Month: October 2017

Wrap-around Mortgages Explained

Learn about wraps and structure better deals

A “wrap-around” mortgage (also referred to as a “wrap”) is a subsequent and subordinate mortgage secured by real property where a first mortgage remains outstanding and unsatisfied. A wrap differs from a conventional second mortgage in that it requires an agreement between the parties for payment of the first mortgage obligation by the lender. Consequently, the principal of the wrap-around loan is the sum of the outstanding indebtedness on the first mortgage and new funds advanced.

The wrap technique is typically employed in transactions involving large commercial loans. However the same financing technique is used in single family real estate investments.
Wrap around mortgages explained
Here’s an example:

Joe owns a commercial property with a $500,000 value and a mortgage of $150,000. He enters into a contract to sell the real property to Jane for $500,000. The contract consists of a note for the entire $500,000 payable to Joe.

Jane will make payments on the $500,000 loan directly to Joe.

Joe will in turn continue to make payments on the $150,000 underlying mortgage and retain the excess, if any.

Wraps and installment sales

Frequently in the sale of real estate, the seller may elect to receive payment in installments, providing the purchaser a convenient financing option while generating desirable tax benefits to the seller. As described in more detail in How to Defer Taxes on Capital Gains, installment payments can defer taxes on capital gains if the seller receives at least one payment after the year of a disposition. Use of an installment sale permits a seller to spread the recognition of taxable income over time and avoid recognizing the entire gain before actual payment is received.

Generally, if a buyer assumes a mortgage or purchases the property subject to an existing mortgage, the excess of that debt over the seller’s basis is treated as a payment received in the year of sale (triggering gain recognition). In addition, the assumed mortgage is not included in the contract price, resulting in a higher gross profit percentage, accelerating recognition of taxable income.

If a wrap mortgage is used, the contract price is the entire sales price, resulting in a lower gross profit percentage (and correspondingly less gain recognized in each year’s collections). Also, since the property is not taken subject to the seller’s mortgage, there is no tax on a phantom payment in the year of sale, even if the mortgage exceeds the seller’s basis.

Beware the due on sale clause

The due on sale (or acceleration clause) is a provision in most mortgage documents that allows the lender the right to demand payment of the unpaid loan balance when the property is sold. This is a right provided by the contract, not by law. This means if title to the property is transferred, the bank has the right, but not the obligation, to demand payment.

Benefits to buyers and sellers

Wrap-around mortgages can offer flexibility and tax benefits to both buyer and seller. The wrap also includes credit risk if the purchaser defaults or if the underlying mortgage lender calls the loan.

We’ve got your back

Are you considering using the wrap-around technique on your real estate transaction? You’ll need to consider both the tax and legal ramifications. At KRS, we’re pros at real estate taxes, so contact us to  discuss your plans at 201.655.7411 or [email protected].


KRS Business Insights Breakfast: Avoiding Employer Pitfalls

The recent KRS Insights Breakfast featured Randi Kochman, Esq., chair of the Cole Schotz Employment Law Department. Randi spoke about best practices for hiring and documentation, and the complexities of family and medical leave.

For those who missed the breakfast, we wanted to share some of Randi’s insights.

Randi Kochman, Cole SchotzBest practices for interviewing job candidates

There are laws about what you can and cannot ask when interviewing a job candidate. “New Jersey is an employee-friendly state and there’s a long list of what you can’t ask by law,” said Randi. For instance, you can’t ask:

  • Are you married?
  • Do you have children?
  • Where are you from?
  • Are you pregnant or planning to get pregnant?

The best practice – and one that will keep you out of trouble – is to ask only what you need to know to determine if the applicant can do the job. You can ask, for example:

  • Is there any reason you can’t be here from 8 to 4 and travel to California once a month?
  • This job requires that you be able to lift 50 lbs. routinely. Are you able to do that?

She also recommended putting a salary range in any job ads. In some states, including New York, you cannot legally ask about salary history.

Bottom line: stick to asking questions that relate directly to the job qualifications.

Best practices for background checks

When you need to check out a potential new hire, you must comply with the Fair Credit Reporting Act (FCRA) and state law. “Hire a reputable firm to do your background checks,” Randi said. “There are specific forms that must be completed. These forms are very detailed and the potential employee must sign them.”

Using the Internet to check out potential employees can be risky. “There are potential problems when an employer learns information about an applicant from social networking sites that it is otherwise prohibited from obtaining, such as an applicant’s age, disability, or sexual orientation,” she noted. To reduce risk, Randi recommended:

  • Having a comprehensive Internet background search policy for your company
  • Using a third party, or “screened” employee to conduct any Internet background checks and send only information relevant to the employment search to decision makers.
  • Training employees – especially supervisors – on the risks of conducting private Internet background searches on applicants.

Best practices for HR documentation

“There are a lot of areas in the employment world that can trip you up and documentation is a big one,” noted Randi. She went on to list the extensive number of documents your employee files should contain, including, but not limited to:

  • Offer letters and employment agreements
  • Background checks
  • Job descriptions
  • Confidentiality or non-compete agreements

The complexities of family and medical leave

How and when family or medical leave can be taken by employees can be complex. The Federal Family and Medical Leave Act (FMLA) applies only to employers with more than 50 employees within a 75 mile radius of the worksite of the employee. There are also specific eligibility requirements for employees who want to apply for leave under FMLA.

Leave laws also vary by state. In New Jersey, for example, the NJ Family Leave Act applies to employers with at least 50 employees (located anywhere) who have worked for at least 20 weeks during the current or previous year.

The Americans with Disabilities Act (ADA) and the NJ Temporary Disability Benefits Law (NJTDB) also have to be considered.

“Let’s say your employee comes to you and says they have cancer and need a leave of absence. It’s important to consider all the factors that can apply – FMLA, NJFMLA, NJTB, etc.,” said Randi. “Your company also should have in place a company policy for medical and disability leave.”

We’ve got your back

At KRS CPAs, our goal is to make it as easy as possible for you to get the advice and counsel needed, so you can focus on what matters most to you. The KRS Insights Breakfast Series offers timely and relevant information from experts like Randi Kochman, who can help your company avoid HR pitfalls by following best practices.

Visit our Insights page to subscribe to our newsletter and you’ll be notified about upcoming breakfasts plus other KRS news, events and resources.

With more than 20 years of employment law experience, Randi Kochman is dedicated to helping employers understand and navigate complicated and ever-changing employment laws so they can effectively manage employees, avoid costly mistakes, and focus on their core business.  A recognized employment law expert, Randi was recently quoted in an article on tip pooling in the Society for Human Resources Management (SHRM) employment law blog.

What You Ought to Know about Affordable Housing

What You Ought to Know about Affordable Housing

The federal government used to build its own public housing. However, the government banned public housing construction in 1968 and began demolishing many of its buildings in the 1990s.

While the direct construction went away, the need for new units did not. The National Low Income Housing Coalition published in its 2015 report that one out of every four renter households is extremely low income (“ELI”). ELI households are those with incomes at or below 30% of area median income.

Recognizing the need for additional affordable housing, Congress developed a strategy to entice private developers to build such housing. Cognizant that developers would not pursue these projects when market-rate developments would offer higher returns, Congress included an incentive in the form of a tax credit. The National Council of State Housing Agencies (NCSHA) states nearly 3 million apartments for low-income households have been built because of the Low Income Housing Tax Credit (LIHTC). It estimates that approximately 100,000 units are added to the inventory annually.

Low Income Housing Tax Credits

The tax credits to which a developer is entitled are based on multiple factors including the investment made by the developer, the percentage of low-income units created, the type of project, and whether the project is funded by any tax-exempt private activity bonds.

Claiming the Credits

Following construction or rehabilitation and lease-up of a building, the developer submits a “placed-in-service” certificate showing it has complied with its application and project agreement. The certificate typically includes information on qualified costs incurred, the percentage of units reserved for low-income qualified tenants, and constructions agreements.

If the certificate is approved, the developer is issued IRS Form 8609. The credits can then be claimed on the federal tax return. The credit is a dollar-for-dollar reduction in federal income tax liability.

Types of  Low Income Housing Projects

A common misconception is that affordable housing is required to be new construction. The LIHTC can be used for:

  • New construction
  • Acquisition and rehabilitation
  • Rehabilitation of a property already owned by a developer.

Affordable Housing Development Tax Implications

The low-income housing tax credit program is an option for real estate professionals seeking to develop a rental property. The tax credit will reduce Federal income taxes or can be sold for equity, reducing the debt needed to develop a project.

If developing affordable housing is part of your real estate game plan, don’t go it alone! A real estate CPA can help you devise effective tax strategies around the Low Income Housing Tax Credit program. Contact The Real Estate Tax Guy at [email protected] or 201.655.7411.