I was reading the WSJ this morning and came across THIS POST which references a report issued by the National League of Cities which shows property tax revenues declining for the first time in this recession. It’s kind of interesting if you think about it. Typically property taxes are based on the value of the real property. So despite the fact that property values have been declining nationwide since 2007 this is the first year that tax revenues are declining. There is obviously significant lag time in the process of accessing real estate values.
This prompted me to go to wikipedia and read about Oregon’s landmark property tax legislation that was passed in the 1990’s. Among other things measures 5, 47, and 50 limited property tax growth by 3% per year. Therefore, if a person owns a home and it doubles in value their property tax bill can only rise by 3% per year (unless they made significant property improvements. This explains why homes with the same market value can have drastically different property taxes. If one home has been lived in continuously by the same person for 20 years then beginning in the 1990’s their property taxes could only rise by 3% despite the fact that on average their home’s value likely increased by 4-5% per year.
However, if an identical home across the street was bought and sold multiple times over the same 20 year period their tax bill would have adjusted to the market because when the property changes ownership the 3% limitation doesn’t apply.
This article in the WSJ last Friday indicates that President Obama and lawmakers are likely to allow income tax rates on the highest earners to increase in 2011. Currently, Bush-era tax cuts are set to expire at the end of the year. Assuming lawmakers don’t intervene this means that households will pay higher income taxes. Here is a chart with the changes:
However, Treasury Secretary Tim Geithner indicated in the article that President Obama and demo’s would like to see the tax cuts for income earners less than $250,000 (married filing jointly) extended. My guess is they’ll get their way and high income earners will end up paying significantly higher tax rates. If that happens then there will be more focus and planning on how to reduce taxable income. This will create a renewed focus on planning opportunities to shelter income.
One way this is possible is through qualified retirement plans where income can be deferred into retirement savings account and grow tax deferred. Charities will also benefit as more Americans look for ways to reduce taxes. The mortgage interest deduction will become more valuable making the “Effective Percentage Rate” even lower. If you are a household that is likely to be impacted by these tax increases it would be wise to schedule an appointment with your tax professional and/ or financial planner now so that you begin planning.
Being in the real estate finance business for over 8 years now I have come across many a conversation about the tax and investment benefits of owning rental real estate. I’ve found that many people (including many real estate and mortgage professionals) overstate the tax benefits of owning investment real estate. There is a lot of detail in the tax code designed to prevent owners of investment real estate from using losses on their property to offset earned income (from their “regular” full-time work). One area that I find particularly detailed (i.e. annoying) is the tax treatment of property held for investment AND recreational use. These rules are designed to apply to vacation homes where the owners occupy the property for a portion of the year and rent it out to vacationers for a portion of the year.
Before I go into detail it’s important that I mention that I am not a tax professional. If you are reading this blog post and are wondering how these rules apply to your situation you are encouraged to visit the IRS’s website and consult with a tax professional.
So how are vacation homes taxed? As is the answer to many tax questions- IT DEPENDS.
The first question to ask is whether or not the home is rented out for 14 or fewer days during the year? If it is then the income DOES NOT have to be recognized and the only expenses that would be deductible are property taxes and qualifying mortgage interest on schedule A of the taxpayer’s return. The best example of the potential benefit of this rule is for property owned on Augusta National Golf Course. Every year property owners are able to rent their homes out during Master’s Week for thousand’s of dollars. Assuming they only rent the property out during that week they do not need to claim that income on their tax returns. However, they are not able to deduct the cleaning and maintenance expenses either.
If a vacation home is rented out for 15 or more days during the year then the next question is whether the property is used by the owner for the greater of 14 days or 10% of the rental days. If the personal use is less than the greater of 14 days or 10% of rental days then the property will be considered a rental home and ALL of the income and associated expenses will flow through schedule E on the owner’s tax return. If the personal use of the rental property exceeds that threshold then the property is considered to be “mixed-use” and the associated expenses must be pro-rated based on the number of personal use and rental days.
For example, let’s say a person owns a home down at the coast. During the year the home is rented out to vacation-goers for 180 days. The property owner may use the home for up to 18 days (10% of the rental days) and still classify the home as a rental property. They would report all income and expenses on a schedule E. However, if they used the property for 20 days during the year then the home is considered to be mixed-use and 10% of the expenses would be considered personal (20/200 days in use) and 90% of the expenses (180/200) could flow through schedule E of the tax return. All of the income would also be claimed.
This is a fairly complex rule but the tax code wasn’t designed for ease of use. Feel free to leave any questions below in the comment section.
Homebuyers with bad lenders just got a break. Congress has passed an extension provision to the popular homebuyer credit. Now homebuyers who qualify under the other rules (including going into contract by April 20, 2010) have until the end of September to close.
For many people saving for a rainy day is hard enough as it is. Add on top of that all the other financial objectives a person is typically concerned with (i.e. retirement, college savings, paying down debt) saving for a down payment on a home can be difficult. Because of this I often have clients who are interested in accessing funds in their retirement accounts to come up with money for a down payment. In order to do this it’s important that homebuyers be educated on their options. Therefore, I have put together this post to summarize the important points of using 401K, IRA, and Roth IRA funds towards the purchase of a home.
One quick note that is generally applicable to all three sources. Typically funds derived from a retirement plan used towards the purchase of a home may only be used as a down payment and “usual or reasonable settlement costs” and may not be used to pay other debts in order to qualify for a new mortgage.
401K
Rules for each 401K plan are slightly different so homebuyers need to talk with their plan administrators to make sure they can use their 401K. Technically, a person cannot generally withdraw money from their 401K to use towards the purchase of a home. Instead most 401K plans will allow participants to borrow money from their 401K and pay it back with payroll deductions. For funds being used to purchase a home the repayment period can be longer than the normal required period of 5 years but check with the plan administrator to make sure the payments won’t be onerous .
The plan will usually assign an interest rate to the loan but because the participant is paying and receiving the interest the effective cost of borrowing is 0%. However, while the loan is outstanding keep in mind that it is not receiving investment returns so the true cost of tapping into a 401K is the “opportunity cost”. Homebuyers wishing to use their 401Ks should consider the impact this will have on their future ability to retire. Also, keep in mind that repayment of a 401K loan is made with after-tax dollars. Therefore, when that homeowner retires int he future they will effectively pay tax on the loan amount twice (once when they repaid the loan with after-tax dollars and again in retirement when they take a taxable distribution from the account).
Typically the maximum a person can borrow from their 401K is the lesser of $50,000 or 50% of their vested balance. If the vested balance is less than $20,000 then sometimes they can borrow up to the vested balance or $10,000 whichever is greater.
It’s important to note that a person does not have to be a first-time homebuyer to use 401K funds. It’s also important to note that because the homebuyer will pay back the 401K loan with payroll deductions then it is generally not possible to access funds in a 401K with a previous employer. The homebuyer must currently be working for the plan sponsor. This also creates a significant risk because if the employee is terminated during the repayment period on the loan and cannot pay back the remaining balance the amount will be treated as a non-qualified distribution and be subject to ordinary income tax plus a 10% penalty.
Please note that some 401K plans do allow “hardship” withdrawals for participants who qualify as a first-time homebuyer. However, these distributions are taxable so unless cash-flow is a major concern often times a loan will make more sense.
IRA
IRAs are different from 401Ks in that a person is able to take distributions instead of having to take out a loan. The question then becomes whether or not the distribution will be a deemed a “qualified” or “non-qualified” distribution. A “qualified” distribution IS NOT subject to a 10% penalty while a “non-qualified distribution” is subject to a 10% penalty.
In order for a distribution to be qualified the homebuyer must be a first-time homebuyer which the IRS defines as a person who has not owned real estate in the previous 24 months. The $10,000 cap is a lifetime limit so once a person has utilized the $10,000 they may not use it again.
So long as the contributions to the IRA were tax deductible for the homebuyer then the distribution will be taxed as ordinary income. If the distribution does not meet the criteria of being a “qualified” distribution then it will also be subject to a 10% penalty. Since the homebuyer will typically incur income tax liability for an IRA distribution it’s important they account for that when budgeting out their money from the time of distribution to the following April 15th when taxes are due.
Roth IRA
The rules for Roth IRA distributions used towards the purchase of a home are similar to the aforementioned traditional IRA guidelines in that it is only available for those who meet the IRS’s definition of a first-time homebuyer and is only available up to $10,000. However, there are a couple key differences.
One key difference is that for a distribution to be “qualified” it may not be made inside a 5-taxable-year period which begins January 1st of the taxable year for which the very first contribution was made to any Roth IRA the homebuyer owns. In other words, for a first-time homebuyer who wishes to take a “qualified” distribution from their Roth IRA account anytime in 2010 must have made their very first Roth IRA contribution (to any Roth account) no later than the 2005 tax year.
The other key difference is taxation. Because Roth IRA contributions are not tax deductible at the time of contribution “qualified” distributions are not treated as taxable income. However, if the distribution is not deemed to be “qualified” then it will be subject to a 10% penalty and depending on the contributions made and distribution taken may also have income tax implications.
I hope this summary enables homebuyers out there to make better decisions with their money. Please remember that I am not a tax professional and tax code is subject to change. It is best to discuss your options with a knowledgeable professional when you are close to make such a decision. It is also important to consider the impact that the decision will have on your ability meet your retirement accumulation goals.
As I blogged about back on September 14th many first-time hombuyers have received gifts or loans from family members over the past year so that they can take advantage of historically low interest rates, affordable housing prices, and the government’s tax credit. The onslaught of familial generosity is great for homebuyers who would otherwise be unable to buy a home. However, I get the impression that many of the parents and grandparents who are making gifts or loans are doing so haphazardly without consulting their tax advisers. Furthermore, most mortgage professionals are not properly schooled in this topic and are not providing adequate guidance to the parties involved. As a result I foresee many people getting a surprise when it comes time to file their tax returns.
Back on September 14th I covered the gift tax rules for those who make an outright gift to others. However, I also want to cover loans.
In general loans to family members (or anyone else) are not considered gifts when a reasonable interest rate is charged. However, there are gift tax implications when “below market” or “interest free” loans are made. In this instance the IRS will require that the lender recognize the “imputed interest” as a gift to the recipient of the loan. “Imputed Interest” is the term used in the IRS tax code to describe interest considered to be paid for income tax purposes, even though the interest payment was not actually made. You can think of it as phantom interest. The imputed interest is included in the lender’s income even though the lender did not receive any money. Furthermore, the lender is also considered to have made a gift to the recipient in the amount of the imputed interest. If the funds are used as acquisition indebtedness to purchase a home then often times the recipient will be able to deduct the imputed interest as mortgage interest even if they didn’t actually pay it.
Imputed interest is based on the loan amount and is calculated by taking the difference between the actual interest collected on the loan and the “Applicable Federal Rate” (AFR) which is the rate the IRS deems as the market rate. AFR can be accessed at this link and varies depending on the term of the loan.
If a loan was for $10,000 or less then there is no imputed interest and no gift tax implication.
If a loan amount of $10,0001-$100,000 is made then the imputed interest is the lesser of the net investment income of the recipient in that year (if the recipient’s net investment income is less than $1,000 then imputed interest is deemed to be $0) or the difference between the actual interest collected and the AFR.
If the loan amount is in excess of $100,000 then the imputed interest is the difference between the actual interest collected and the AFR.
It is always wise to discuss your gift giving or generous loan plans with a tax adviser or estate planner before writing the checks. There is significant flexibility in the gift and estate tax code to allow most households to escape tax liability but it may require some careful planning.
I’ve spoken with many past clients over the past few weeks about their property tax statements. Many people are frustrated that their property taxes rose for the 2009-2010 property tax year even though the real market value of their home declined. Brent Hunsberger wrote this great post on the subject for the Oregonian.
Here are the cliff notes:
*As you probably know, you can appeal your assessor’s valuations. But if you’re looking to cut costs, you’d be better off spending time exploring a refinance, a sale or driving down your homeowners insurance premiums.
*The reason: In the ’90s, Oregon voters passed not one but two constitutional amendments limiting growth in property taxes.
*In Oregon, you’ve got until Dec. 31 to fashion your petition.
*Last year, the number of tax petitions more than doubled in the Portland area’s three counties. It’s early, but this year’s volume seems no different, county officials say.
*And now some tips should you mount a challenge:
Talk to your assessors’ office first. The law allows assessors to “stipulate,” or settle, appeals before they reach the board. About one-third of them are resolved this way. It might involve some give-and-take, but it will save you time.
Gather evidence — an appraisal, comparable sales in the neighborhood, or damage-repair estimates. “The worst thing you can do is write a sentence saying, ‘Well, my neighbor’s house is worth this and that,'” Broughal says. “Give us some evidence.” Also, don’t focus on how your tax payment is higher than your neighbor’s. The value is what matters.
Clackamas County officials encourage petitioners to sit in on a hearing before they present their case.
You need not be present when your case is heard, but it’s probably a good idea. You can bring an attorney, but it likely isn’t worth the cost.
If you haven’t heard, the United States Congress and President Obama have passed legislation that expands the first-time homebuyer tax credit and extends it into the first half of 2010. Before we go any further, we want to make it clear that we are not tax professionals and recommend that you contact a tax professional to see how this law may apply to you.
Initially, the first-time homebuyer tax credit came into law as a part of President Bush’s Housing and Economic Recovery Act of 2008. In the original form, first-time homebuyers were eligible to receive up to $7,500 in the form of a tax “credit” but were required to pay back the credit over a 15-year period.
Earlier this year President Obama signed into law the American Recovery and Reinvestment Act of 2009, which increased the maximum amount of the tax credit to $8,000 and eliminated the payback provision. To be eligible for the credit, homebuyers must have not owned a home in the previous three years, must close on their purchase no later than November 30, 2009, and must make less than $75,000 for individuals and $150,000 for households.
Under the new law, the first-time homebuyer tax credit has been extended, and a $6,500 tax credit for existing homeowners has been added. Here are the details:
·Eligibility criteria for the first-time homebuyer tax credit have not changed: a homebuyer must have not owned a home in the past three years.
·To be eligible for the $6,500 homebuyer credit, homebuyers must be buying their primary residence and have lived in their existing home for at least five of the previous eight years. (The credit is not available for vacation or investment property purchases.) Homebuyers do not have to sell their existing home to be eligible for the credit.
·The credit is available to homebuyers who qualify, as long as they enter into a sales contract no later than April 30, 2010 and close no later than June 30, 2010. The $6,500 existing homeowner tax credit becomes effective December 1, 2009.
·In addition to expanding the tax credit to existing homebuyers, the new law raises the income qualification thresholds to $150,000 for individuals and $225,000 for households.
Although many critics have pointed out that the extension and expansion of the home-buying tax credit is poor public policy, there is no question that it offers a unique opportunity for existing homeowners to purchase a new home with a generous government subsidy.
Mortgage rates remain near historic lows and, according to the Case-Shiller Home Price Index, real estate prices in the Portland-Metro area remain 20% off their July 2007 highs. If you’ve been considering a move, this may be your once–in-a-lifetime opportunity. Please contact us if you’d like to review your loan options and obtain pre-approval.
Here is a link to the section of the IRS website which summarizes the new law.
Here are the two key points which look intriguing:
*Senators agreed to extend the existing tax credit for first-time homebuyers while offering a reduced credit of up to $6,500 to repeat buyers who have owned their current homes for at least five years…
*The tax credits would be available to homebuyers who sign sales agreements by the end of April. They would have until the end of June to close on their new homes…
Forbes.com is reporting that the IRS has amended their stance on large mortgage interest deduction. Prior to their amendment homeowner’s who borrowed >$1.0 million to purchase their home were only able to deduct interest on the first $1.0 million. However, if that homeowner borrowed only $1.0 million to acquire their home and then later took out a $100,000 equity loan they were then able to deduct interest on the entire $1.1 million.
What this article is reporting is that the IRS is effectively viewing these two scenarios as being the same. Therefore, the interest on the $1.1 million in acquisition indebtedness is now tax deductible. Homeowners who benefit from this change can amend their taxes back 3 years to take advantage of this change.
