A Closer Look

REAL ESTATE INVESTMENTS AND BUSINESS OPPORTUNITY BROKERAGE

OVERVIEW                In this , the following topics are discussed: various types of investment real estate, types of risk associated with the purchase and ownership of real estate, methods of analyzing such investments, the tax consequences of both owner-occupied and investment real estate, and the distinction between most real estate transactions and the sale of a business.

OBJECTIVES After completing this , you should be able to do all of the following:

            Distinguish among the different types of real estate investments

            Identify the advantages and disadvantages of investing in real estate

            Calculate the percent of profit or loss, given the original cost of the investment, the sale price, and the dollar amount of profit or loss

            Distinguish among the various types of risk

            Explain the importance of investment analysis

            Describe the similarities and differences between real estate brokerage and business brokerage

            Describe the types of expertise required in business brokerage

            Distinguish among the methods of appraising businesses

            Explain how to determine taxable income of investment real estate

            Distinguish between installment sales and like-kind exchange

            Describe the steps in the sale of a business

KEY TERMS  Appreciation Asset

Basis

Capital gain/loss Cash flow

Debt service Equity

Going concern value Goodwill

Installment sale Leverage

Like-kind exchange Liquidation value approach Liquidity

Profit Risk

Tax shelter Taxable income

            REAL ESTATE INVESTMENT ANALYSIS

            The purchase of real estate as an investment has been popular for both high- and

            moderate-income investors. Most investment decisions depend on the rate of return or

            profit, which the investor expects to earn by assuming a risk in real estate or other type

            of investment. A real estate sales associate can be a major resource to a potential

            investor if he or she is familiar with investment real estate, which includes both

            terminology and analysis.

            A thorough analysis is critical when evaluating the potential of a real estate

            investment. Investment analysis must take into consideration land use controls, such as

            zoning, deed restrictions, and permitting requirements that affect the value of a property.

            Investment analysis considers economic forces, such as population growth,

            investment of foreign capital, and the impact of taxation on real estate investments. The

            most important factor underlying every investment decision is economic soundness.

            Real estate licensees should be capable of evaluating the advantages and

            disadvantages of a potential real estate investment compared to alternative investments.

            The process of investment analysis begins with the search for and location of

            potentially desirable real estate investments that are based upon the investor’s personal

            objectives.

            Real estate investors can receive potentially significant rewards from real estate

            investments that include income generated by the property, a build-up of equity,

            appreciation in value, tax benefits, positive leverage, and prestige. Investment in real

            estate can also serve as a hedge against inflation when the property has level-payment

            mortgage where the payments remain the same, but the rental income increases with

            inflation.

            Disadvantages of investing in real estate include the illiquidity of property (it cannot

            be bought or sold as quickly as other assets), the local (immobile) nature of the real

            estate market compared to other types of investments that can be bought and sold in a

            variety of markets, the expense or overhead required to manage the property or hire a

            property manager, and the need for additional investment assistance from experts such

            as brokers, tax accountants, and other professionals.

            TYPES OF INVESTMENT PROPERTIES

            The following discussion provides information about some of the different types of

            real estate available for investment.

                        Agricultural. Agricultural property investors have many different motivations for

            investing in agricultural land. Some investors wish to personally engage in

            agricultural endeavors, while others may own the land and lease it to others for

            agricultural activities. Investors may also purchase agricultural land in the path of

            growth, allowing for lower taxes through agricultural exemptions, before

            ultimately selling or developing the property.

                        Business opportunities. Business opportunities are typically smaller local

            businesses, such as barbershops, hair salons, print shops, corner stores, and

            boat rental businesses. Often an investor may be looking for a small business

            that he or she could own and manage, creating an income for him or herself.

            Business opportunities are normally valued based upon applying a multiplier to

            the net income being produced by the business. Value may also be applied to

            intangible assets such as a business’s name or reputation in the community.

                        Commercial. Commercial investment properties include retail centers, such as

            regional shopping centers usually located near major transportation routes. Major

            retail centers attract anchor tenants that draw people to the center. Typically,

            these are the name-brand department stores in which people plan to shop. They

            are called generative functions, since they generate customer traffic to the

            center. Suscipient functions are businesses that attract passersby, such as card

            and gift shops, ice cream and novelty stores, and so on.

Real Estate Investments and Business Opportunity Brokerage       

                        Industrial. Industrial investment properties involve manufacturing, assembly, and

            distribution. These properties are located most often near major transportation

            arteries. Weight-reducing operations, such as mining operations, prefer locations

            near the source of their raw materials. Weight-gaining operations, such as

            assembly plants, prefer locations close to their market areas in order to reduce

            transportation costs.

                        Office. Office investment properties are usually located in central business

            districts or professional office parks in suburban areas near their tenant base.

            Offices are usually good long-term investments since office tenants generally

            lease for extended periods.

                        Residential. Residential investment property is available in a wide range of

            prices. Important factors to be considered when selecting residential properties

            are location, availability of transportation, schools, and shopping. Typical

            residential investments include condominiums, villas, single-family homes, and

            apartment complexes.

            Real Estate Investment Trust (REIT)

            A real estate investment trust (REIT), a type of business trust, allows groups of

            investors to invest in income-producing property. A REIT provides a method for

            individuals to pool financial resources to invest in larger, professionally managed

            properties. Investment trusts invest in office buildings, large apartment complexes, and

            retail centers. Purchasing shares in a REIT is similar to purchasing shares in a mutual

            fund. (Please refer to  , Joint Business Relationship section for more

            information on a business trust relationship.)

            REAL ESTATE INVESTMENT TERMINOLOGY

            Amount Realized

            The amount realized, also referred to as net proceeds from sale, is expressed by the

            following formula:

            Amount Realized = Sale Price – Costs of Sale

            Sale price is the total amount the seller receives for the sale, including money, notes,

            mortgages, or other debts the buyer assumes as part of the sale. The costs of sale

            include brokerage commissions, relevant advertising, legal fees, seller-paid points, and

            other closing costs paid by the seller.

            Basis

            Basis, or cost basis, is the original value of an asset for tax purposes. When

            purchasing a home, the basis includes the purchase price and any associated

            acquisition costs. Basis is used to determine the gain or loss on the sale, exchange, or

            other disposition of a property.

            Adjusted basis is a measurement of how much is invested in a property for tax

            purposes, including any IRS-allowed improvements, referred to as capital improvements.

            Examples of capital improvements include a new addition to the home, paving the

            driveway, replacing the roof, installing central air conditioning, and rewiring the home. By

            adding the cost of improvements to the basis, the amount of gain is reduced, thereby

            decreasing the amount of capital gains tax otherwise owed. Refer to “Tax Benefits of

            Homeownership” in   for tax benefits associated with the sale of a principal

            residence.

            The adjusted basis may also include certain IRS-allowed reductions including such

            items as depreciation of investment property, casualty losses, and residential energy

            credits.

            The basic formula for adjusted basis is:

            Adjusted Basis = Cost Basis + Increases – Decreases

            Capital Gain/Loss

            A capital gain is an increase in the value of an asset, such as personal or investment

            property, that gives it a higher value than the cost of purchasing the asset. If a property

            sells for more than the purchase costs, there is a capital gain. A capital loss is incurred

            when there is a decrease in the value of an asset that gives it a lower value than the cost

            of purchasing the asset.

            A capital gain or loss is not realized until the property is sold. A capital gain may be

            short term (one year or less) or long term (more than one year) and must be claimed on

            the investor’s tax return.

            The capital gain is represented by the basic formula:

            Gain = Amount Realized – Adjusted Basis

            Cash Flow

            Cash flow is the movement of money into or out of a business or investment,

            measured over a period-of-time. Generally speaking, cash flow is the money that

            remains after all the income, such as rents, is collected and all the day-to-day expenses

            associated with owning the property are paid.

            Cash flow can be ongoing or one-time. Ongoing cash flows are received by the

            investor throughout the investment-holding period, as in rental income. One-time cash

            flows are sales proceeds received as a result of the sale of an investment property.

            Cash flows may be positive or negative. Positive cash flow occurs when there is

            more money coming in than going out, resulting in money remaining. Negative cash flow

            occurs when there is more money going out than coming in, resulting in a deficiency that

            the investor or business owner must pay out of pocket. Most investors and business

            owners desire a positive cash flow in order to achieve a profit and a high rate of return

            on their investment. However, there are tax benefits to negative cash flows.

            Appreciation

            Appreciation is an increase in the value of an investment over time. Investment

            property can appreciate in value for many reasons, such as inflation, supply and

            demand, and capital improvements. Most real estate investors purchase income

            property with the goal of realizing a positive cash flow and appreciation.

            Tax Depreciation

            Tax Depreciation, also referred to as cost recovery, is an income tax deduction that

            allows a taxpayer to recover the cost of investment property over a number of years.

Real Estate Investments and Business Opportunity Brokerage       

            Equity

            Equity is the difference between the current market value of a property and the

            amount the owner still owes on the mortgage. The initial down payment creates equity.

            Additional equity is created through principal reduction and appreciation.

            One advantage of investing in real estate is the equity build-up that can occur on

            mortgaged rental property. An investor who collects rent from a tenant can use the rental

            income to pay expenses and reduce the principal amount of the loan, which can

            increase the equity in the property. Over time, the tenant essentially pays for the

            property to the benefit of the investor. Some investors consider equity build-up as a good

            use of cash flows when the interest rates on savings accounts and certificates of

            deposits are lower than the rate of return on the investment property.

            Liquidity

            Liquidity refers to an asset’s ability to be easily converted through an act of buying or

            selling without causing a significant movement in the price and with minimum loss of

            value. Cash is the most liquid asset. A liquid asset can be sold rapidly with minimal loss

            of value. The essential characteristic of a liquid market is that there are ready and willing

            buyers and sellers at all times.

            An illiquid asset is one which is not readily saleable due to uncertainty about its value

            or a lull in the market in which it is regularly traded. One disadvantage of investing in real

            property is that property is considered an illiquid asset, which cannot be transferred as

            easily as other assets, such as stocks or bonds.

            Tax Shelter

            A tax shelter is a legal method of minimizing or decreasing an investor’s taxable

            income, and therefore, his or her tax liability. Depreciation of a real estate investment

            can reduce an investor’s taxable income and is, therefore, a form of tax shelter.

            Risk

            Risk is the possibility of losing all or part of the investment. Every investment

            involves a certain degree of risk. There are two primary types of risk: dynamic and static.

                        Dynamic risk. Dynamic risk is risk associated with changes in general market

            conditions. The different types of dynamic risk are outlined below.

            o          Business risk. Business risk is the possibility that an investment will yield

            lower than anticipated profits, or that it will experience loss rather than a

            profit. Business risk is measured by comparing actual income and expenses

            to budgeted income and expenses. If expenses are higher than projected,

            and/or income is lower than projected, the investment could be in jeopardy.

            o          Financial risk. Financial risk is associated with extremely high expenses

            and/or extremely low income. The investor may be faced with adding to the

            original investment to keep it in operation. In the alternative, the investor may

            have to borrow more money or sell other assets to raise capital to prevent

            losing the investment. If an investor is unable to make the required payments

            on their debt obligations, they risk defaulting on the loan.

o          Inflationary risk. Inflationary risk, or purchasing-power risk, is the risk that future inflation will cause a decrease in purchasing power of the currency, resulting in a rise in the cost of goods and services. Inflation causes the investor’s expenses to increase. Potential buyers may also lack the purchasing power to buy the property.

o          Interest rate risk. Interest rate risk is the effect of the economy on the investment. If the value of a dollar increases or decreases because of inflation or deflation, interest rates could increase or decrease, which may affect the value of the investment or reduce the likelihood of selling it.

o          Liquidity risk. Liquidity risk is the risk that an investment property cannot be bought or sold quickly enough to prevent or minimize loss.

o          Market risk. Market risk is the possibility for an investor to experience losses due the effect of the national or local real estate market. There are many sources of market risk that can affect the real estate market, including recessions, unemployment rates, availability of financing, changes in the economy, and other local conditions affecting specific markets.

            Static risk. Static risk is risk that can be offset with insurance, such as fire, flood, robbery, and so on.

Investors attempt to evaluate and minimize risk. A feasibility study is used as a basis

            for making a real estate investment decision. The feasibility study assesses financial,

            governmental, legal, social, physical, and locational factors that may influence the

            investor’s decisions, based on anticipated risk and potential reward.

            Leverage

            Leverage is the use of borrowed funds to purchase assets. Most investors make real

            estate investments with borrowed money. Positive leverage allows an investor to earn a

            higher rate of return on funds invested by borrowing than they could earn by paying cash

            for the investment. Financial leverage can be either positive or negative.

                        Positive leverage. Positive leverage occurs if the investment returns more to the

            investor than the cost of borrowing the money necessary to purchase the

            investment.

                        Negative leverage. Negative leverage occurs if the investment returns less to

            the investor than the cost of borrowing the money necessary to purchase the

            investment.

            In most instances, an investor will use leverage to purchase real estate because of

            the expectation of positive leverage. However, highly leveraged investments require

            cash flows from the property to make the mortgage payments; debt service that is too

            high may make that impossible.

            EVALUATING INVESTMENT PROPERTIES

            Evaluating an investment property begins with the preparation of a reconstructed

            operating statement that shows annual forecasts of income and expenses over a period-

            of-time. Required rates of return based on forecasted income, expenses, risk, and length

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            of the ownership period are applied to estimate the value of the property. The rate used

            to estimate value is dictated by the individual investor’s requirements, but tempered by a

            competitive market.

            An analysis of the past income and expenses of an income-producing property can

            help to evaluate the future income of the property. However, it should be noted that new

            ownership and new management often result in a change in the operating characteristics

            of a property. Historical information is obtained from current owners to serve as a basis

            for making projections, but cannot always be relied upon. Consequently, figures

            obtained from the current owner must be evaluated based on the individual investor’s

            requirements and allowances made for any changes that are anticipated in income and

            expenses.

            As a result, the analysis must be based on revised historical operating data. In this

            case, the reconstructed operating statement includes items that are not included by the

            current owner and deletes items that are not expected to recur. Other figures may be

            increased or decreased based on the investor’s operating philosophy and management.

            The forecast of income and expenses (shown below) is performed in the same

            manner as was discussed in the Appraisal  of this book. However, investment

            analysis goes beyond the calculation of the net operating income and considers the

            effect of financing and taxation on the investment.

            PGI      =          Potential gross income (contract rent plus market rent)

            – V&C =          Vacancy and collection losses

            +          OI        =          Other income (from sources other than rent)

            EGI      =          Effective gross income

            –          OE       =          Operating expenses

            =          NOI     =          Net operating income

            – ADS =          Annual debt service (one year’s mortgage payments)

            = CTO =          Cash throw-off (BTCF, before-tax cash flow)

            Operating expenses include fixed expenses, variable expenses, and a reserve for

            replacements. Each is outlined below.

                        Fixed expenses. Fixed expenses include costs that do not change with the level

            of occupancy, such as real estate taxes and hazard insurance.

                        Variable expenses. Variable expenses change with the level of occupancy and

            include costs, such as management fees, maintenance, utilities, yard care,

            janitorial, and so on.

                        Reserve for replacements. Reserve for replacements is a noncash expense.

            This money is for future use to replace worn-out components, called short-lived

            items, such as carpeting, appliances, central heat and air systems, roof

            coverings, and so on.

            Mortgage payments, called debt service, are not considered an operating expense.

            Real estate does not borrow money, people do. The type and amount of financing is

            dictated by the needs of the investor, not the property. It would be inappropriate to

            charge the property for something unrelated to its operation.

            After the net operating income is estimated, debt service is subtracted to obtain the

            cash throw-off (CTO). This is also called the before-tax cash flow (BTCF). Investors will

            be concerned with an additional computation to determine the after-tax cash flow

            (ATCF), which is beyond the scope of the pre-license course.

            The objective of real estate investment analysis is to assist an investor in choosing

            the best property available among available alternatives and to base a price decision on

            the analysis performed. Applying ratios to the forecasted income and expenses can

            facilitate analysis. Ratios commonly used in the evaluation of income properties include

            the operating expense ratio and the loan-to-value ratio.

            Operating Expense Ratio

            The operating expense ratio expresses the relationship between the expenses

            incurred in operating the property (the operating expenses) with the amount the investor

            actually receives (the effective gross income). This relationship is expressed as a

            percentage, or ratio. The formula is as follows:

            Loan-to-Value Ratio

            The loan-to-value (LTV) ratio measures financial risk in an investment by comparing

            the mortgage loan amount to the price, or value, of the property. This ratio indicates the

            percentage of the property value that is represented by debt. A higher LTV ratio

            increases the risk of the borrower’s default. The formula is as follows:

            Calculating Profit on Investment

            Profits from investments are calculated on the amount that is originally invested, not

            on the amount received when the investment is sold or liquidated. The following formula

            is used to determine the profit based on the original investment amount paid:

            Example: Assume that an investor paid $, for a parcel of land, divided it into

            three separate lots, and sold each lot for $,. What is the profit on this

            investment?

            Solution: The profit on this investment is %. Profits from investments are

            calculated on the amount that is originally invested, not on the amount received

            when the investment is sold or liquidated.

            $ , Sale price of each separate lot

            x          Number of lots sold

            $, Gross sales price

            – $, Amount paid

            $ , Amount made

            To determine the percentage of profit, divide the amount made by the amount paid.

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            Rate of Return (ROR)

            The money made in an investment is referred to as the return. The investment

            amount made with the original purchase is referred to as the capital, or capital

            investment. The return from an investment is calculated based upon the capital

            investment. Investors want to achieve a high rate of return.

            The IRV formula discussed in   to derive capitalization rates can also be

            used to calculate the rate of return (ROR). When evaluating investments, the ROR

            replaces the cap rate that was used in  . Dividing the net operating income

            (NOI) by the investment value will provide the investor with the ROR.

            If the investor wishes to determine the rate that is being received based upon the

            actual equity invested (vs. the rate on the overall investment), then an equity dividend

            ratio would be used. The formula for equity dividend ratio (EDR) is:

            The equity dividend ratio provides the investor with a more accurate picture as to the

            return on the money actually invested.

            Loan Constant

            A loan constant is an interest and principal factor used to calculate a level monthly

            payment necessary to pay off both principal and interest over the term of the loan.

            Today, financial calculators and computers are typically used to calculate payments and

            amortization schedules. In the past, booklets were published where the interest rate and

            term of the loan were matched to arrive at a constant. The constant was then applied to

            the original loan amount to determine the monthly payment.

            Example: Calculate the monthly payment on a new loan of $, at % for

            years, using a monthly loan constant of ..

            Solution:

            Loan Balance x Loan Constant = Monthly Payment

            $, Loan balance

            x . Loan constant

            $. Monthly payment

            IMPACT OF FEDERAL TAXATION

            Real estate investment strategies and long-term planning of investment portfolios are

            impacted by federal taxation. Since taxation is an important consideration in all real

            estate transactions, real estate licensees must be knowledgeable concerning tax

            matters. However, they must also exercise extreme caution to avoid giving advice

            regarding tax matters. Investors should be advised to seek the advice of qualified

            experts in the field of taxation.

            The Tax Reform Act of , the Tax Act of , the Taxpayer Relief Act of ,

            and revisions to the tax code made in  have made significant changes in tax

            treatment associated with real estate. The following discussion presents some of the

            changes related to these laws.

            Depreciation

            One benefit that is not available to homeowners but is available to investors and the

            owners of businesses is the ability to deduct a portion of the money that they have

            invested in their property each year from their gross income. This deduction is referred

            to as cost recovery, or tax depreciation.

            A system called the Modified Accelerated Cost Recovery System (MACRS) was

            adopted in , thereby replacing the Accelerated Cost Recovery System that was

            implemented in . Cost recovery, in the language of the tax code, refers to tax

            depreciation. The MACRS stipulates the time periods over which investment real estate

            can be depreciated for tax purposes. The time period begins when the property is placed

            in service, which, essentially, means the time in which title is taken.

            Tax law currently allows the owners of residential and low-income investment

            properties to depreciate a portion of their investment over . years on a straight-line

            basis. The residential category includes single-family rentals, all apartment rentals, and

            mobile homes. The owners of nonresidential investment properties may depreciate a

            portion of their investment over  years, also on a straight-line basis. Hotels and motels

            are classified as nonresidential.

            To calculate the amount of the allowable deduction, the total cost of acquisition,

            including the total cost of the property plus closing costs, is allocated on a percentage

            basis to the land and improvements. The basis for depreciation is that portion of the total

            cost, including closing costs, which applies to the improvements. Land cannot be

            depreciated. This amount is evenly divided by the number of years allowed, either .

            or , depending on the type of property. That is what is meant by straight-line; the same

            dollar amount is deducted each year. This percentage can be calculated by having an

            appraisal made or using the percentages of land and improvements utilized by the

            property appraiser’s office. The basis is reduced each year by the amount allowed until

            the total depreciable basis equals zero or the property is sold.

            Example: An apartment complex was purchased for $,; closing costs were

            $,. An appraisal indicated the improvements represented % of the value of

            the property. What amount may the investor deduct each year for tax purposes?

            Solution:

            $, Purchase price

            + $ , Closing costs

            $, Total acquisition cost

            x          . Improvements percentage

            $ , Basis for depreciation

            In the example above, the investor can claim $, each year as an expense on

            his or her personal tax return until the entire $, has been claimed.

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            Capital Gains Tax

            Capital gain is profit made when an income property is sold.

            Under the American Taxpayer Relief Act of , the top capital gain tax rate has

            been permanently increased to % (up from %) for single filers who have incomes

            above $, and married couples filing jointly who have incomes exceeding

            $,. The Act also changed the depreciation recapture rate to % for all

            taxpayers, independent of tax bracket.

            A summary of the current capital gain tax rates for taxable income ranges follows:

            If tax depreciation has been deducted during the ownership period, the proceeds of a

            sale will be taxed at two different rates. The capital gains tax rate shown above is for

            capital assets held over  months. A portion of depreciation claimed during the

            ownership must be recaptured at the time of sale, and is taxed at a depreciation

            recapture rate of %. Profit made on the sale of property owned for a period of

            months or less is taxed at the investor’s ordinary tax rate.

            Example: Capital gains tax calculation.

            An apartment building was purchased for $, by an investor with a taxable

            income of $,. Closing costs were $,. An appraisal indicated the value of

            the improvements represent % of the value of the property.

            Only that portion of the purchase price allocated to the improvements can be

            depreciated. The basis for depreciation is reduced each year to arrive at the adjusted

            basis. When the adjusted basis reaches zero, no further depreciation may be

            claimed.

            After five years of ownership, the adjusted basis is calculated as shown:

            $, Purchase price

            + $, Closing costs

            $, Acquisition cost

            x          . Improvement percentage

            $, Basis for depreciation

            , Annual depreciation allowance

            x          Years of ownership

            $, Total depreciation

            $, Basis for depreciation

            – $, Depreciation claimed

            $, Adjusted basis

            If the property was held longer than  months and sold for $,, the capital

            gains tax due on sale would be calculated in two steps:

            Step     $ ,        Sales price      $,         Capital gain

                        – ,        Acquisition cost           x          .           Capital gains tax rate

                        $ ,        Capital gain     $ ,        Tax on gain

            Step     $,         Depreciation recaptured         $ ,        Capital gains tax

                        x          .           Tax rate on recapture + ,        Tax on recapture

                        $ ,        Tax on recapture        $ ,        Total tax due

            Income Classification

            Under the Tax Reform Act of , income must be separated into three categories:

            active, passive, and portfolio.

                        Active income. Active income is income from salaries and wages.

                        Passive income. Passive income includes income from rental activity and any

            investments in which the investor does not materially participate.

                        Portfolio income. Portfolio income is income from dividends.

            The significance of the separation of income into separate categories is that a loss

            cannot be offset against income from another classification; it can be offset only by

            income in the same classification. This is in order to eliminate many forms of tax

            shelters, and to expose more income to federal income tax. Losses that cannot be offset

            by gains in any given year must be carried forward to subsequent years; they may not

            be deducted against income from other sources such as salary, interest, dividends, or

            other active business income. If a property is sold at a gain, any losses from previous

            years may be used to offset losses carried forward.

            Exceptions are as follows:

                        Limited exception. A limited exception is when a small investor has an

            opportunity to retain a tax shelter advantage. An investor with an adjusted gross

            income of $, or less may offset up to $, of passive losses against

            active portfolio income as long as,

            o          Management decisions are made by the taxpayer

            o          The taxpayer owns at least % of the investment

            o          The adjusted gross income of the taxpayer is below $,

            This benefit is phased out on a percentage basis when the investor’s income

            rises above $,, and is eliminated when the investor’s income is above         $,.

            This exception exists even if a rental agent or property management firm

            handles the property. Management decisions include approving new tenants,

            deciding on rental terms, approving expenditures, and other similar decisions.

                        Exception for real estate licensees. The exception for real estate licensees is

            found in the Tax Law of  that provides additional relief for real estate

            licensees who spend a minimum of  hours per year in the real estate

            business and incur passive loss from rental activities. Real estate licensees who

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            own investment real estate should contact their tax accountants for clarification of

            this provision.

            Capital Gains and Losses

            A capital gain or loss occurs when an investment or business property is sold for an

            amount greater or lesser than the amount paid. Income from properties held for sale to

            customers, such as model homes offered for sale by builders, is considered to be an

            active income since these are not considered to be investment properties.

            As discussed above, passive losses must be carried forward and offset against

            future gains from passive activity. Capital gains, on the other hand, are realized income.

            Generally speaking, realized income is subject to income tax in the year in which it is

            earned.

            There are two methods an investor can use when a property is sold to reduce or

            defer the amount of tax due on the transaction: a tax-deferred exchange or an

            installment sale.

                        Tax-deferred exchanges. Tax-deferred exchanges allow any capital gain

            realized from the sale of investment property to be transferred into another

            property by exchanging properties. An investment real estate that is exchanged

            for other investment real estate is called a like-kind exchange. The problem with

            this type of transaction is that most properties do not have the same value.

            Therefore, in order to conclude the exchange, investors often include cash, or

            other forms of unlike property, to equalize the transaction. Unlike property

            received in a tax-deferred exchange is called boot and is taxable to the recipient.

            To the extent that the equities are equal, the capital gain is deferred, or

            postponed, until the property is sold.

            Note that this does not eliminate the tax; it is allowed to be recognized in a

            later tax year. This can be an advantage in tax planning, particularly when an

            investor expects to be in a lower income tax bracket in future years.

                        Installment sale. Installment sale is a form of seller financing. No down payment

            is required to qualify as an installment sale. It qualifies as long as at least one

            payment is received in a tax year subsequent to the year of sale. Under

            installment sale treatment, only the percentage of gain received in any given year

            is taxable. Therefore, the gain can be spread over several years, thereby

            reducing the amount of tax due in any tax year.

            Investment Interest Limitation

            Deduction of investment interest is limited to the amount of net investment income

            within the tax year. The investment interest limitation applies to all interest paid for tax

            years beginning after December , , regardless of when the debt was incurred.

                        Investment interest. Investment interest is all interest charged on debt that is

            not incurred in connection with the taxpayer’s primary trade or business.

                        Investment income. Investment income is gross income from interest,

            dividends, rents, royalties, and income not derived from a trade or business.

                        Net investment income. Net investment income is the excess of investment

            income over investment expense.

            At-Risk Rules

            A taxpayer may deduct losses from an activity only to the extent of the amount of

            investment capital that is at risk.

            Retained provisions of the Tax Reform Act of  include credits for a taxpayer who

            restores a historical building. The Act also provides credits for qualified low-income

            housing projects.

            BUSINESS ENTERPRISE AND OPPORTUNITY BROKERAGE

            Business Brokerage

            A business brokerage offers real estate services that are connected with the sale or

            lease of businesses. The sale of a business may or may not include the sale of real

            property.

            Business brokerage consists primarily of analyzing financial statements. Those

            engaged in this aspect of real estate are required to have knowledge concerning

            business formations, and be able to read and understand operating statements and

            financial balance sheets. An income statement is a history of income and expenses over

            a stated period, such as a month or a year. A balance sheet reflects the financial

            condition of a business as of a particular time.

            The sale of a business may involve the transfer of ownership of shares of stock,

            limited partnership interests, or other forms of securities. Persons who deal in securities

            are required to have a separate license. Real estate licensees must be certain that

            securities laws are not violated when listing or selling a business.

            The sale or lease of a business is a real estate transaction. Persons and firms that

            offer brokerage services connected with the sale or lease of a business are regulated by

            F.S. , and are required to hold a real estate license. Regulation of business

            brokerage became effective in . The legislature believed a real estate license

            should be required in the brokerage of a business since the transaction almost always

            involves either the sale of real estate or negotiation of a lease.

            A real estate licensee may also need to hold a securities license if the transaction

            includes the transfer of corporate stock or limited partnership interests. Legal counsel is

            strongly advised before proceeding with the sale of a business.

            Business Enterprise Defined

            A business enterprise involves transactions that are in excess of $,. The

            brokerage of larger businesses usually involves the transfer of stock shares or other

            types of security. The transaction may or may not involve the sale of real estate. If not,

            negotiation of a lease may be required.

            Markets for business enterprises are typically wider in geographic scope than

            markets for individual parcels of real estate.

            Business Opportunity Defined

            Business opportunities involve smaller businesses with sales prices of $, or

            less. These businesses typically have a limited amount of assets. The ownership of such

            businesses may also involve securities, but many are sole proprietorships or

            partnerships that do not.

            The sale of many of these businesses involves only the sale of inventory and

            fixtures, and an assignment of a lease.

Real Estate Investments and Business Opportunity Brokerage       

            Expertise Required of Business Brokers

            Generally, business brokers work in conjunction with certified public accountants and

            attorneys. Business brokers must have an understanding of corporate finance and

            knowledge regarding the classes and characteristics of corporate stock, securities

            analysis and valuation, capital management, and budgeting.

            A business broker must have knowledge regarding business accounting, including

            classes of assets and liabilities, income statement analysis, balance sheet analysis,

            cash-flow analysis, asset depreciation methods, and taxation.

            Appraisal Using the Liquidation Value Approach

            The comparable sales approach, cost-depreciation approach, and income approach

            (discussed in  ) can all be used to appraise a business. A fourth method, the

            liquidation value approach, may also be used. This approach is unique to the valuation

            of a business.

            Liquidation value is the value that remains after liquidating all the assets of the

            business and satisfying all the liabilities. This approach is used to value a failing

            business that is not expected to continue to do business. It can also be used to establish

            the minimum value of a profitable business.

            The appraisal of a profitable business presents a unique challenge. The value of the

            business is not just the value of any real estate owned, but rather, a composite of the

            values of the real estate, personal property, and intangible assets, such as licenses,

            franchises, noncompetition contracts, and so on. When the value of all assets is

            combined, it creates what is known as going concern value.

            Reasons for a Business Appraisal

            Business owners or potential purchasers may request an appraisal in order to

            establish a sales or purchase price, obtain a loan, or for insurance purposes. Other

            reasons include condemnation, buy-sell agreements, property settlements, estate

            settlements, or to be used in connection with employee stock option plans.

            Uniform Commercial Code

            The Uniform Commercial Code (UCC) is a body of standardized rules that regulate

            commercial transactions throughout the nation by focusing on the sale and financing of

            personal property. Florida has adopted a version of the UCC as law.

            When personal property is sold in a commercial transaction, a Bill of Sale is used to

            identify the property conveyed. This document is similar to a deed. If financing is

            involved, a standard Security Agreement is used to identify the property that is security

            for the debt. The Security Agreement is similar to a mortgage and is usually recorded to

            protect the lender’s interest in the property.

            An attorney must be retained to prepare documents used in compliance with the

            UCC; real estate licensees may not prepare these on behalf of customers or principals.

            Accounting Terms

            Agents involved in the selling of businesses should be familiar with the following

            terms and the accounting formula:

            Assets. Assets are items of value that are owned by a business. Assets include accounts and promissory notes receivable, cash, inventory, production machinery, real estate, personal property, patents, trademarks, and goodwill (the value of the name of the business in the marketplace).

            Liabilities. Liabilities are debts that are owed by a business. Liabilities include accounts and notes payable, and long and short-term debt. Short-term liabilities are debts that must be recognized within one year or less. Long-term liabilities are debts that will not come due for more than a year, such as mortgage balances.

            Owner’s equity. Owner’s equity is the difference between assets and liabilities.

            Basic accounting formula. The basic accounting formula is

Assets – Liabilities = Owner equity

            Capital. Capital is the total amount that is invested. Capital includes the funds that were used to start the enterprise, money that is invested during operation, and retained capital.

            Tangible assets. Tangible assets are assets that have physical existence such as buildings, furniture, office equipment, and so on.

            Intangible assets. Intangible assets have no physical existence, but have monetary value. Intangible assets include stock shares, trademarks, copyrights, research and development expenses, noncompetition contracts, franchises, and goodwill.

            Steps in the Sale of a Business

            The steps taken to list and sell a business are not unlike the steps that are taken to

            list and sell any other real estate. The exception, of course, is the knowledge and

            experience necessary to properly value and market the business.

            Step     Acquire the listing. The listing process is virtually the same as listing

            other property for sale.

            Step     List the assets. A detailed list of all tangible and intangible assets is

            required.

            Step     Valuation. Estimate the value of the business by using the appropriate

            appraisal methods.

            Step     Deduct liabilities. The value established in Step  must be reduced by

            the amount of liabilities, long- and short-term. This includes the value of

            any preferred, outstanding stock.

            Step     Valuation of stock. If a corporation is being sold by transferring shares

            of stock, the share value must be determined. Divide the net value of the

            business by the number of shares to determine the per-share value.

Real Estate Investments and Business Opportunity Brokerage       

            Step     Legal compliance. Review the transaction carefully before proceeding in

            order to be certain that all laws have been complied with. This includes

            real estate, securities, mortgage brokerage licensing laws, and UCC

            requirements.

            Step     Close the transaction. Locate a buyer who is interested in the business

            and conclude the sale.

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Gold or Fools Gold?

When it comes right down to it, successful investing over the long-term is firstly about being true to oneself, and secondly, grasping the facts and figures. Sam Stovall, CFRA Chief Investment Strategist, informed market participants this morning in his weekly report that “gold” has returned an average of 2.7% in the month of August the past 25 years. Of course, history is simply a guide and just that. No one knows for certain how any risk asset will perform from one moment to the next.

My job as a money manager is to allocate assets across the spectrum of choices according to clients’ timeline and objectives. Covid-2020 has been a year of despair and hope, more the former. Federal governments and global central banks have spent and pledged trillions more, to support society. The U.S. has authorized $10 trillion in relief money with more to come. The flood of easy money has been a tailwind for gold of late.

Ray Dalio, founder of the world’s largest hedge fund said, “Gold, I believe can be both risk-reducing and return-enhancing.”

Prudent investors who are not speculators and risk-averse should have their money spread across assets that can grow, as well as assets that are safe. To achieve this objective it is wise to own various investments that are less correlated. Gold’s correlation to stocks over the past decade has been about 20%.

https://www.1db.com/disclosures/

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FREDCAST – I hit #2 for the month!

#TADA! I’ve been an active participant in the St. Louis Fed’s ongoing forecasting game since it launched a few years back. I just hit my highest outcome ever! I predicted that GDP would fall ↓30% in Q2, the actual number was ↓32.9%. Is there a sign to be had from all this? It’s great to be lucky!

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Biden’s Blue Wave Capital Gains Bite

How much of an impact will the “Biden Capital Gains Tax” have on consumers’ wallets, the economy, and the stock market? Some fearmongers are calling the “Blue Wave” tax strategy a stake right through the heart of U.S. economic recovery! Really?

My father said to me when I was a young man, “Son, believe half of what you see, and none of what you hear.” He meant this to be instructional, by that, encouraging me to take a moment to review the facts. He would say, “facts are stubborn” to drive home the point.

According to the dqydj.com calculator, 99% of American households earn less than $488,849 per year. Therefore, Biden’s capital gains rate increase, if there is a Blue Wave, and Mr. Biden defeats the incumbent President and is able to enact tax reform, the target appears to be on the back of the top one-percent income households. So, as far as Biden’s Bite, I’d say it is more of a nibble with few teeth. For now.

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Covid-19 Palm Beach County Update

There are currently reported 369,834 positive coronavirus cases in Florida. Palm Beach County (PBC) has a population of 1.5 million, with 26.9 thousand positive cases, or 7% of the state’s total, Broward and Miami report 12%, and 24%, respectively.

Currently, the ratio of infected persons in PBC is 1 out of every 56 people; the rate of infection has not decelerated in PBC. So, what should each individual do about this? Here is what the Director of the CDC has to say.

“We are not defenseless against COVID-19,” said CDC Director Dr. Robert R. Redfield. “Cloth face coverings are one of the most powerful weapons we have to slow and stop the spread of the virus – particularly when used universally within a community setting. All Americans have a responsibility to protect themselves, their families, and their communities.”

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Everyone Needs a Partner!

Everyone needs a partner! Capital is that partner. Capital has proven to have been a reliable and rewarding partner, historically! Capital works for you. It is always on the clock, never tardy or absent, and shows up 365 days a year, including holidays, and pandemics. Whew! That’s what I call an ultramarathon worker for certain!

Since 1970, capital equally invested in residential housing, equities, and bonds has grown around 7% a year including appreciation, interest, and dividends. During this same period wages and salaries have increased at a rate of about 6%. So, what I am suggesting is to put your money to work side-by-side with your hard labor by way of human insight and financial technology. 1db.com’s digital advisory solution professionally manages your money and invests in leading stocks, bonds, and real estate, globally.

Our #fintech enables the masses to invest like the classes. Save and invest in yourself. The best time to save for the future is the present! Put your capital to work. The minimum is $1.

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Mortgage Rates Fall to Record Lows▼

Since 1971, Freddie Mac has been tracking the 30-year fixed mortgage rate; 3.03% is the lowest ever! There has never been a better time to refinance and invest the savings for your future.

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Follow the Money!

Want to become a better investor?

The Federal Reserve does a yeoman’s work to provide the American saver and investor where all the money goes. Anne Scheiber, one of my investing heroes who amassed $22 million over her lifetime by investing minimal sums, according to Wikipedia. In fact, she never earned a salary of more than $4,000 a year. She was a shrewd investor and learned her way by analyzing where wealthy folks invested their money.

Simply follow the money!

https://lnkd.in/eeqbU6Z#invest#save#spendless#minimalism1db.com

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A $10 Trillion Rescue Package: Will it Ignite Inflation?

“Inflation is always a monetary phenomenon that occurs by a rapid increase in the quantity of money.” —Milton Friedman (Nobel Prize Recipient)

Inflation averaged 3.2% since 1914; today it sits anchored at .2%. There have been episodes of high inflation rates over the past half-century stemming from excess liquidity. Money supply growth (blue line) has risen by double-digit rates; this, at times, has sparked bouts of inflation. In 2020, money supply (M2), comprising cash, checking accounts, and savings accounts has swelled a whopping 23%, from $14.4 to $17.9 trillion, a $3.3 trillion increase, whew! The surplus in liquidity has been a boon for investors owning financial assets.

Historically, a substantial increase in the money supply, as measured by the monetary aggregate M2, has accompanied elevated periods of rising costs. Monetarists suggest that the money supply is a primary factor influencing demand in the economy. Keynesian theorists advocate that stimulative fiscal policy is essential to curtail job destruction and reignite economic activity, after an exogenous shock. Covid19 has squeezed supply chains and seized consumer spending, sending our economy into a sharp recession. The federal government unleashed $10 trillion in fiscal stimulus and central bank monetization to address the coronavirus economic storm,

According to Yogi Berra, “a nickel ain’t worth a dime anymore” was his novel way of saying that a rapidly rising inflation rate is undesirable. Presently, financial markets, analysts, economists, politicians, and the Fed, do not foresee inflationary headwinds. However, if the $10 trillion and counting rescue package proves to be more than was necessary to resuscitate the Covid19 recession, and the economy picks up steam faster than is expected, perhaps then we may have a new problem, Inflation!

Savvy market participants are keen to keep their eyes focused on the rising prices of goods and services and potential threats to their fixed income holdings, particularly long-dated bonds. One thing that is promising occurring from an inflation bout is that it makes it easier for the federal government to service its debts by collecting higher taxes and draconian indexing.

Important Disclosures Any views, thoughts, and opinions pertaining to the subject matter presented in this post are solely the author’s subjective opinions and do not reflect the official policy or position of 1st Discount Brokerage, Inc. Information is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and are not guaranteed. Past performance is no guarantee of future results. Any examples, outcomes, or assumptions expressed within this article are only hypothetical illustrations and should not be utilized in real-world analytic products as they are based only on very limited and dated open source information. Dollar-cost averaging, diversification, and rebalancing strategies do not assure a profit or protect against losses in declining markets. Asset allocation and diversification do not ensure or guarantee better performance and cannot eliminate the risk of investment losses in declining markets. Assumptions made within the analysis are not reflective of 1st Discount Brokerage, Inc. nor its personnel. 1st Discount Brokerage, Inc. is a licensed FINRA broker-dealer and Registered Investment Advisor. Securities offered through 1stDiscount Brokerage, Inc., Member FINRA/SIPC.

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🐮 V-Shaped Recovery ↔ The Sky is Falling 🐔

“I am very cautious about going against the herd; I am liable to be trampled on.” —George Soros

Has the stock market’s behavior been a resounding clarion call to anyone open to listening? Real investors, the intrepid souls with skin-in-the-game who are willing to take the risk, have been justly rewarded.

Chicken Little is a story about an anxious bird that gets hit from a falling object overhead and acclaims to no end, “The sky is falling; the sky is falling.” Chicken Little’s panic-driven message created widespread fear before the facts were ever counted. It is a narrative that sensationalists hold tight. Even some of the most respected minds are bellowing a perilous situation for Americans and the world order. They contend that financial markets are hanging by a mere Fed thread. Collectively, their words become the headlines.

  • “Worst Recession Since the Great Depression.” IMF
  • “World faces the worst recession in 100 years.” Economists
  • “Expect worst recession in 150 years,” says former IMF chief 
  • “Worst recession in 300 years.” Magzter

Michael Mauboussin reminds thinkers of the inherent wisdom of crowds by way of diversity prediction theorem, teaching that when there is a vast diversity of individuals in a group, the error of the crowd is limited. In other words, the self-anointed intellectual elite, who are published and venerated by the establishment, are likely to have the rug pulled out from under them if their message goes against the wisdom of the masses.

June’s employment rebound does just that. 4.8 million hires were put back to work last month, and the employment rate jumped by 2.3%. Is this further confirmation that the crowd/stock market has been the right path to follow so far? Americans love life and pride themselves on making a difference and working hard. The best is yet to come.

Add to that → for savers and investors looking for a modern way to invest, check out 1db.com’s digital advisory solution, “where the masses invest like the classes.” → robo.1db.com/notice

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