Real estate ownership can provide a means for accumulating great wealth. In order to establish a valuable investment portfolio, one must work hard, take carefully calculated risks, and apply appropriate leverage. One way to acquire a substantial amount of real estate is to periodically refinance those properties already owned and then use the proceeds to purchase new properties. This procedure is termed pyramiding.

Pyramiding through refinancing is based upon retaining all properties acquired. By not selling the properties, the investor is constantly increasing the refinancing base while capital gains taxes are postponed. Pyramiding through refinancing begins with the purchase of a property. If more than one property can be purchased to start the plan, the refinancing base will be enhanced at the outset. The type of property to be purchased should be improved income property that has the ability to generate cash flow.

To approach pyramiding from a theoretical point of view, the investor anticipates that the original property will increase in value over time. Simultaneously, the loan payments being made will reduce the balance owed and build equity for the investor. Assuming a five-year refinancing cycle, it could be possible to secure a new loan every five years in an amount sufficient to satisfy the balance of the old loan, pay the loan acquisition costs, and return at least enough cash to make a down payment on the next purchase.

As the new loan is for a larger amount than the old one, higher payments will be required, perhaps at a higher rate of interest. The passage of five years should also provide the owner with an opportunity to raise rents commensurate with the property’s increasing value and inflationary market trends in order to satisfy at least the breakeven requirements.

It is in the best interests of the pyramid investor to purchase better properties in stable or growing areas. An older property in a declining neighborhood would make a poor investment. Rents and values of such buildings might actually fall and destroy the refinancing cycle. After refinancing the initial property, the pyramider will then purchase an additional rental unit, either residential or commercial, with the net proceeds from the refinancing. The investor now owns two properties from the original investment. Theoretically, by continuing this sequence, the pyramider should be able to double holdings every five years. The two properties would increase to 4 at the end of 10 years, 8 in 15 years, and 16 in 20 years. Of course, there would be a substantial amount outstanding in loans against these properties, but if an estate of this size was sufficient for the investor, the rents could then be turned inward to satisfy the various balances owed and end the pyramiding process.

With the appropriate application of allowable deductions, most, if not all, of the net income earned during the years of ownership can be sheltered, as capital gains taxes are delayed through the refinancing process. The estate can then be left to the investor’s heirs, without the investor ever having paid capital gains tax on any profits derived from ownership of these properties. A deceased person’s property is appraised to determine its value for estate tax purposes. The heirs take title to the property, its book value being the appraised value established as of the date of death. The old book value, which reflects the deceased owner’s acquisition costs, is eliminated.

If the heirs choose to sell the property at this point, the capital gains tax would be based upon any profits secured from the difference between the sale price and the new book value, which reflects current market value. In other words, if the heirs sell the inherited property at a price equal to its probated estate value, no capital gains will be paid even though the property is sold for many times more than what the deceased paid for it. Just as important as this savings is the opportunity for the heirs to develop a larger estate.

Should they decide to keep the inherited property, the heirs can refinance it, secure new tax-free cash for reinvestments, and shelter much of their earnings through allowable deductions based upon the new, and higher, book value of the inherited property. Although the pyramiding plan is theoretical, it is completely workable if adjustments are made for those problems that will inevitably arise.

This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional advice. If legal advice or other expert assistance is required, the services of a competent professional should be sought.
President: Dr. Andrew Temte
Executive Director, Real Estate Education: Toby Schifsky Development Editor: Adam Bissen
CALIFORNIA REAL ESTATE FINANCE TENTH EDITION
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