Understanding Loan Over Basis

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Wanna know why 9 of 10 real estate investors are lost when understanding loan over basis? They’ve never heard of it. It can and often does prove a very expensive lesson.

Transcript: We’re going to talk today about a problem people have that they didn’t know they were creating. It’s called loan over basis and it can get you into a real problem. You invest in a property and when you bought it it cost you $200,000 years ago. You end up borrowing 150. It got down to 100 but over all these years your property value went from 2 to 300. You say when the rates when down in the last several years, you said “You know what? I can borrow a lot of money here and Jeff says it’s tax-free when I do that.” Well, yes it is. You have a $300,000 appraisal and you go get a loan for $210,000 because they’ll let you take a 70% loan and get some cash out, and $210,000, you owed 100. You took $110,000, put it in your Levis. So far so good, right? Then we have something like the bubble bursting. Now your $300,000 property that you paid $200,000 for can only sell for enough to net $210,000. You get a check big enough to pay for Happy Meals for the wife and the kids. You say “Well, at least I didn’t lose any money.” Here’s the problem. Let’s say you had that property for a decade and you took depreciation for a decade. That means, being conservative, you probably took, give or take, $250,000 in what we’ll call straight line, vanilla, boring depreciation. That $50,000 means you didn’t pay 200,000 for your property; you now paid 150. They call that your adjusted cost basis. Let’s assume that that’s how you ended up. At 150 what they’re going to look at is that even though you didn’t get anything out they’re going to take that $210,000 sales price that you sold to your neighbor across the street and they’re going to say “You had cap gain,capital gains, which means you’re going to be liable for tax, of $60,000.” Now what if there was no real capital gain? Maybe that value went down to where there was a wash. The IRS many times is going to like at that refi you did not long before that sale. They’re going to say “You know, that smart guy was clever. He took out over $100,000 and when he closed his sale, which was for 150, he owed 210.” We call that loan over basis. Even though you had no net proceeds in a literal sense almost you’re going to owe taxes because they’re going to say “You did that in anticipation of selling, or worse, if you didn’t sell maybe you were going to do a tax-deferred exchange and you had a lot of equity but you refi’d before that 1031 exchange.” They’re going to look at it like you got cash out of the exchange, not in the refi. Either way, be careful of selling and/or exchanging your property not long after you do a refi with cash out on that investment property. The last thing is this. It doesn’t matter what your intent was, and there’s no set time. I can’t look you in the eye and say “As long as a year has passed you’re good.” I’ve seen it go two or three years and they go “No, that’s why you did that.” They’re going to tell you your intent. It’s the government, right? So beware. Talk to your tax accountant, the expert that can tell you in terms of the internal revenue code what might happen. Just don’t look at the tax-free aspect of refinancing for a cash out on an investment property.

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