Next you must identify and close on one or all of the replacement property or properties. You have 45 days from your closing date to identify up to three replacement

properties. You also have 180 days from your closing date to close on one or all three replacement properties. These timelines are set in stone.

Exchanging will not affect your ability to obtain a mortgage. The lender just needs to see the original paperwork pertaining to your first sale and the escrow intermediary

agreement that you obtained at your initial closing. You will make the mortgage application in your name and you must qualify for the new mortgage. The cash down payment comes from the exchange intermediary account and is released at the closing of the replacement property (ies). My mortgage company, Venture Development, has helped many investors obtain a mortgage as part of the exchange process.

There are times when an exchange may not be the best choice. One particular situation comes to mind. You might prefer to have a sale instead of an exchange if you have a large capital loss that would otherwise sit suspended. The large capital loss might be so large that there is no conceivable way you would use it up in your lifetime. This would be the perfect time to sell a property and offset your large capital gain with the large capital loss. Assuming the gain and loss were of equal amounts, you would not have to pay any capital gains tax on this transaction. You still would recognize the recapture of the depreciation you’ve previously taken. This may work out better for you than deferring the gain and having a large suspended capital loss. As with all tax strategies, each situation is unique. You will need to consult with your appropriate advisors to see what is best for you. Two qualified intermediaries that provide a lot of useful information about 1031 exchanging are Starker Services http://www.starker.com and Timcor Exchange Corporation at http://www.timcor.com.

Under current tax law, there is the possibility of converting an exchanged property into a personal residence. I have a client that has done this successfully. He initially exchanged a lake lot for a townhouse and later moved into the townhouse as his personal residence.

The key point that made this transaction work was that he ultimately moved into the rental property and converted it to his primary residence. He lived in the converted rental property for two years. By doing this, he was able to convert all of the accumulated tax deferred gain that had originally come from the lake lot into a primary residence that was now subject to the two year hold, $250,000/$500,000 primary homestead exclusion.

Tax laws are always changing. For further clarification on holding periods for converted rental property into homestead property, I will refer you to legislation signed on October 22^nd, 2004 regarding this in IRC 121. This legislation refers to a five year holding period in order to qualify. Since this legislation, the IRS has clarified it further, with a new ruling for sales after January 27, 2005 that lets you do an exchange on any excess over the exclusionary amount of the $250,000/$500,000. This could be huge for the right person in the right situation. This means that you might want to consider purchasing rental property today that will ultimately serve as your primary residence in the future.

Plan ahead and consider doing some exchanging into property that you ultimately might like to call home. As you might expect, IRS rules are always subject to change. Always consult your tax advisor and IRS for the latest information.

Chapter 8

Lease Considerations-Clauses & Concerns

Does thinking about interfacing with tenants make your hair stand on it’s end? Is this one part of owning rental property of which you are most fearful? Don’t worry; I will try to assuage your fears. Yet, this is another one of those areas that can make or break your rental property career. If you do this part wrong, you will not enjoy being a landlord. Other parts of owning rental property sometimes take care of themselves. For example, it is possible that if you over pay for a property, in time you may overcome this through appreciation. If you pick the wrong financing, you can always refinance. But, if you pick buildings that only attract bad tenants or if you are not selective about finding appropriate tenants, you will undoubtedly sell your building and put the entire idea of being a landlord behind you. Dealing with bad tenants can be very discouraging. To borrow a cliché from the anti drug commercials of the 80’s-“Just say no” to bad tenants and the properties that might attract them.

In my opinion, the State of Minnesota has created laws that are biased in favor of tenants.

If you would like a free copy of the booklet “Landlord And Tenants: Rights and Responsibilities” which is provided by the Minnesota Attorney General’s office, go to http://www.ag.state.mn.us and download a free copy. This booklet covers the laws and provides the statutes that are applicable to owning and managing rental properties. The state provides other useful booklets, too. Order or download as many as you wish.

Now that we know that the laws are slanted in favor of the tenant, we must select our tenants with extra care so we don’t run afoul of the laws. It doesn’t mean we can’t win at

the landlord game. We must be careful and become very knowledgeable about of the laws. With this in mind, I’ve observed a few landlord mistakes that will almost always cause you problems. This is one place you CAN learn from others. First, always require a criminal and credit background check as part of every application. The saying goes,

“You can’t judge a book by its cover” and this certainly is true with tenants. Always, always complete the screening process regardless of what your first impression might tell you. Most professionally managed rental properties have an application fee and the fee is generally equal to the charge from the rental screening agency. Prospective tenants are used to paying this fee and you should charge it. Usually, the cost to do the criminal credit search is around $25 and is non refundable. I use a company called Rental Research. You can find them online at http://www.rentalresearch.com. There are other companies that provide rental screening. The point is, have a screening service in place. Screen the tenants according to your accepted criteria and stick to it. Have you ever seen the movie Pacific Heights with Michael Keaton? This should be required viewing for any prospective landlord. When you are done reading this chapter go out and rent the movie. In the movie, Michael Keaton is a very very bad tenant who preys upon the desperation of a new landlord who is out of money due to renovation cost overruns. I don’t want to say any more as I want you to see the movie.

Second, consider establishing two rules for your properties regarding pets and smokers.

Keep these rules as sacred and use them to define your tenant criteria. Promise yourself you will never deviate from these rules once they are in place. I do not rent to smokers or anyone with a pet. I have in the past. I’ve learned my lesson. Learn through my

mistakes. Smokers and pet owners are not a protected class-hence you are not

discriminating. You can have no smoking as your building or rental criteria. You might want to visit http://www.MNsmokefreehousing.org for more information. Once you set the criteria, advertise it in your rental ad and do not deviate. You don’t want to be accused of changing criteria for one group of renters and not the other, that is, discrimination.

Why would you want to exclude these groups? Let’s look at each group. Starting with smokers, there will be more wear and tear on your property. You will have to repaint sooner and you will have to replace carpet sooner. At the same time, how many non smokers will rent a place that smells like smoke. The answer is none or almost no one.

This means you may have to spend the money for the repair/replacement sooner than you had hoped. Imagine if a tenant moved out after one year. It would cost you more for carpet and paint than the rent you would have generated over the year time period.

The next group is pets. In the past, I have allowed tenants with pets. I speak to this with first hand experience. That being said let me add that I love pets and have had them in my personal residence. I have nothing against them. I just don’t want them in my rental property. From my landlording experience, all cats spray. I’ve been told otherwise, but I don’t believe it anymore. My experience with cats has been poor. One town home I was managing for my family had very expensive grass cloth wallpaper. The wall paper became my tenant’s cat preferred scratch pad. That particular tenant’s cat also permanently stained brand new Berber carpet with urine and fur ball stains. The total

damage came to about $3000. I could go on with pet stories but I think I’ve made my point. Suffice to say that pets cause extra wear and tear on a property. Even if you disagree with what I’ve just said, I have yet another reason for you to consider. If you have a new prospective tenant that has allergies or is offended by pet smells he/she will certainly select a different property. If you still want to open your property to either smokers or pets, you might want to increase the rent or require a larger damage deposit.

A contrarian argument could be made that these two groups of tenants face limited options. Therefore, if you are willing to accept them, you will have a niche tenant base in which to market. These tenants may stay longer since they have fewer options for housing. Even with this positive slant, it isn’t a niche I wish to pursue.

A point we’ve discussed previously is that you need to think about the type of tenant you wish to interface with when you buy your property. For example, if you are purchasing a condo in a high rise you will have a different tenant than if you owned a property in a very transitional neighborhood. A more transitional area may have a tenant base more predisposed to seeking a rental relationship under Section 8 instead of at open market rates without any government subsidy. Section 8 is a program where the rent is subsidized or paid completely by the government. With my properties, I want to deal with as few problems as possible and have the most number of prospective tenants. For me, this means avoiding transitional areas and avoiding Section 8. This takes us back to location-location-location. We have had this discussion earlier in the book so I won’t repeat myself. I don’t want to have to enforce my leases in family court for non payment of rent. I don’t want to negotiate with tenants for rent. I don’t want to file an unlawful detainer (UD) action against someone for non payment of rent. I have purchased

properties where I think I will have the best chance of finding many credit worthy tenants who have the ability to pay full market rent without a subsidy.

When you have a property in a desirable area, you will be able to enforce a more

stringent tenant criterion such as prohibiting smoking and prohibition against pets. This is because you will have a greater number of prospective tenants. The better properties will always attract a larger tenant base from which to choose a tenant. On the other hand, in certain areas and with certain properties you may find that setting up restrictive tenant criteria will eliminate most of your prospective tenants. This is often the case with properties that are being marketed with heavy cash flow. These properties are generally located in more transitional areas. Don’t buy perceived cash flow unless you are

prepared to earn it through a lot of hard work to collect the rent. How much of your time and effort are you willing to devote to this? If you don’t want to do it, then you will need to hire a property manager.

Once you have found a prospective tenant, he/she will need to sign a lease. Properties such as condominiums and townhouses, which are generally subject to an association, may require you to have a tenant sign a one year lease. They may also require you to do a background check and submit both the lease and the background check for their review and approval. Some associations require that the tenant obtain a rental insurance policy.

Once the tenant has his/her policy in place, you will need to provide the association with a copy. Make sure you read your associations rules and regulations. You must comply

with the rules. You also should state that this lease is subject to the rules, regulations, and bylaws of an association, which shall supersede this lease both now and in the future. This will protect you in the event that the rules are ever changed and your lease has language that is in conflict with the new rules. Also, you must provide a copy of the rules, regulations, and bylaws to your tenant. Have the tenant sign off that they have been provided. You can’t expect tenants to conform to the rules if they don’t know what they are.

Another question that comes up often regards the type of lease one should use and where you can get one. Personally, I prefer to use the lease and landlord kit that is available for purchase from the Minnesota Multi Housing Association (MMHA). There isn’t one single approved lease for use within our state. At the same time, there are things you can’t have in a lease. I don’t want to use an illegal lease. I want a lease that conforms to the state laws and has the best interests of the landlords in mind. I feel this is best

accomplished by using the Minnesota Multi Housing Association lease. MMHA

represents all landlords- small landlords and large multi unit owners who have thousands of units. Their leases stand up in court. It is always a good idea to have any lease you decide to use reviewed by your attorney in advance of using it. The last thing you want is to lose a lawsuit or eviction because you used an illegal or unenforceable lease. MMHA also provides addendums for pets, non smoking, and lead based paint, etc. They sell a great starter landlord kit for $20 for members and $40 for non members. You can go to their website at http://www.mmha.com and order a kit for yourself. While you are at their website please consider becoming a member. The membership cost for small landlords in under $100 annually. Another excellent resource is the

http://www.completelandord.com. They have a free report entitled “Rental Property Management Secrets For Landlords” which you can get from their site. They provide other resources, too.

Here are some additional tips on leasing:

Tip #1 Name all of the occupants in the property

Always list the names of all of the tenants and occupants on the lease. Follow their names with a comma and the words “only” like John Doe, only. This will clear up any confusion if you need to have the police involved at a later date. There should be little to no confusion as to the legal occupants of the property and who are guests or trespassing.

Tip #2 Create an addendum to the lease

Always have an addendum to the lease specifying such things as painting. Additionally, consider these items: indicate whether painting is allowed or not, who can change the locks during the tenancy, renter’s insurance requirements, your ability to gain access to the property for sale or viewing with a certain amount of notice, define the responsibility for guests and their actions, establish a penalty for late payments or returned checks if you want something stricter than what is in the lease, and define the responsibility for your costs of attorney fees should you have to initiate legal proceedings against the tenant.

Tip #3 Require a 60 day notice

Always consider having a 60 day notice period in your lease. This means the tenant must give the owner 60 days notice before they can leave and the landlord must do the same if they want the tenant to leave. This is important because it gives you an extra 30 days to figure out if you are going to market and sell the building or to find a new tenant. If you don’t write this into your lease, you will have the standard 30 day notice apply as the default in Minnesota. In my opinion, you will find that the 30 day period is too short.

Tip #4 Damage Deposits

Don’t forget to return the tenant’s damage deposit within the required time period and with the required amount of interest. Currently, Minnesota law requires you to return the damage deposit to the tenant with simple 1% interest on the initial damage deposit. You must return the required amount within three weeks of the tenant vacating. If you are not going to return the tenant’s full damage deposit with interest, you will need to indicate why in a letter within this three week period. Failure to do this will cost you treble damages in court. Even if the tenant trashes the building and is entitled to nothing, you still must send the letter. Many newbie landlords have had insult added to injury when a tenant sued and won their case against the landlord because they didn’t send a letter.

When I send my letter with anything less than the full damage deposit with accrued interest, I make sure it is sent certified mail with a signature return receipt required. If the tenant knows they won’t be getting any money back, they will usually disregard picking up the letter. In that case, when the letter is returned, put it in your file and save it in case you need to prove in court that it was sent.

Lastly, you should also know that when you buy or sell a building, the existing lease and its terms along with the occupants stay with the property. This means that you will inherit the current tenant(s) when you buy a property. One of the duplexes I purchased had a tenant named Keith. Keith had a history of non payment of rent. In fact, he was one of the main reasons the seller was selling the building. The owners were sick of

Lastly, you should also know that when you buy or sell a building, the existing lease and its terms along with the occupants stay with the property. This means that you will inherit the current tenant(s) when you buy a property. One of the duplexes I purchased had a tenant named Keith. Keith had a history of non payment of rent. In fact, he was one of the main reasons the seller was selling the building. The owners were sick of