Noobie looking for advice on buying an existing car wash

[JGinther]

This is not correct. when the "Sale" occurs, Seller cannot have control of the $ (net proceeds) it is held by a Qualified intermediary, then the intermediary is directed to acquire the new property with the proceeds. The new property can be financed as well, and it ma have to have finacing to have enough $ to make up any difference for a higher price or if some of the original sale proceeds paid of a lon, but if you break open your piggy bank to make up the difference that is OK.

Well, I'm pretty sure they see debt reduction as a 'recognized' gain, and tax you on that portion. I'm not sure, but are you saying that isn't true?

The situation you describe is no different than 2 apartment buildings built or aquired for the same price and 10 years later one is in a part of town that became gentrified and sells for double what the first one sells for. If that is done thru an exchange is it "Tax Evasion"

No, that is real estate appreciation through time. The one I described is where the property is sold based on its ability immediate ability to cashflow after construction. The construction cost is near fixed in a short time period and so is land value, so the rest is goodwill. Goodwill is not exchangeable right? Well, what if you claim that it isn't goodwill when it really was...? Maybe its tax evasion. Or maybe you call it lucky since the ignorant buyer agreed! That is the point I was making.

Is deducting mortgage interest, IRA's, 529 plans also tax evasion schemes.

Ok, now I know you are misunderstanding me. I don't think anyone would say yes to this. Its not the 1031 exchange I am talking about. Its the improper allocation within the exchange.

What if the property was a real exchange, no money trading hands or the only $ was any funds needed to make up a difference in value. Would the lower cost property owner be evading taxes? Maybe the better word is "Avoiding"

Well, assuming equal values in both properties, no problem. However, if one received 'funds needed to make up a difference in value', then that one would be liable for tax on that amount.

Anyways... I used the word evading because that's what I think it is in my example. But I don't think the IRS can go back for it because both parties agreed to the allocations...? I know that the gain would become taxable when the ultimate sale happens, but what if there is a 1 million dollar loss on the second property as I described previously...? The IRS would see no gain overall, when, if allocated correctly, the gain on goodwill would have already been paid.

 

[Earl Weiss]

Well, I'm pretty sure they see debt reduction as a 'recognized' gain, and tax you on that portion. I'm not sure, but are you saying that isn't true?

No, that is real estate appreciation through time. The one I described is where the property is sold based on its ability immediate ability to cashflow after construction. The construction cost is near fixed in a short time period and so is land value, so the rest is goodwill. Goodwill is not exchangeable right? Well, what if you claim that it isn't goodwill when it really was...? Maybe its tax evasion. Or maybe you call it lucky since the ignorant buyer agreed! That is the point I was making.

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Don't know where "Debt reduction" comes in. Example: Scenario. Property costs $1 Million and still has a $500K mortgage. Seels for $2 Million so $1.5 Million goes into the exchange and is used to by a property for $3 Million. It is irrelevant if the $1.5 Million balance of the new purchase is financed or funded thru some other means.

With the apartment building example, the rents are the business. The property is valued on income stream. We seem to have a different perspective. You view the car wash income stream as different than rent income stream. From a tax standpoint / 1031 issue it
s no different if that is how the land is valued. From a lender perspective it certainly would be. From an investor perspective it may very well be similar.

 

[JGinther]

Don't know where "Debt reduction" comes in. Example: Scenario. Property costs $1 Million and still has a $500K mortgage. Seels for $2 Million so $1.5 Million goes into the exchange and is used to by a property for $3 Million. It is irrelevant if the $1.5 Million balance of the new purchase is financed or funded thru some other means.

In that example, there is no debt reduction.

With the apartment building example, the rents are the business. The property is valued on income stream. We seem to have a different perspective. You view the car wash income stream as different than rent income stream. From a tax standpoint / 1031 issue it
s no different if that is how the land is valued. From a lender perspective it certainly would be. From an investor perspective it may very well be similar.

I don't think I see it different than you, as you mentioned 10 years and a gentrified market area. If it were sold based on its rents, that would be income value. And if that value is a whole lot higher than the real estate value, you have goodwill involved. Now say that the apartment complex seller told all of the renters they would get discounted rent at his new building across the street in one year as soon as its built. Lastly say the seller did a 1031 exchange by calling that goodwill value 'real estate' instead and have the buyer agree. Now you have 'evaded' tax since it should have been goodwill. I do think the IRS perspective/ tax standpoint percieves it as 'not allowed' and that is why they narrow their definitions of what goodwill is - they want that to be taxed and not exchanged! But maybe its not evasion since there is no referee, right? Only the buyer and seller are the ones deciding. So the IRS has no recourse right....? I know they would get theirs in the end if the ultimate sale is profitable also, but what if it isn't...?

 

[Earl Weiss]

..... I do think the IRS perspective/ tax standpoint percieves it as 'not allowed' and that is why they narrow their definitions of what goodwill is - they want that to be taxed and not exchanged! But maybe its not evasion since there is no referee, right? Only the buyer and seller are the ones deciding. So the IRS has no recourse right....? I know they would get theirs in the end if the ultimate sale is profitable also, but what if it isn't...?

Since it is the IRS tat sets the regs. If they did not want to allow this tax deferrence method they could eliminate the reg. Instead in recent years they added to them by providing for reverse exchanges. They could also simplify it by eliominating the extra paperwork and just impose the 45/180 day rule for replacement property.

At least they made thinks simpler with portability of Estate tax exemption between spouses now.

 

[robert roman]

Without 1031 exchange, payment of tax would reduce buying power by 20 to 30 percent.

Earl is right there is no “evasion.”

As long as money continues to be re-invested in other real estate, capital gains taxes can be “deferred.”

IRS depreciates real estate investments at 3% a year as long as the investment is held until fully depreciated.

So, when an asset is sold, the intent of 1031 is to tax on the depreciated portion as income tax at the marginal tax rate.

1031 is fairly complicated stuff requires CPA to steer clear of the pitfalls.

Some try to abuse 1031 to cut a fat hog. Just don’t get caught.

 

[JGinther]

I don't think you read all of what I wrote. I know how a 1031 is supposed to work. I also know that some parts of transactions (like goodwill) are not 'like kind' property as recognized by the IRS, and therefore the goodwill portion is taxable. So if you call it something else like 'real estate', and have the buyer agree, you temporarily 'evaded' the tax (because it should have been paid if reported correctly). Now, when the property that the seller exchanged into sells for a loss that was equal to the original gain, the gain is permanently offset, and the tax has been permanently 'evaded'.

 

[Earl Weiss]

I don't think you read all of what I wrote. I know how a 1031 is supposed to work. I also know that some parts of transactions (like goodwill) are not 'like kind' property as recognized by the IRS, and therefore the goodwill portion is taxable. So if you call it something else like 'real estate', and have the buyer agree, ......................'.

You are overlooking another crucial factor.

Traditional mortgage lenders must be adequately collateralized. This collateral is typicaly Real Estate. They won't accept "Goodwill" as collateral. They therefore need the purchase price allocated to real estate in a sufficient loan to value ratio. I have had deals where the parties may have agreed to certain purchase price allocations only to change them to satisfy the lender. So, the allocation may have been something required by the mortgage lender.

 

[robert roman]

“I don't think you read all of what I wrote.”

“So if you call it (goodwill) something else like 'real estate', and have the buyer agree, you temporarily 'evaded' the tax (because it should have been paid if reported correctly).”

The preliminary value of a business (business-only) is a function of available cash flow and capitalization rate multiplier.

Goodwill can be calculated as the preliminary value (business-only) less the liquidation value of FF&E.

So, goodwill is an intangible asset and FF&E is incidental to its value.

So, if you call goodwill something else like real estate, this isn’t reporting incorrectly, it’s just plain old lying as in cheating.

 

[Earl Weiss]

.....Now, when the property that the seller exchanged into sells for a loss that was equal to the original gain, the gain is permanently offset, and the tax has been permanently 'evaded'.

Note that the "Basis" is the original property Basis so the loss is not based on an amount lower than the acquisition cost of the replacement property but lower than the basis of the original property.

This somehow different than having personal, S corp or LLC type enterprises where one has a gain and one has a loss and one is offset by the other?

 

[JGinther]

Note that the "Basis" is the original property Basis so the loss is not based on an amount lower than the acquisition cost of the replacement property but lower than the basis of the original property.

I don't think this is correct. When my accountant was doing basis calcs on one property where I was going to do a 1031 exchange, the gain was added in as part of the basis calculation on the second property. It made me curious though, so I found this: http://www.1031exchangetax.com/worksheet.htm See line 32 under D - adjusted basis of new property.

This somehow different than having personal, S corp or LLC type enterprises where one has a gain and one has a loss and one is offset by the other?

I think it is very different. In the exchange example provided the tax is not paid because of false reporting. Splitting up entities is different in that even though one entity might have a loss and one have a gain, it doesn't really matter because all of those losses and gains fall to the personal returns in the end where they are all added up and finally taxed. I would say the 1031 example is more along the lines of claiming "personal expenses" as "business expenses" and paying a lower income tax because of it; except on a much larger scale (like buying a fleet of 7 ferrarri's and expensing them for the car wash as loaner cars for detail shop). In an audit, you could get sucker punched for cheating on expenses; however, I'm not sure the IRS has recourse for the 1031 example since both parties agreed on the allocations of the sale!

 

[JGinther]

So, goodwill is an intangible asset and FF&E is incidental to its value.
So, if you call goodwill something else like real estate, this isn’t reporting incorrectly, it’s just plain old lying as in cheating.

Right, so if that 'lying as in cheating' results in taxes not being paid, I use the word 'Evasion'!

 

[Greg Pack]

"Both brokers tell the same story regarding the financials. It's mostly cash, not everything is reported, yada yada. "


I'll pay based on what has been reported. So does just about every other operator I know.

"He says that a person with experience in the industry will be able to see the value of the business."

Not many experienced operators buy from business brokers. By the time they have made it to a business broker the local operators have passed on it.

"One brokers says that about half of all car wash sales go down in this fashion. I have also read somewhere on line that sometimes the best deals go down like this and that you have to be ready to jump on a good deal when one is available"

Again, if it was that good a deal the broker wouldn't have it listed. A local operator would have bought it before it got listed

"This is a little frustrating. I am learning about the business as fast as I can. Any advice would be appreciated."

The SECWA show is in Orlando next month. Go on the bus tours and talk to as many experienced operators as you can.

http://secwa.org/

 

[Earl Weiss]

I don't think this is correct. When my accountant was doing basis calcs on one property where I was going to do a 1031 exchange, the gain was added in as part of the basis calculation on the second property. It made me curious though, so I found this: http://www.1031exchangetax.com/worksheet.htm See line 32 under D - adjusted basis of new property.

!

It is still correct. I may have been wrong about breaking open the piggy bank since most need the mortgage on the replacement to make up the difference I have never run into the situation. Instead, once the deal is done to get $ out they simply refi for an amunt greater than the original mortgage. But the basis for the ultimate sale is the original property basis (not the cost but the basis. The basis may be lower than the original cost due to depreciation expense having been taken.) The pril is that with refi's you can well end up with less equity / cash from the ultimate sale than the tax due.

 

[Earl Weiss]

I think it is very different. In the exchange example provided the tax is not paid because of false reporting.

It is not false reporting if the IRS permits it. Again this "Goodwill" as you call it is a function of an income stream the property generates which has a direct bearing on it's value. . In your perspective it is somehow different than the income stream generated by a rental building. Certainly their are different elements to it, but as far as affecting market value of the property it's the same.

If you were the landlord for car washes and could charge more rent for a busioer locations the ones generating more rent are worth more. It's not goodwill from the landlord's perspective and does not become goodwill just because the operator owns it.

Similarly a person could own thru one entity and operate thru another, always a smart way to go. Now, when they sell, they only sell the real estate, and the busienss may sell the assets seperately to the buyer whobuys in the same smart fashion without actualy "Buying the Business" also a smart way to go aside from the tax issue.

 

[JGinther]

It is still correct... But the basis for the ultimate sale is the original property basis (not the cost but the basis. The basis may be lower than the original cost due to depreciation expense having been taken.)

This didn't add up to me, so I did some research.... The basis of the second property is the the cost of the second property less the gain. That's it. The gain is the amount of the sale of the relinquished property less its basis (which is the original cost of the first property less any depreciation taken - as mentioned). This means that the gain is part of the second properties basis calculation. Here is something that clears it up... http://www.1031.us/PDF/Depreciationof1031.pdf

It is not false reporting if the IRS permits it.

But they don't permit it. They say that goodwill is Never a like-kind property, and therefore can't be exchanged...which means immediately taxable.

Again this "Goodwill" as you call it is a function of an income stream the property generates which has a direct bearing on it's value. . In your perspective it is somehow different than the income stream generated by a rental building. Certainly their are different elements to it, but as far as affecting market value of the property it's the same.
If you were the landlord for car washes and could charge more rent for a busier locations the ones generating more rent are worth more. It's not goodwill from the landlord's perspective and does not become goodwill just because the operator owns it.

I tried to explain that I don't see the difference between the two. The example of a gentrified marketplace suggested real estate appreciation. However, two similar pieces of land and similar construction apartments gaining different rents immediately after construction would indicate a willingness for more customers (renters) to be available at the one that commands a higher rent. And that creates a going concern value - or goodwill. Its intangible, so defining it is sketchy. So the easy way to explain it is if the property (land and building) only costs x, and the value of the business is x + $500,000.00 because of its current ability to cashflow, and its expected ability to retain that level of income; then the goodwill value is $500,000.00

 

[Earl Weiss]

This didn't add up to me, so I did some research.... The basis of the second property is the the cost of the second property less the gain. That's it. The gain is the amount of the sale of the relinquished property less its basis (which is the original cost of the first property less any depreciation taken - as mentioned). This means that the gain is part of the second properties basis calculation. Here is something that clears it up... http://www.1031.us/PDF/Depreciationof1031.pdf

Yes it ads up see example below. Follows your instructions above.

First Property cost $1M Basis after Dep $500K, Sale Price $2M Gain $1.5M

2nd Property cost $2M Less Gain , means basis of $500k – original property basis.

Of course if the new property costs more that increases the basis. Sorry, my comment was based on oversimplification of relinquished and acquired property having identical sale / purchase price. Of course, if it costs more for the new property the basis increases.

 

[Earl Weiss]

But they don't permit it. They say that goodwill is Never a like-kind property, and therefore can't be exchanged...which means immediately taxable.

I tried to explain that I don't see the difference between the two.

Well, here is the rub. You don't see the difference between the two and neither does the IRS. You considerate commercial property income non exchangeable "Goodwill" and they don't. It's the same for any income generating property.

So in your view virtualy all income property that has appreciated sold thru an exchange would be "Tax Evasion"??

Look at any commercial property appraisal. Income is one of the methods used for valuation of the real estate.

 

[Louey]

"Both brokers tell the same story regarding the financials. It's mostly cash, not everything is reported, yada yada. "


I'll pay based on what has been reported. So does just about every other operator I know.

"He says that a person with experience in the industry will be able to see the value of the business."

Not many experienced operators buy from business brokers. By the time they have made it to a business broker the local operators have passed on it.

"One brokers says that about half of all car wash sales go down in this fashion. I have also read somewhere on line that sometimes the best deals go down like this and that you have to be ready to jump on a good deal when one is available"

Again, if it was that good a deal the broker wouldn't have it listed. A local operator would have bought it before it got listed

"This is a little frustrating. I am learning about the business as fast as I can. Any advice would be appreciated."

The SECWA show is in Orlando next month. Go on the bus tours and talk to as many experienced operators as you can.

http://secwa.org/

All good points.

I'm on vacation from July 19 through August 5. So I can't make the show in Orlando. I wish that I could. Looks interesting.

 

[Louey]

So, I am giving up on the express tunnel wash. They just aren't offering anything as far as documentation goes.

I am meeting the owner of the self serve on Friday with Mac to evaluate the equipment. It's old and needs to be replaced. The owner will supposedly have some documentation for me. We'll see.

I'm in no rush to make a deal on this wash. I'll make an offer that I can live with and they can take it or leave it. I'll wait for a better deal to come along before I pay too much.

 

[JGinther]

Well, here is the rub. You don't see the difference between the two and neither does the IRS. You considerate commercial property income non exchangeable "Goodwill" and they don't. It's the same for any income generating property.

Turns out that this issue has been argued and litigated many times over with the IRS.
1. The IRS does see improperly allocating the amount of a sale to defer or avoid a tax that otherwise would would be payable as tax evasion.
2. The goodwill or going concern value is only the difference in value from the other assets of the sale. So if real estate made up 80% of a sale of a business, and there are no other intangible assets, then the rest of the value (20%) came from 'goodwill'. How do you know how much is attributable to real estate? An appraisal and comparison with other land sales and construction cost valuations. Only the goodwill portion of a property is immediately taxable...

So in your view virtually all income property that has appreciated sold thru an exchange would be "Tax Evasion"?? Look at any commercial property appraisal. Income is one of the methods used for valuation of the real estate.

No. Real estate appreciates... But if the sale price is higher that what the real estate actual value is, then there is a goodwill portion.

So this is the reason that I say that car washes are unique: you can't have the business without the special use building. And if you have the special use building (think self serve wash) without any business - what is the value? Likely its the cost of the land plus some for utilities less demolition costs of leveling the property....