

From BayBear:

You say your life is and will continue to be disrupted, however there is absolutely no benefit to us and you are asking to be compensated for infringement on your privacy. I see no reason for compensation. Is this situation less than ideal? Yes. Inconvenient? Absolutely. You mentioned on the phone that he refuses to pay $600 grand for a 1400 sf dump in a shithole of a neighborhood. I can certainly see your point and can relate fully, but in making a life decision to rent rather than own, for whatever reason, you then unfortunately have to live your life under the terms of a lease. You made the choice to rent.

This amuses me. Why would your landlord be willing to piss you off and burn that bridge at this point? What if he can't sell and decides to continue renting for whatever reason? What if the rental market cools off again at that time? What if you, out of spite, refuse to renew and leave him high and dry? Some people are idiots. Good luck to you, though, and keep us posted on the outcome!

Argh! italics, again!

From BayBear:

You say your life is and will continue to be disrupted, however there is absolutely no benefit to us and you are asking to be compensated for infringement on your privacy. I see no reason for compensation. Is this situation less than ideal? Yes. Inconvenient? Absolutely. You mentioned on the phone that he refuses to pay $600 grand for a 1400 sf dump in a shithole of a neighborhood. I can certainly see your point and can relate fully, but in making a life decision to rent rather than own, for whatever reason, you then unfortunately have to live your life under the terms of a lease. You made the choice to rent.

BayBear,

This amuses me. Why would your landlord be willing to piss you off and burn that bridge at this point? What if he can’t sell and decides to continue renting for whatever reason? What if the rental market cools off again at that time? What if you, out of spite, refuse to renew and leave him high and dry? Some people are idiots. Good luck to you, though, and keep us posted on the outcome!

After the dot com bubble burst daytrading restrictions were put into effect — accounts with less than $25k couldn’t execute more than 3 daytrades every 5 days (the rule is still in effect). What will the comparable rule be for the housing market?

It is a silly rule anyway. Small-time daytraders should be allowed to emty their wallets if they choose to.

Glen,

Actually being a flipper had several advantages over the other trades you mentioned.

Tax free money every 24 mos.

Write off all your expenses.

Walk away from closing with cash. (I've never heard of any flipper getting "whacked" walking out of the title office!)

I am not joking here! This is the very system we've allowed to perpetuate itself. Please to notice all of the sleazy types that were drawn to this. The qualifications were remarkably similar. HS Diploma not req. ESL? No probalo! Shaky credit and sketchy job history? We'll get you qualified!

I was watching one flipper show where the job site had been getting ripped off so the flippers hung out in a truck drinking beer waiting for the perps with a baseball bat! Classy.

George,

Interesting to note (as always) the "investment group" get their money out of the deal on the front end! Of course if it's easy, take it twice!

That's why I just love the C/L ads that tout 50K in FREE equity to you! You keep the equity! This is priced 50K below market value!

(Well, dickhead, if this is such a lay-up why don't you.......... OH, you know what? just never mind!)

George,

Interesting story. Reminds me of the real estate version of "pump and dump" using straw buyers:

1. Buyer A buys house worth $300K for $400K from his cousin's best friend, B. Gets appraisal from "Phony Appraisals 'R' Us."
2. B sells house to his aunt's friend for $500K, C. Gets another phony appraisal.
3. C sells house to A's friend, D for $600K. Yup, another phony appraisal.
4. D skates back to his home country with ruined credit, leaving lender holding the bag. Discreetly funnels ill-gotten proceeds back to A, B and C via offshore accounts.

You have to wonder how much of this kind of fraud contributed to inflated reported sales prices, which pumped up the expectations of the average homedebtor and struck fear into the hearts of buyers.

I should have said "C" (the last seller) funnels proceeds to A, B and D.

George Says:

> Regarding matters of fraud….
> Without naming names, I can relate to you this
> insider’s story.

The real estate “investment” groups have also been active in multi-tenant investment and commercial property.

To get started they find long time SF apartment owners that are getting $500 per month per tenant under rent control.

They will buy a couple triplexs from the owners for say $750K then do about $10K of work to each unit and sell them to TIC suckers (I mean buyers) for $500K.

The real estate “investment” groups then get the two triplex owners to do a 1031 exchange with their $1.4mm in equity in to a $3mm office building (that the “investment” group usually just bought for $2mm).

At the end of the day you have six idiots owning units with crappy stainless steel clad appliaces in a crappy 100 year old building in San Francisco that have no idea that they will loose everythign if one of their fellow TICs runs in to financial problems.

You have two families that had super low LTV SF apartments that now "think" they have a low LTV office building (because they put 50% cash down) and are making just a little more than they were with the rent control apartments after paying a management fee to the "investment" group...

The real estate “investment” group makes:
3% Commission on the 6 TIC apartments $180K
Profit on the sale 6 TIC sales $1.4mm
3% Commission to buy the $2mm office $60K
Profit selling to the TIC group $1mm
6% Commission on the $3mm sale to the TIC Group $180K
Total Profit $2.82mm + 6% management fee every month until the office owners sell and are forced to use the "investment" group as the listing broker paying another 3% on the sale...

tinyurl.com/fst7s

The solution to the housing bubble, the war in Iraq, and all problems in general.

Enjoy.

@Surfer-x,

Jeebus. All the option-ARM brokers need to do is inject "ZIP" into FB's brains after they get wiped out, then lure them right back. Scary.

FAB:

TICs are huge right now because no one wants to pay cap gains when they sell their old investment properties. Not all of the TICs are fraudulent, but they do tend to have high fees, are highly illiquid and subject to all kinds of fine print restrictions on transfer, etc...

TICs are huge right now because no one wants to pay cap gains when they sell their old investment properties.

Cap-gain tax should really be abolished. I think it will be eliminated when boomers have to sell their highly-appreciated stocks for their retirements.

I think income tax will be raised accordingly.

If I owned highly appreciated income property that I could sell at a 3% cap rate, I would 1031 into a REIT.* I'm pretty sure you can do this now. Gets you out of active management and gives you a higher yield. But for some reason, a lot of these folks like the idea of buying into a TIC promoted by a smooth salesperson. Kind of reminds me of the hedge fund phenomenon. It can't end well.

*Not real estate advice

Cap-gain tax should really be abolished. I think it will be eliminated when boomers have to sell their highly-appreciated stocks for their retirements.

What stocks? Most boomers have smallish 401ks and virtually nothing in taxable accounts. They are planning to "retire on the house." I seriously doubt that Cap gains will ever be eliminated, given the gov'ts massive debt and total lack of spending discipline. If anything, the pendulum might swing in the other direction if angry FBs vote for populist anti-rich politicians.

If anything, the pendulum might swing in the other direction if angry FBs vote for populist anti-rich politicians.

Exactly. Personally, I don't see how eliminating all cap gains tax would result in a net positive for either the National Debt or society. It would in fact be incredibly regressive, as most securities are owned by a relatively small % of rich families.

Why should I see income tax on my modest salary (which is already inadequate for CA cost of living) shoot up, while Bill Gates, Warren Buffet, George Soros, etc. get to sit and watch their passive riches multiply tax-free?

How about a flat tax that taxes all forms of income (including capital gains) at the same rate? Truly asset-class neutral.

s most securities are owned by a relatively small % of rich families.

And here I thought it was public pension funds and institutionals. Learn something new every day.

How about a flat tax that taxes all forms of income (including capital gains) at the same rate? Truly asset-class neutral.

But capital gains are not really income. Pure consumption-based taxation can be the answer. But that would disincentivize spending...

Peter P,

Correct

Incorrect. We already have a ridiculously complex web of consumption and use taxation, and consumption plods along stubbornly. A pure consumption tax would result in many sales/use taxes being lowered.

Glen,

There was a time when mature RE holdings could readily be converted into REIT's via 1031. Since so many of the smaller shops that would normally be open to this have either been bought out or dried up it's getting tougher. There was a time not all that long ago where you'd have a "brick kicker" client who was getting too old to manage his own holdings. Call the REIT guys upstairs, bada bing, he's now a REIT holder.

Now with HUGE AUM (assets under management) it just doesn't make as much sense anymore, especially with the costs of appraisals etc.

THAT SAID, there are still a few shops that will perform this service, but get prepared for a "hair cut".

I think it can start with the privatization of most public services. This should keep costs down, improve productivity, and improve quality of service all at once.

I think it can start with the privatization of most public services. This should keep costs down, improve productivity, and improve quality of service all at once.

Like PGE? :(

How about a flat tax that taxes all forms of income (including capital gains) at the same rate? Truly asset-class neutral.

HARM,

It's a nice dream. It would work best if accompanied by the elimination of the estate tax; provided that any inherited assets would immediately be taxable as income to the recipient, using the dead person's cap gains tax basis. This would solve a lot of the current abuses and distortions of the current system:
1. Owners of appreciated assets would be indifferent as between selling or holding an asset, so they would allocate their capital in the way that makes the most sense from an investment perspective. Plus, they could safely sell their business when they retire, instead of letting it wither and die before passing it to their kids. Then they could use the money to buy investments that make sense for their kids.
2. Eliminate the entire estate tax. Finished. Kaput. It is a bizarre, extremely inefficient and distortive tax anyways.
3. No more complicated 1031 rules, etc... If you sell it, you pay tax. Period.
4. Eliminate all 401ks, 403bs, IRAs, SEP IRAs, Roth IRAs, SIMPLE IRAs, Keoughs, etc., etc..
5. No more cap gains exclusion on home sales.
7. Less work for accountants, lawyers, financial planners, etc. Much more simple and transparent tax system for taxpayers. Lower rates (and broader base) for all.

Like PGE?

I thought it failed in 2000 because it was not allowed to pass costs directly onto consumers.