Who comes first, Uncle Sam or debt?

Suppose, on an nnn lease, net rent (rent minus interest and depreciation) is sufficient to cover mortgage and federal and state income taxes, and then the IRS's rates are legislatively raised beyond the rental income, and the investor's other income, ability to cover, what happens? Does the purchase go down the drain, or does Uncle Sam back off? I am correct that the portion of rent going to mortgage debt reduction and equity increase (as opposed to interest and depreciation) is always current income, right? What brings the question up is the proposed increase in rich man's taxes to pay for the new health care legislation. No, I'm not rich enough for the problem to apply to me, at least not THIS year. But it seems a tax rate increase could doom a lot of real estate investments.
In General Area - Asked by Jere C. - Nov 8, 2009
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Answer(s)

Earle W.
Broker/Agent
Portland, OR

Profit pays debt service and Non budgeted items. Therefore health care triggers an event on small businesses that do not currently provide health insurance to employees. That means in most states a minimum of $11,000 in gross sales to cover EACH EMPLOYEE for the approximate $4,800 mandated health benefit is necessary. According to Pelosi/Reid language in their bill will help soften this, but to date not one congressman or senator has provided America with a clear understanding to each page of the document and neither has the White House kept its door open to go over every single page. Therefore with such behavior coming from the Beltway boys & girls it is reasonable to presume the worst case scenerio looms for small businesses. Remember, Profit pays debt service and non budgeted items, not Cash Flow. Taking cash out of operations is a killer which usually finds in approximately 90 days a need for a bulge in your line of credit. Do not fall into this trap!

Nov 9, 2009
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Robert W.
Broker/Agent
Akron, OH

I'm a little confused by how you word your question. Some terms you may be looking for on a rental property are "Gross rental income" - the total rent paid.. "Net Rental income" -- the income left after paying expenses of RE taxes, management, repairs, insurance, etc. "Net Taxable Income" is the amount left after reducing Net Rental Income by tax deductible expenses - typically interest and depreciation. Many net leased rental properties already suffer what is known as phantom income tax (this is when the tax assessed on your Net Taxable Income is in excess of your Net Rental income after paying any required debt service). Properties may start out without such phantom income tax but edge closer to tha threshold each year as depreciation remains constant but the interest componentn of a loan typically declines year by year, pushing the taxable income of the property higher with time. Obviously if federal tax rates were to increase, the tax burden on any Net Taxable Income will increase and that will serve to push the threshold of phantom income tax to a lower level than before. A property that was not previously incurring phantom income tax could suddenly be put in that position and one that already was paying phantom income tax will be paying more phantom income tax. With that all as background, the answer to your query is YES... a tax increase could render some real estate investments to be no longer sustainable by the owners of the real estate.

Nov 10, 2009
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Gregory G.
Broker/Agent
San Francisco, CA

It will.
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Gregory Garver - Commercial Real Estate Broker
Broker License# 01716531
(415)225-9894
gregory.garver@gmail.com
Web Reference: http://www.gregorygarver.com

Dec 3, 2009
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