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Go Zone Strategies

August 6, 2007--San Diego--For those of you who are unaware, there is a unique opportunity (50% depreciation deduction in the 1st year) available to investors who purchase or develop new properties in the Gulf Opportunity Zone (areas that were destroyed by Katrina & Rita). This deduction can be carried back 5 years or carried forward 20 years. We may never see anything like this again in our lifetimes.

If you are a real estate professional, you can use this deduction freely against your income. If you are not a real estate professional (most of us are not), there are ways to maximize of this opportunity. Here are some examples of strategies that work.

Example #1

One of our clients is selling some property with an $8 Million capital gain. He can either 1031 exchange this gain into more property, or he can set up an LLC and use the Go Zone Deduction as a tool.

In order to eliminate the entire tax liability without having to jump through all of the 1031 exchange hoops, we have the following solution: If our client creates his $8 Million gain in an LLC and uses $2 Million of that gain to purchase $16 Million of Go Zone real estate, he will be able to use the 50% depreciation deduction to eliminate his entire tax liability, and have $6 Million free to do whatever he chooses. With careful execution, our client would be purchasing equity on every transaction, and end up creating tremendous wealth, while eliminating a $2 Million tax liability. The client can also 1031 exchange $2 Million of his gain (this will off-set $2 Million of gain) and use those funds to purchase $12 Million of Go Zone real estate ($6 Million deduction).

Example #2

One of our clients (this situation is quite typical) came to us with over $1 Million of home equity along with over $750k trapped in an IRA. We suggested that he should separate at least 80% of the equity from his home, since it was not liquid, not safe from loss, and was earning a 0% rate of return. We could use the new mortgage interest deduction to help the client to eliminate the tax liability from his IRA by taking distributions and using them to pay the mortgage interest. We would also borrow some of the money from the IRA to purchase real estate, which will create additional wealth for us 7 years from now, and additional tax deductions (mortgage interest and depreciation). Essentially, the client will be moving his current equity (dead capital) into a maximum funded life insurance contract, which will grow tax free (9.2% avg. return with 1% total avg. yearly cost of insurance = 8.2% IRR), be accessed tax free, and will transfer tax free to his heirs.

In order get the entire amount of the mortgage interest to be tax deductible, we need the following solution:

Our client does a refinance cash-out and proceeds to loan this money into his LLC. Most of this money will eventually end up in the maximum funded life insurance contract to create a tax-free, steady retirement income, but the money has to be deposited into this contract over a 4 to 5 year period of time. While the money is waiting to be invested, the client would proceed to invest the side money into taxable instruments like CDs or loan the money to real estate developers-backed by (60% LTV or lower) real estate (which earn 12+%) - this would be creating taxable income for Uncle Sam. In the tax code, it specifically says that we are unlimited as to how much mortgage interest we can write off as long as that money is being used to create enough taxable income. Now the mortgage interest is fully tax deductible, but that deduction will be located on different parts of the tax return (Schedule A, and Schedule C). If the client proceeds to purchase some Go Zone properties in that same LLC, we can use the depreciation deduction to make that taxable income – to be tax-free!

If there is a net loss in the LLC, we can carry over up to $25k loss per year. This client has now eliminated the entire tax liability from his IRA and has created a tax-free income stream from his current dead equity position. If we are borrowing from the property at 7% (tax deductible) and loaning the money to real estate developers at 12+%, we are even making money on that arbitrage.

Go Zone Risk Mitigation

The tax deduction is a great bonus, but blindly purchasing properties in these areas is a recipe for an unsuccessful investment. We want to protect ourselves against natural disaster risk and from no-renter risk. We recommend staying away from New Orleans, since it is still below sea level. We like Biloxi, MS because there are over 17 casinos scheduled to be built in the area, and there is a lot of money being invested in the area because of those casinos. This area is going to be the quaint version of Las Vegas…the next great real estate success story. These casinos and resorts create jobs, and jobs create a need for housing. The appreciation is set to follow. Not only do our clients enjoy this incredible tax deduction, but they can enjoy purchasing instant equity, and incredible appreciation down the road.

Property insurance now covers all of the issues that the previous policies did not, and it does cost more. The price of the land and homes in the area is so cheap, that these properties still cash-flow at 10% down. The best way to proceed is to put as little down as possible, and continue to take the equity out of the properties every few years using HELOCs or other forms of financing. If you keep very little equity in the property, you will have very little risk.

Note: Please consult C3 or your CPA / Tax Attorney regarding how the Go Zone depreciation may be applied in your specific situation. The information provided herein is provided for informational purposes only, and is not intended to be a substitute for your own due diligence and independent research. You agree that any decisions you make will be based solely on your evaluation of your personal financial circumstances, investment objectives, risk tolerance, financial condition, liquidity needs, and any other information available to you. You are reminded and agree that all real estate used for income, appreciation, or other investment purposes face the risks attendant to such an application, including that real estate values may go down, rents may decrease, and that vacancy rates may increase. Additionally concerning real estate; a ready market may or may not exist for any particular property once purchased. Capital Consulting Company has created asset allocation models. We have provided models that suit your particular risk profile, as you've defined it in our Confidential Profile. Capital Consulting Company cannot be held responsible for the accuracy (or inaccuracy) of the information you provide us at any point in the process. Our model allocations are but one of several alternatives from which to choose. Under no circumstances should you make financial decisions by relying solely on the Comprehensive Portfolio Audit and without thoughtful consideration. No guarantee can be made with respect to actual investment results. Past performance does not guarantee future results.

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