Do "Go-Zone" Investments Make Sense?

In recent weeks, I have been studying the investment opportunities available in the southern Gulf Coast states like Louisiana, Mississippi, and Alabama.   It seems that in the wake of Hurricane Katrina, there were a lot of homes destroyed.  According to my research 40,000 people are still living with friends and family and 30,000 people are living in FEMA trailers.  The rebuilding of homes is just now starting (all the builders have been busy for the last few years on bigger commercial projects) and as an incentive to investors from across the country to participate in the re-building effort, the federal government has created a number of tax incentives for investors who choose to invest in real estate in these areas.

A number of real estate agents, educators, and investment consortiums have begun investigating cities along the Gulf Coast within the Go-Zone region and packaging investment opportunities for those of us living outside the areas, and providing tours, research and other due-diligence to help us make a decision about investing there.

The biggest tax-incentive available through Go-Zone designation is the ability to write-off 50% of a building’s depreciation in the first year of ownership.  However, this deduction is only available to people claiming "real estate professional" status on their tax returns.

How the Depreciation Works:

Usually, residential rental property is depreciated over 27.5 years.  The "phantom expense" of depreciation can create large write-off losses which reduce your taxable income and therefore the income tax you owe each year.

However, these tax losses can lose a lot of their value if

• You’re not a qualified "real estate professional" for tax purposes,
• You already have a large number of tax write-offs and are therefore in a low income tax bracket or have very little taxable income, or
• If you’re being hit with the nefarious AMT (households with a gross income above $150,000 are at risk!) which gives you a different formula for computing your taxes altogether… one which does not allow you to take so many write-offs!

On the plus side, in the case of the massive first year 50% tax write-offs for go-zone investors, you can carry back these depreciation losses on 5 years of previous years tax returns… reducing your taxable income in prior years and entitling you to an immediate tax refund.  You can also carry the tax losses forward for up to 15 years, so if your situation changes in the future, you’ll be able to take advantage of the depreciation at a time when it’s more useful to you.

Other Go-Zone Incentives for Real Estate Investors:

Other incentives to attract real estate investors are being seen in some areas.  For example, the MDA programs offer a "quick build" incentive ($9,000 purchase credit) for completing new construction quickly, and forgivable loans which give you up to $27,500 in debt forgiveness over 5 years on a single family home.

In exchange, though, to qualify for the MDA, you have to make your unit available at "affordable housing" rental rates (which may be below regular market rent levels) for five years.  Overall, you’d probably break even… you get your $27K in debt forgiveness, but you lose about that much on your rental income.   If you do a duplex, though, the numbers could work a little better, you’d get $55K in debt forgiveness (twice the amount for two units going up) and only have to rent out one of the units at below-market rental rates.

Some Benefits of the Debt Forgiveness Program Are:

• You’d get your money back sooner (from forgiveness of debt over the 5 year period and not having to wait to make all the money on the rental cash flow)
• You’d fill properties more quickly and have fewer vacancies because of your low rental rate, and
• You were participating in the program and not trying to charge full-price for your rent, you wouldn’t suffer as much from downward pressure placed on the market from your neighbors participating in the program and offering rents lower than yours.

Overall, I would say these incentives are "attractive" but their relative value to different investors could easily be overstated and oversold by real estate groups promoting property in this area.

In my opinion, tax incentives alone are rarely a strong enough incentive to invest, and are certainly NOT of uniform value to every potential investor.

The fundamentals of the investment – including cash flow, cash on cash return, projected appreciation, etc. still need to be in place in order for the investment to be sound.

That being said, many of these areas are expected to do well in the regrowth period.  Biloxi and Gulfport, MS have projected growth due to the casino industry expanding there.  Mobile, AL has been named as Forbes #1 small city for business growth due to its small-business friendly environment with expanding job opportunities in a variety of industries.

Both are on my watch list… but I won’t be jumping in blindly with both feet just because the government and a salesman has told me it’s a good idea to invest there.

Emily

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