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Saturday, October 28, 2006
1031 Exchange Deadlines
There are two deadlines associated with a 1031 exchange.
- The 45-day deadline: In a delayed 1031 exchange, you have 45 days in which to identify the replacement property, from the day you sell your relinquished property. Once you identify the property, you have to submit the Identification of Replacement Property form, which is a written announcement of your choice, to your qualified intermediary or accommodator for the exchange. You can change the replacement property within the 45-day period if you so desire.
- The 180-day deadline: Once you transfer title of your relinquished property, you have 180 days to close on the sale. There is a caveat to this deadline though. If your Federal tax returns are due for the year in which you sold the relinquished property before the 180 days are up, you will have to complete all formalities associated with the purchase before your tax due date. This period includes extensions for time to file. In other words, unless you complete the sale of your relinquished property before October 17 of any year, you will have less than 180 days to finalize the purchase of your replacement property.
No extensions on account of weekends and holidays are allowed for either deadline.
What do these people see in being a landlord? Extra income and excellent tax deductions, for starters, and possible appreciation of the investment. But there are pitfalls as well. Inevitably, there will be times when apartments are vacant. Property owners must be prepared to pay for all expenses themselves during such periods, which could last a few months or more. Unexpected repairs, possibly costing thousands of dollars, are another downside. And not everybody is cut out for the landlord-tenant relationship.
These are the primary things to consider:
Find out where renters want to live
Location, location, location takes on added economic urgency when purchasing a rental property. Ask your real-estate agent to show you properties that have an established rental track record going back two or three years, during which vacancies were limited to no more than three months at a time.
The best rental properties usually are in neighborhoods where there are a lot of jobs or sufficient public transportation to take people to work, shopping areas, or entertainment venues. Ideal rental communities are often populated by either Gen X-ers just starting out in their careers or senior citizens, who prefer to avoid the effort and expense of owning a home. In addition, look for neighborhoods that are on the rise, particularly where the town is putting money into roads and recreational improvements and where people are taking care of their property by doing basic things like mowing the lawn, keeping the streets clean, and maintaining the exterior of their home.
Home ownership is higher than 70 percent--a record--and finding areas with good, trustworthy tenants has become much more difficult."
Do the math
Before you buy, figure out whether the rents will cover your expenses and leave room for profit. To determine how much yearly rental income you are likely to receive, ask real-estate agents for the going rates and scan the classifieds for comparable properties in the same neighborhood. Don't forget to take into account the possibility that the property may be vacant for a month or so. Then subtract annual mortgage payments and operating expenses--insurance, utilities, projected repairs and maintenance, and landscaping. Also figure out what you can deduct, but more about that later. Ideally, income tops outlays, and what's left is called cash flow. If outlays top income, producing negative cash flow, the property is too expensive. Either negotiate a lower price or continue hunting.
Negative cash flow doesn't always bother investors, particularly if the property is in an area that has a high potential for appreciation. That's because any shortfall could be more than made up for by the increase in the price of the property when it is sold. Or so the theory goes. Also, you might be able to deduct your losses. But remember that this can be a risky strategy: Long-term appreciation is no guarantee.
In general, the best values will be found in multiunit housing, so-called triplexes or fourplexes. Often these properties cost about the same or less than one- or two-family homes and "offer economy of scale," says Norm Bour, a real-estate agent who co-hosts "The Real Estate and Finance Hour," a nationally syndicated radio show based in Southern California. "If you landscape or paint the house, for instance, you are doing it for four renters, not one or two. And if one apartment is vacant, you lose 25 percent of your income, not 50 or 100 percent." But the economies of scale work both ways. The building furnace is probably bigger than your backyard and costlier to fix than your kid's teeth. So keep in mind that some improvements and unexpected repairs can be more costly for larger properties.
Assess the tax consequences
Anything left over after expenses is taxed as ordinary income. You can depreciate the cost of residential rental property, but not the land it sits on, over 27.5 years--even if it is increasing in value. Suppose you paid $400,000 for a triplex on a sliver of property assessed at $50,000. Depreciation would come to nearly $13,000 a year, or, put another way, you could have that much rental income without paying taxes on it.
Losses from rental property can also be advantageous, but only for some people. If your adjusted gross income (essentially wages, interest, and capital gains) is less than $100,000, up to $25,000 of the shortfall from rental real estate is deductible each year. For income between $100,000 and $150,000, the deduction is gradually phased out.
Choose tenants carefully
Neophyte landlords often fail to conduct a thorough background check on prospective renters, says Vito Simone, a broker at Simone Real Estate in Baltimore. Such a lapse can be costly if the tenant stops paying rent or damages the property. Don't approve tenants until you have checked their credit and criminal histories and talked to references and employers. The lease should lay out rules about pets, parties, rent due dates, and late fees. (You can find boilerplate leases and other landlord resources for purchase on the Web at www.lawdepot.com and at www.landlord411.com.) If tenants already occupy the property when you buy, you will have to honor their lease until it expires.
You may not be thrilled about dealing with tenant problems: responding to complaints, pestering people for the rent check, and enforcing rules like making sure a tenant's permanent "guest" leaves. If so, consider hiring a reputable management firm. Such companies charge 7 to 10 percent of the monthly rent, but their value in easing landlord pain could more than make up for the cost.