January to March 2007 Quarterly Newsletter

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Aloha to all the new recipients of our newsletter. We have been mailing an eight-page, quarterly newsletter to absentee owners of real estate on Oahu for over 14 years, using state tax office records for address information. Recently we added a number of new absentee owners to our database with most of them owning property in the Ewa Plain area of Oahu.The Postal Service has proposed first class shape-based pricing for non-standard shapes such as this folded newsletter. Presorting our 10,000 plus newsletter by zip codes avoids the shape-based pricing as well as significantly reducing the cost of first class postage. However, to be able to presort in a timely and effective manner, we had to change our format so the printer could automate the printing, assembly, addressing, and mailing steps. So with this newsletter, we bid farewell to blue and yellow inserts, manual assembly in our conference room, peeling & sticking address labels, etc. and say hello to automation and two folded, four-page sheets.

Much of the Odds & Ends section of the newsletter on pages 2-3 discusses an excellent new book on taxes. A new wrinkle for me was the fact that depreciation recapture tax will be owed on the sale of a personal residence for the portion of time after May 6,1997 that the home was used as a rental property even if there is an exclusion of up to $250,000 of gain (single) or up to $500,000 (married); i.e., the exclusion of gain does not include an exclusion of recent depreciation recapture. This particularly applies to an owner who conducts a 1031 exchange into a replacement property that is rented for at least a year and then converted into a personal residence. Page 7 of the newsletter is an article on this prepared by First American Exchange that I found by conducting a Google Search of personal residence depreciation recapture after May 1997.

Odds & Ends

Avoiding Probate: Periodically, we’re asked how heirs can avoid the probate process. The following information is from attorney/author Robert Bruss who recommends that properties be placed in a revocable living trust. The living trust has two benefits: (1) avoidance of Probate Court costs and the attendant delays after the trustor (owner) dies and (2), management of living-trust assets if the trustor becomes incapacitated. With a revocable living trust, the trustor can continue managing their living-trust assets including buying and selling real estate. However, if they become incapacitated through a stroke, Alzheimer’s disease, etc. and their assets need to be sold or refinanced to provide for their care, the successor trustee (often a son/daughter) can handle that without Probate Court interference. When the trustor dies, the heirs get a new stepped-up basis to the market value at time of death. This advantage may be lost in 2010 if Congress eliminates the estate tax. The basis then will be the decedent’s basis rather than the fair market value at time of death.

There is another problem that can create a delay in heirs being able to sell Oahu property, particularly if the property has vacation potential. Some heirs may want to sell the property right away to cash-out their share of equity while others may want to hold on to the property for their future personal use. There are legal steps to force a sale; however, this might create major intra-family conflict. Our experience indicates that when the heirs cannot agree on the sale of Oahu property, the heirs will usually wait for several years prior to selling. To eliminate this potential problem, some of our clients have conducted a 1031 exchange for tax purposes and bought several similar replacement properties (one for each heir) or they’ve purchased a replacement property that may not be too liquid, but provides a good cash flow. Others have paid the capital gains taxes and replaced their Oahu property with easily dividable securities. Contact us or call toll-free at 1-800-922-6811 if you would like to discuss this topic.

Hawaiian Street Names: is the title of a new book that contains the meaning of over 5,000 street names in Hawaii along with several pages of introduction discussing such things as the importance of diacritical marks such as the glottal stop. Example: ‘ai with the glottal stop means to eat while ai without the glottal stop means sexual intercourse. The 2007 addition should include most of the newer streets on Oahu. Send us an e-mail with your street name and we’ll e-mail you back the meaning of the street name.

Real Estate Tax Secrets of the Rich: is the title of another new book that some of you may want to purchase. The author is Sandy Botkin, CPA, 2007, McGraw-Hill, New York, 226 pages. I paid Amazon.com $16.47 for my paperback version. Considering the rather boring topic of taxes, the book is very easy to read with simple explanations and numerous drawings and cartoons. The chapters are short with summaries at the end. Also at the end of each chapter are citations to recent IRS rulings and tax court decisions. An Appendix at the end of the book provides various resources, most of them online. The book contains both basic and advanced tax explanations on virtually every tax topic applicable to homeowners and investors. The author has an excellent sense of humor making his book a reasonably easy, enjoyable read. The remainder of this section provides applicable information.

1. Improvements versus Repairs: Improvements made to personal residences and second homes increase your tax basis as well as adding value to the home. Repairs made to personal residences and second homes are considered personal expenses and are not added to basis. However, if you make what would normally be a repair become part of a general plan of improvements, the IRS has ruled that the whole expenditure can then be an improvement. For rental properties, it’s just the opposite; you are better off classifying fix-up expenses as repairs because repairs are deductible when they are incurred. The book discusses the difference between repairs and improvements in two separate chapters, one oriented towards personal residences and the other towards rental properties.

2. Excluding Gain When Selling Your Home: Several chapters deal with the $250,000 or $500,000 (single or married) maximum exclusion when you sell your own home and have occupied it for two out of the past five years. I found it interesting that a surviving spouse can wait for up to two years after the year of death to file for the full $500,000 exclusion if the surviving spouse maintains a household for dependent children. If there are no dependent children, the surviving spouse can claim the full $500,000 exclusion only in the taxable year of death. Taxable depreciation recapture is discussed on pages 1 and 7 of this newsletter.

A partial exclusion is authorized if ownership was less than two years and a move is/was for health or job purposes; this occasionally applies to owners that are either moving to or have moved from Hawaii to the Mainland. If the home ownership was only for 12 months and the owner is single, the maximum exclusion would be 12/24 times $250,000 or $125,000.
There was an entire chapter dealing with selling a former home to your own Chapter S Corporation if you rent the property and are about to lose the two out of five years of occupancy. By selling the home to your own Chapter S Corporation, you could claim the $250,000/$500,000 exclusion in the sale and then continue to operate the home as a rental through your own Chapter S Corporation.

3. Tax Splitting: There were several chapters that discussed minimizing taxes by splitting income/ownership among family members. Several examples were provided ranging from relatively simple techniques such as transferring rental property to children that are then taxed at their lower tax rates vice the higher tax rate of the parents. More complicated techniques involved buying rental property and having children own title to the land with the parents owning the building. The parents then rent the land from their children while depreciating the building. Another technique is to depreciate equipment used in investment property (washers, dryers, ranges, etc.) and then give title to the equipment to lower tax-rate children. The parents then lease the equipment back, paying monthly rent; i.e., first you depreciate the equipment and then you lease it or, in effect, you deduct the equipment twice.

There were more complex examples involving the sale and leaseback of a personal residence through a note to children that would cover their payments via rent from the parents. The home then becomes investment property with deductible repairs. Moreover, the children can visit their property (and their parents) via deductible caretaking trips. I encourage anyone considering a sale and leaseback of a personal residence to discuss the potential consequences of not having actual title to the property with a real estate attorney.

4. Seller Financing: A relatively long chapter discussed Seller Financing and how seller take-backs can create more wealth than selling for cash. I found this to be one of the more interesting sections of the book; however, it may not be too practical now with the relatively low mortgage rates that continue to exist.

5. Miscellaneous: Other chapters covered what you can claim or deduct while searching for investment property; hiring family members; maximizing your deductions when building a home; understanding depreciation; the pro’s and con’s of selling a home to an ex pursuant to a divorce decree; using 1031 exchanges and installment sales to reduce taxes; IRS record keeping requirements; minimizing passive loss problems; how to calculate gain or loss; understanding vacation home and second home rules; a whole chapter covering frequently asked questions; and another chapter on using today’s technology, primarily the Internet.

A Mixed Plate of Talk Story

Considerable disagreement exists over the fixed-rail route. By a 5:4 vote in February the City Council approved a route that would begin near the planned University of Hawaii West Oahu campus and end at the Ala Moana Center, bypassing the Airport in favor of Salt Lake and stopping before either Waikiki or the University of Hawaii at Manoa. Very strong editorials in both daily newspapers opposed the route as being politically motivated by selected Council members vice something beneficial for greater Oahu . . . In late-March, I attended a special briefing for real estate agents on the Hawaii Superferry, the 350 foot, double-hull ferry that is scheduled to start service this summer carrying passengers, automobiles, fresh produce, trucks, buses, etc. between the major islands. Hawaiisuperferry.com is an excellent website with extensive information and numerous photos. Two ships are being built in Mobile with the first scheduled to start sea trials about the time this newsletter goes to press. Service between Honolulu, Maui and Kauai is expected to begin in July. A second ferry is scheduled to arrive in late-2008 with service between Honolulu and the Big Island to start early in 2009. The first ferry will depart Honolulu at 6:30 a.m. arriving in Maui about 9:30 a.m. At 11:00 a.m. it will return to Honolulu arriving about 2:00 p.m. At 3:00 p.m., it will then depart for Kauai arriving about 6:00 p.m. At 7:00 p.m. it will return to Honolulu arriving about 10:00 p.m. There will be two fares, one for peak times, Friday through Monday, and the other for non-peak weekdays. Pre-purchased, one-way fares for Maui and Kauai will be $52 (peak) and $42 (non-peak). The one-way fare for cars/SUV’s will be $65 (peak) and $55 (non-peak). There is considerable elbowroom for passengers along with comfortable seats, a large movie screen, a bar/lounge area, etc. The ships can carry a maximum of 866 passengers and 282 cars; however, it is projected that a typical trip will have about 400 passengers and about a 100 cars, trucks and buses; i.e., be about half full.

Here and here are links to articles in the 3/20/07 and 3/23/07 issues of The Honolulu Advertiser discussing Japanese real estate tycoon Genshiro Kawamoto’s plan to have needy Native Hawaiian families occupy some twenty houses he owns on Kahala Ave. The first three families have moved into homes Kawamoto purchased for $2 to $4 million apiece in 2005. Initially, Kawamoto was going to charge rent of $150/mo; however, with the first three families, he decided to waive the rent. As you might expect. the neighbors that live in Kahala have mixed opinions over Kawamoto’s plan to have formerly homeless Native Hawaiian families live in their prestige area . . . Years ago, we showed about 20 houses to Genshiro Kawamoto one Saturday, most of them unlisted properties. Kawamoto would only work with the owner of the company and did not speak English. My wife and I led a car caravan with Kawamoto and several aides following us in a large limo. An interpreter was in the third car with a local attorney bringing up the rear in a fourth car. One of Kawamoto’s aides looked at every home; however, Kawamoto himself only got out of the limo to look at five of them. When we finished the tour, his entourage went to a Japanese restaurant and about an hour later the phone calls started. Over the following 24 hours, I was on the telephone almost constantly with an English-speaking aide, an interpreter or with various homeowners. By Sunday night, we had sold (reached a verbal agreement) on 12 houses, all in a period of about 36 hours. Not included were the several weeks our staff had spent searching for and contacting owners of houses we believed would meet Kawamoto’s desired parameters.

Making national news in mid-March were the two completely unrelated, fatal crashes of tour helicopters about five miles apart on Kauai within a three day period. The first killed four people including the pilot and injured three others. The pilot was the company’s lead pilot with over 10,000 hours of flight experience. Loss of hydraulic power is believed to have caused the crash. Two passengers died in the second crash, which involved loss of the tail rotor. By all reports, the pilot did a heroic job of landing the spinning aircraft in the only clear patch in the area. Two different tour companies were involved in the crashes with two different types of helicopters . . . The real estate industry mobilized in March and helped defeat a bill that had passed the state House and was under consideration by the Senate. The bill would have added a new state tax on top of the existing state capital gains tax for real estate held for less than 24 months. The bill proposed a new tax of 60% of the state capital gains tax on property held for less than six months prior to sale; 30% for a holding period of 6-12 months and 15% for a holding period of 12-24 months. The intent of the bill was to discourage Hawaii real estate speculation . . . For the second year in a row, exports of Hawaiian deep-sea water was Hawaii’s leading locally produced export. The water, pumped from 2,000 to 3,000 feet below the ocean’s surface, has become a big hit in Japan where it sells for about $5 per 1.5 liter bottle and is marketed as a pure, nutrient-rich drink (after salt removal).

Another tourist stop . . . A life-sized bronze statue of Elvis Presley will be unveiled in July (30 years after his death) in front of the Neil Blaisdell Center, site of a historic 1973 concert titled “Elvis, Aloha from Hawaii.” It was the first musical event beamed around the world by satellite. 51% of TV households in the U.S. tuned-in along with hundreds of millions of viewers in over 40 different countries. Elvis had close ties to Hawaii. He was a frequent vacationer in Hawaii and made three movies here in the 1960’s. He considered the Hawaii concert to be one of his crowning achievements . . . Inflation on Oahu in 2006 was 5.9%, the highest in 15 years and more than double the national rate of 2.5% which negatively impacts on retirees living on fixed incomes . . . Retail chains continue to expand to Hawaii, as the state enjoys gross sales that are among the highest in the nation. However, our very low unemployment rate has created a shortage of retail sales people. Two well-known chains that will be expanding to Oahu this year are Walgreen’s into the old Tower Record spot on Keeaumoku St. near the Ala Moana Center and Target, which plans their first store in Hawaii to be in the Kapolei area. A couple of years ago, Target was voted the store local residents most wanted to move to Hawaii.

This was Riley Wallace’s 20th and final year as the UH men’s basketball coach. The question for Athletic Director Herman Frazier is should he replace Wallace with Wallace’s long time, very dedicated, fan-favorite assistant Bob Nash who was one of the UH “Fabulous Five” in 1970-72 and who has certainly earned the opportunity to move up. And, by the way, whose son, Bobbie Nash, is a starting guard. Or, should Frazier go to the Mainland for a name coach who may be able to open up some new recruiting doors . . . More basketball, the reign of the Iolani Raiders has finally come to an end after five consecutive state basketball titles, the longest dynasty in local boys high school basketball history. Iolani was upset this year in the quarterfinals by a Big Island team (Kamehameha-Hawaii) . . . Colt Brennan, the NCAA record setting UH QB decided to return to school for his senior season vice bolting to the NFL. Brennan is already getting some early Heisman hype . . . Six UH football players were invited to the NFL combine, a school record . . . Jerry Glanville (65), the UH Defensive Coordinator for the past two years and a former NFL head coach of both the Houston Oilers and Atlanta Falcons, has accepted a position as the head football coach at Portland State. Glanville significantly improved the UH defense during the past two seasons, a key factor last year in the end-of-season Top 25 ranking . . . Former UH & St. Louis High School QB Timmy Chang, the NCAA career leader in passing yardage, has signed with the Hamilton Tiger-Cats of the Canadian Football League. Chang was in the NFL with the Arizona Cardinals, Detroit Lions and Philadelphia Eagles.

An increasing number of owners are taking advantage of our rent/sell program where we list a home “for sale” and “for rent” simultaneously. The owner usually takes the first acceptable rent or purchase offer. Thus far, the split has been in the middle with about half of the homes rented prior to selling and the other half sold before renting . . . On a purely personal note, our 18-month-old Rhodesian Ridgeback, Nubuk, became a Champion in late January by winning best-in-breed twice over a weekend (two dog shows). In the Group competition (hound group) he finished second both days out of 14 best-in-breed winners, most of them Champions . . . We write two E-Mail Updates each month, one done by me that is island-wide in scope and one done by my daughter, Tracey, which is tailored towards Windward Oahu. To be added to the distribution list, contact us.

Property Management Information

We received such positive feedback on our last newsletter that was oriented towards Property Management (PM) I’ve decided to incorporate a PM section in the newsletter. Two Mainland sources I’m using that write on PM are Robert Griswold, a property manager and James McKinley, an attorney. They each use a question & answer format. I have made some minor editing to both the questions and their responses. I’ll also use a question & answer format for input we provide based on the 300 plus rental properties we manage island-wide on Oahu.

Question: In Hawaii, how much notice has to be given to a month-to-month tenant to vacate? What if I am selling my house and the tenant may not be vacating until after the scheduled closing date?

(Stott) A month-to-month tenant in Hawaii must be given 45 days written notice to vacate.  Once such notice has been given, the tenant can vacate immediately and not be responsible for any additional rent. Most transactions that fall out of escrow result from problems arising from the contractor’s inspection. Therefore, it is usually prudent to wait until after the contractor’s inspection has been completed to give notice to the tenant to vacate.
The following is a clause The Stott Team normally inserts in the sales contract when we represent a seller who has a month-to-month tenant: Tenant is on a month-to-month lease and has the option to remain in the property for up to 45 days after receiving notification to vacate. Buyer and Seller agree that they will mutually decide when to give the tenant notice to vacate, normally after resolving any C-51 inspection deficiencies. Buyer and Seller understand that the 45-day provision of Hawaii law could impact upon the scheduled closing date.

Question: I understand the Landlord can ask for a larger security deposit as long as the tenant is given proper notice and as long as the increase does not exceed any maximum limits as outlined in state or local law. What happens if the tenant is unwilling to pay the increased security deposit?

(Griswold) If the tenant does not pay the increased deposit as required by the written notice, then the landlord has the option of considering the tenant in breach of the lease or rental agreement. The landlord can serve the tenant with a legal Notice to Cure or Quit for the failure to pay the increased security deposit. It is a good idea for landlords to increase the security deposit to current rent even for an established tenant that has occupied the property for a long period of time if their security deposit is well below what is currently expected in the market. A landlord could find that the security deposit on hand does not cover the current costs of repairing damages to the rental unit that are not allowable as normal wear and tear. You might want to allow the tenant to pay an increased security deposit over a period of time so that it is more acceptable and doesn’t create as much of a hardship.

Question: My tenant informs me that he must send me a federal 1099 tax form with the total amount of rent he paid me for the year to be able to collect a federal tax credit. Can you tell me where I can find the tax ruling on this?

(McKinley) Check with your tax advisor, however, I believe it would be totally inappropriate for one of your tenants to give you a federal 1099 form for rent he paid to you. A Form 1099- is given to self-employed workers or independent contractors as a record to the IRS of payment or compensation for services. Rental income is any payment you receive for the use or occupation of a property. There is no federal renter’s tax credit, and no need for a tenant to give you a 1099. The tenant is probably trying to harass or intimidate the landlord. There are some states that do offer a limited renter’s tax credit but that is a personal income tax credit for tenants that can be used only to offset their own tax liability and has nothing to do with your income of tax situation. Refer to the IRS Web site: www.irs.gov

Oahu Real Estate Market

It’s hard to find a news magazine these days that doesn’t contain an article on sub-prime lending woes and the resultant impact upon the real estate industry.  Numerous mortgage companies have either been forced to shut their doors or are handing on by the slimmest of margins.  Even the big guys have problems.  Less than 9% of Countrywide’s loans are sub-prime; however, its stock price declined by 21.4% during the first quarter of 2007.What we’re seeing locally is lenders and underwriters becoming far more demanding on loan qualification, particularly for 100% financing mortgages.  I don’t think this has become a major factor in our market slowdown, as we are still seeing a lot of 100% financing offers.  However, some of the buyers may be getting a home a step below what they might have been able to qualify for 3-6 months ago.  Total Sales (houses plus condos) were down 15% comparing this past quarter to first quarter 2006.  The monthly figures were all down:  Jan –16%; Feb-8%; and Mar –20%.  Refer to the upper table below.

Prices showed some recent improvement, particularly in March where the median sales price for houses jumped to $643,500, well above the $629,100 average of the prior 11 months.  Note, though, in the lower table that March tends to be a high month for houses; the March increase to $643,500 is actually lower than the $650,000 figure a year ago for March 2006.  Condos (high-rises & townhouses) appear to be stabilizing at a price range of about $310,000 to $320,000.

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