Closing Costs in a §1031 Exchange: A Trap for the Unwary?

Closing statements are replete with prorations and credits that adjust the sales price.  Other line items reflect the payment of recording fees, title insurance and other transaction expenses.   Seemingly routine, the way these expenses are handled in a §1031 exchange may have unintended tax consequences.

Remember that the rationale for tax-deferral under §1031 is that the taxpayer has merely moved his investment from one property to another.  The form may have changed, but as long as the underlying investment remains unchanged no tax is due.  Any “cashing out” of the investment (i.e. reduction in equity) will be taxed.

In some instances, using exchange funds to pay closing costs or issue credits that adjust the price, may be a form of cashing out.  The result is that the transaction may be partially taxable.
Another concern is that paying certain expenses could be construed as impermissible receipt of the exchange funds.  Under the IRS regulations the taxpayer cannot have actual or constructive receipt of the exchange funds.  Improper receipt could cause the entire exchange to fail.
The IRS and case law provide very little guidance on this topic.  This article discusses the issues in general, but because of their uncertainties and technical nature, it is important that every taxpayer have his tax advisor approve each closing statement, so there are no surprises when preparing the tax return.

EXCHANGE EXPENSES

Certain items paid at a closing are considered “Exchange Expenses”.  Using exchange funds to pay those expenses will not result in a tax liability to an investor doing a §1031 exchange.  For example, Revenue Ruling 72-456 provides that if exchange funds are used to pay brokerage commissions, it does not result in the transaction being partially taxable.  There are no other clear rulings on this subject, but most tax advisors agree that the following expenses are exchange expenses and may be paid at the closing of the relinquished or replacement properties without any tax consequence:
• Brokerage commissions • Exchange fees • Title insurance fees for the owner’s policy of title insurance • Escrow fees • Appraisal fees required by the purchase contract • Transfer taxes • Recording fees  • Attorney’s fees incurred in connection with the sale or purchase of the property

NON-EXCHANGE EXPENSES

Not all expenses are Exchange Expenses.  Exchange funds can be used to pay a non-exchange expense, although doing so may result in the exchange being partially taxable.
Such payments will not invalidate the application of the Qualified Intermediary safe harbor, but they may still constitute boot to the Exchanger.  On a typical settlement statement the seller of the relinquished property will give the buyer a credit against the sales price, representing security deposits and prorated rents.  Effectively, the seller was using exchange funds to pay the security deposit and prorated rent amounts to the buyer.  To avoid a taxable event, the seller should deposit his own funds to pay those security deposits and prorated rents to the buyer, rather than giving a credit.
In addition, most tax advisors believe that fees and costs paid in connection with getting a loan to acquire the replacement property should be considered costs of obtaining the loan, not costs of acquiring the replacement property, and thus are not Exchange Expenses.  To avoid any potential tax liability, the buyer may want to deposit his own funds to pay loan related expenses.
Some non-exchange expenses create a tax liability but are offset by a deduction.  One example of this is property taxes.  Although property taxes are not an Exchange Expense, the investor will get a deduction for paying the property taxes, and that liability will be offset by a deduction.
The following items are typically found on a closing statement but are generally not considered Exchange Expenses because they do not relate directly to the disposition of the relinquished property or the acquisition of the replacement property:
• Loan costs and fees • Title insurance fees for the lender’s title insurance policy • Appraisal and environmental investigation costs that are required by the lender • Security deposits • Prorated rents • Insurance premiums • Property taxes

TRANSACTIONAL ITEMS AND CONSTRUCTIVE RECEIPT

A separate, but important, issue is whether paying a non-exchange expense from exchange funds will be construed as constructive receipt of those funds by the investor, which has the potential to disqualify the entire exchange.  Under the IRS Regulations exchange funds can be used to pay “transactional items that relate to the disposition of the relinquished property or to the acquisition of the replacement property and appear under local standards in the typical closing statement as the responsibility of a buyer or seller (e.g., commissions, prorated taxes, recording or transfer taxes, and title company fees).”
For example, an investor may want to use exchange funds to pay a rate lock-in fee to a lender.  Since these fees by their nature are paid before the closing, and are not strictly required for the acquisition of the replacement property, paying the fee from exchange funds may trigger a constructive receipt problem.
Since there is no clear IRS guidance, it is important that investors discuss the issue with their tax advisors before seeking to use exchange funds to pay non-exchange expenses, whether prior to, or at the replacement property closing.

 

REFERENCES

Revenue Ruling 72-456; TAM 8328011; Treasury Regulation §§ 1.1031(k)-1(g)(6) and (7); IRS Form 8824.  – See more at: http://firstexchange.com/July2013Newsletter

-from First American Exchange Company July 2013 Exchange Update

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Don’t Jeopardize Your 1031 Exchange – from First American Exchange Company – Exchange Update Newsletter

When completing a §1031 exchange there are some little-known requirements that could potentially disqualify your tax-deferred transaction.  Here are a few that could put your exchange at risk.

Qualified Intermediary Selection

 

Someone who is acting as your agent at the time of the transaction is disqualified from acting as a Qualified Intermediary.  Who is considered an agent? Someone who has acted as your employee, attorney, accountant, investment banker or broker, or real estate agent within the two-year period ending on the date of transfer of the first relinquished property. These persons are disqualified because they are presumed to be under the Taxpayer‘­s control.  Thus, the Taxpayer is deemed to have control of the exchange funds, otherwise known as “constructive receipt”. Constructive receipt by the Taxpayer invalidates the §1031 exchange. See here for exceptions to this rule.

 

If exchange funds are set aside or otherwise made available to you, it is also considered to be constructive receipt. Of course, if you actually receive the exchange funds you will invalidate your exchange.

 

Identification Deadlines

 

The most common reason an exchange fails is missed deadlines.  Potential replacement property(ies) must be identified by midnight of the 45th day after the relinquished property transfer.  Therefore, it is advisable to begin searching for the replacement property as soon as possible. In addition, the replacement property must be received by the taxpayer within the exchange period which ends on the earlier of 180 days from the date on which the taxpayer transfers the first relinquished property, or the due date for the taxpayer’s federal income tax return for the taxable year in which the transfer of the relinquished property occurs.  Extensions may be available for Taxpayers within a Presidentially Declared Disaster Area, or in active service in a combat zone. See here for exceptions to these deadlines.

 

Same Taxpayer Rule

 

Another mistake someone could inadvertently make would be to change the manner of holding title from the relinquished property to the replacement property. As a general rule, the same Taxpayer that transferred the relinquished property should be the same Taxpayer that acquires the replacement property. There are a variety of reasons you might want to change how title is held in an exchange and some changes are allowed, but you must be sure to talk it over with your tax advisor first. You can read further details on vesting title in a §1031 exchange, here.

 

Related Party Exchanges

 

You must also give serious consideration to any relationship you might have with the seller of the replacement property. Acquiring replacement property from a related party is potentially problematic, so the facts of the transaction should be reviewed by your tax advisor before proceeding.  The IRS could view the transaction as an abusive shift of basis between related parties resulting in tax avoidance and disallow the exchange.  Exchanges involving related parties are allowed, but both parties must hold their newly acquired properties for at least two years or both exchanges will fail.  For more information on exchanging with related parties, click here.

 

First American Exchange has helped thousands of taxpayers successfully complete even the most difficult transactions. While we don’t provide tax or legal advice, we make it our business to keep you informed of your exchange deadlines and other potential pitfalls that could jeopardize your exchange.

– See more at: http://firstexchange.com/June2013Newsletter#sthash.7dRJR7Vh.dpuf

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Top Ten 1031 Exchange Misconceptions

1.  Like-kind means I must exchange the same type of property, such as apartment building for apartment building.

 

All real property is like-kind to other real property, but personal property

like-kind requirements do have some restrictions. Real property and personal property are not like-kind to one another.  To read more about like-kind real estate, go here.

 

2.  My attorney can handle this for me.

 

Not if your attorney has provided you any non-exchange related legal services within the two-year period prior to the exchange. To read more about qualified and disqualified parties, go here.

 

3.  I must literally “swap” my property with another investor.

 

No. A 1031 exchange allows you to sell your relinquished property and purchase replacement property from a third party. Watch a short video on the basic process of a 1031 exchange.

 

4.  1031 exchanges are too complicated.

 

They don’t have to be. An experienced Qualified Intermediary will work with you and your tax and/or legal advisors to make sure the process is as seamless as possible.  Go here to read frequently asked questions and answers about doing a 1031 exchange.

 

5.  The sale and purchase must take place simultaneously.

 

No. The taxpayer has 45 days to identify the new replacement property and 180 days to close.

If you would like more information on the identification time period, go here.

 

6.  I just need to file a form with the IRS with my tax return and “roll over” the proceeds into a new investment.

 

No.  A valid exchange requires much more than just reporting the transaction on Form 8824.  One of the biggest traps when not structured properly is the taxpayer having actual or constructive rights to the exchange proceeds and triggering a taxable event.  For more information on tax filing requirements, go here.

 

7.  1031 exchanges are only for real estate.

 

No. Almost any property, whether real or personal, which is held for productive use in a trade or business, or for investment, may qualify for tax-deferred treatment under Section 1031. For more information on personal property exchanges, go here.

 

8.  All of the funds from the sale of the relinquished property must be reinvested.

 

No. A taxpayer can choose to withhold funds or receive other property in an exchange, but it is considered boot and will be subject to federal and state taxes.  To understand more about boot, go here.

 

9.  1031 exchanges are just for big investors.

 

No. Anyone owning investment property with a market value greater than its adjusted basis should consider a 1031 exchange. To find out how to use 1031 exchanges as a retirement planning tool, go here.

 

10.  I must hold property longer than a year before exchanging it.

 

The 1031 regulations do not list a time requirement on how long you must hold property, but it does say that property must be “held for productive use in a trade or business or for investment”.

To learn more about holding period requirements, go here.

from First American Exchange Company “The Exchange Update”

 

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Can I Exchange My Vacation Home?

Rising gas prices have caused many vacation property owners to reevaluate their “get away” options. They still want a cottage on a lake, but the lake needs to be closer to home. With proper planning, a tax-deferred exchange may help them realize that goal.

How much personal use is allowed?

To qualify for tax-deferred treatment under §1031, both the relinquished and replacement properties must be held for investment purposes or for use in the taxpayer’s trade or business. Property held for personal use does not qualify.

So what about vacation homes? Personal use is usually why they were acquired, but how much personal use is too much? Hopefully the properties will appreciate in value. Is that sufficient to demonstrate the necessary investment intent? Or does the property have to be rented out to be considered an investment?

Appreciation ≠ Investment

The Taxpayers in one case faced this exact dilemma.1 They had lake property that was used 2 or 3 weekends in the summer, with maintenance visits in the off season. They exchanged for property closer to home and used it even more often. The Court disallowed the exchange, finding that the property was held primarily for personal use, not for investment.

The mere hope or expectation of appreciation was not sufficient to establish investment intent. The Taxpayers never attempted to rent either property, never claimed deductions for maintenance or depreciation and deducted the interest as home mortgage interest. Also, their failure to properly maintain the relinquished property was inconsistent with an investment intent.

The IRS Safe Harbor: Revenue Procedure 2008-16

In 2007 the Treasury Inspector General for Tax Administration issued a report recommending additional oversight of like-kind exchanges, specifically stating that: “…the IRS regulations for like-kind exchanges of second and vacation homes are complex and may be unclear to taxpayers…and little exists with respect to a published position by the IRS on like-kind exchanges involving such properties.”2

In response the IRS issued Revenue Procedure 2008-16, which provides a safe harbor. If the procedures are followed, the IRS will not challenge whether a property qualifies as being held for productive use in a trade or business or for investment. An exchange may fall outside the safe harbor and still qualify, but expect more scrutiny from the IRS.

Qualifying Properties

Both the Relinquished and Replacement Properties must have been owned by the Taxpayer for at least 24 months immediately before and after the exchange. In each of the two 12-month periods immediately before and after the exchange the Properties must be rented at a fair market value for 14 days or more. The Taxpayer’s personal use cannot exceed the greater of 14 days or 10% of the days during each 12-month period that the property was rented at a fair market value.

Personal Use

“Personal Use” is not limited just to use by the Taxpayer. It also includes use by:

• the Taxpayer’s family members;
• any other person with an interest in the unit, or their families;
• anyone using the unit under an arrangement which enables the Taxpayer to use some other dwelling unit (even if no rent is charged); or
• anyone, if the property is rented for less than fair market value rent.

Meeting the Safe Harbor

First, you must meet the ownership requirements mentioned above. You should also limit personal use of the property to the greater of 14 days per year or 10% of the rental period. If you use the property any additional days for repairs and maintenance, be ready to show proof of the actual work done

The property should be rented to an unrelated party for at least 14 days per year. However, there is no need to rent the property for more than 14 days. You may also rent the property to a related party if they use it as their principal residence and pay fair market value rent.

It is also important to treat the property as an investment. Make sure that the property is properly maintained. Deduct expenses for maintenance, utilities, insurance and depreciation. If you have a mortgage on the property make sure that it is structured as an investment loan, not as a loan for a primary residence.

Vacation Homes Outside the United States

What if you own a vacation property located outside the United States? In some cases you can still benefit from a 1031 exchange. Real estate located outside the United States is not like-kind to real estate in the 50 states, even if it is located in an affiliated commonwealth or territory, such as Puerto Rico.3 However, you can exchange “foreign for foreign”, (e.g. Belize for Bermuda) as long as the other requirements are met.

A tax-deferred exchange is one of the few wealth building tools available to virtually any investor. Taxpayers should consider the benefits of a tax-deferred exchange whenever they plan to sell property that is not their principal residence.

from First American Exchange Company –

The Exchange Update

A Newsletter For 1031 Tax-Deferred Exchanges

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1031 Treatment for Conservation Easements

The decline in real estate development has provided an unexpected opportunity for land preservation. Large tracts of land that were slated for new construction are now being sold in whole or in part to local and regional municipalities or open space organizations. Certainly the sale of the entire fee interest in land held for productive use in a trade or business or for investment would likely qualify for a §1031 exchange. Interestingly, the sale of less than a fee interest may also qualify for tax-deferral under §1031 if certain criteria are met.

The IRS has issued several private letter rulings finding that certain types of conservation and agricultural easements are like-kind to real estate. A conservation easement is a voluntary agreement that allows a landowner to limit the type or amount of development on their property while still retaining ownership of the land1. Generally, the easement needs to be perpetual in nature and considered an interest in real estate for state law purposes.

Typically the land owner receives cash in exchange for granting the easement. Sometimes more than one government agency is involved in the transaction, such as a matching funds agreement between a county and state. In those cases there may be issues coordinating the timely payment of funds from each agency. It is a good idea to confirm how and when the sales price will be paid before entering the transaction.

There have been instances where the land owner received compensation other than cash in exchange for the easement. In a private letter ruling2 the IRS approved an exchange where the taxpayer received stewardship credits as compensation.3

First, using a Qualified Intermediary, the taxpayer conveyed the relinquished property by granting the county a perpetual restrictive stewardship easement over ranch land in return for stewardship credits equal to the value of the property rights that the taxpayer permanently relinquished. During the exchange period, the taxpayer converted the credits to cash by selling them to a third party buyer. The cash was then used to purchase the replacement property. The taxpayer was never in receipt of the credits or the relinquished property proceeds during the exchange period. The stewardship easement was held to be like kind to a fee interest in real estate.

The IRS based its decision on the fact that the stewardship easement was considered an interest in real property under state law and that the easement was perpetual. The ruling also discussed how the sale of the easement significantly and permanently restricted the future use of the taxpayer’s property such that the fair market value of the property, if sold, would be impaired.

In summary, remember that a §1031 exchange opens many investment opportunities for property owners. Do not assume that you can only exchange fee interests for other fee interests. There are many other possibilities, including conservation easements, leasehold interests and water rights. Please feel free to contact your local First American Exchange Company office to discuss your options: (800) 556-2520; 1031@firstam.com.

from First American Exchange Company Newsletter

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Can’t claim a loss when short-selling home

Due to the decline in housing prices, many home sales are “short sales” in which the purchase price offered by the buyer is less than the mortgage amount owed by the seller.

In a recent column, we discussed how some lenders go out of their way to grab both a tax deduction for the mortgage debt not paid while also attempting to go back to the seller and collect that same mortgage debt.

When a lender agrees to a short sale, it can either retain the ability to collect from the seller the amount of mortgage debt owed that is not satisfied by the purchase price, or it can discharge all or a portion of the unsatisfied debt amount.

If a lender discharges debt, it reports this discharge of debt to the Internal Revenue Service on a 1099-C Cancellation of Debt Form. The issuance of the 1099-C allows the lender to take a tax deduction for the loss represented by the amount of debt discharged, and this same amount of debt discharged becomes taxable income to the home seller.

A lender is now able do one or the other, not both. Some consumers are confused by how lenders can collect the mortgage debt owed after agreeing to the short-sale price. Others feel they are protected from the practice under a law passed five years ago.

In December 2007, Congress passed the Mortgage Forgiveness Debt Relief Act. This law provides some relief for homeowners who lose their house through foreclosure or short sales, or who restructure their mortgages with a lower principal amount. The law enables individuals to exclude from tax up to $2 million of certain mortgage debt canceled by lenders.

According to Nathan Gordon, government affairs director for the Washington Association of Realtors (WAR), some short-sale negotiations do not include language of the forgiveness — that the difference between what is owed and what is paid will actually be “forgiven.”

“In cases where, for whatever reason, that is not negotiated as part of the short sale, a recent court case ruled that even if the bank gives the borrower a 1099, (the bank) still can go back after the borrower for the remaining amount for up to three years, because both the bank and the borrower have up to three years to amend their IRS returns,” Gordon said.

“The Mortgage Forgiveness Debt Act really doesn’t speak to this specific point. The MFDA merely says that until the end of 2012, if you do get a 1099 from the bank as a result of a short sale, that you do not have to pay taxes on the forgiven amount even though it is technically unearned income.”

Gordon said the distinction to keep in mind is that currently a 1099 does not necessarily indicate that the debt is forgiven, just that, for the time being, the bank is writing it off as a loss on their taxes. WAR is backing legislation that would clarify all short-sale terms for the homeowner.

“Should our bill (Senate Bill 6337) pass, that would all change and a 1099 would be a concrete declaration of forgiveness of the short sale.”

While you don’t have to pay tax on the forgiven amount, there is no relief or tax deduction for selling your home at a loss. There is no benefit for folks who bought at the peak or made expensive remodels, then had to sell in a hurry and actually got less for their home than the cash they had invested in it.

Uncle Sam will not let you show a loss on your primary residence if you sell for an amount less than the purchase price. If you’ve planned on writing that down on your 2011 federal return, think again.

By Tom Kelly, Wednesday, March 14, 2012.

Inman News®

Tom Kelly’s new e-book, “Bargains Beyond the Border: Get Past the Blood and Drugs: Mexico’s Lower Cost of Living Can Avert a Tearful Retirement,” is available online at Apple’s iBookstore, Amazon.com, Sony’s Reader Store, Barnes & Noble, Kobo, Diesel eBook Store, and Google Editions.

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Converting Investment Property to Your Primary Residence

Exclusion of Gain from Sale of Residence

Many people are aware that they can sell their primary residence and not pay taxes on a significant amount of gain. Under Section 121 of the Internal Revenue Code, you will not owe capital gains taxes on up to $250,000 of gain, or $500,000 of gain if you are married and filing jointly, when you sell a home that you used as your primary residence for at least two of the previous five years. Taxpayers can take advantage of this exclusion once every two years.

Property Converted from Investment to Primary Residence

Taxpayers used to be able to trade into a rental, rent the home for a while, move into it and then exclude all or some of the gain under Section 121. Provided they lived in the home as their primary residence for at least two years, they could sell it and exclude the gain under Section 121 up to the maximum level of $250,000/$500,000. In recent years Congress enacted two amendments to Section 121 in order to limit the benefits of Section 121 when the property has been used as a rental.

First, if you acquire property in a 1031 exchange and then convert it to your primary residence, you must own it at least five years before being eligible for the Section 121 exclusion.

Second, the amount of gain that you can exclude will be reduced to the extent that the house was used for something other than a primary residence during the period of ownership. The exclusion is reduced pro rata by comparing the number of years the property is used for non-primary residence purposes to the total number of years the property is owned by the taxpayer.

For example, a married couple uses a tax deferred exchange under Section 1031 to acquire a house as investment property. The couple rents the house for three years, and then moves into it and uses it as their primary residence for the next three years. The couple sells the property at the end of year 6, netting a total gain of $800,000. Instead of being able to exclude $500,000, the couple will not be able to exclude some of the gain based on how many years they rented the house. Since they rented it for three years out of six, 50% of the gain, or $400,000, will not be able to be excluded. Because of this new limitation, the couple will be able to exclude $400,000 of the gain rather than $500,000.

Exceptions

There are a couple of exceptions to this restriction. If the house was used as a rental prior to January 1, 2009, the exclusion is not affected. Using the example provided above, if the three year rental period occurred prior to January 1, 2009, the exclusion would not be reduced and the couple would be able to exclude the full $500,000.

Another important exception is that property that is first used as a primary residence and later converted to investment property is not affected by these restrictions on excluding gain. For example, if you own and live in a house for 18 years and then you move out and rent the house for two years before selling it, you can receive the full amount of the exclusion. Because your investment use occurred after the last day of use as a primary residence, all of the gain accumulated over your 20 year ownership of the property can be excluded, up to $250,000, or $500,000 for married couples.

Combining Exclusion with 1031 Exchange

Fortunately, the rules are favorable to taxpayers who have more than $250,000/$500,000 of gain and are looking to combine Section 1031 with Section 121 to both exclude and defer tax. When the property starts out as a primary residence and then is converted into an investment property, you can exclude gain under Section 121, and then defer tax on the remaining gain, provided you comply with the requirements of both Section 1031 and Section 121.

The Internal Revenue Code still provides investors with favorable options for exclusion of gain and tax deferral. The rules can be complicated, but with the right planning taxpayers can still make the most of their real estate investments. For additional information about the 1031 exchange process or to open an exchange contact us at First American Exchange.

References: Internal Revenue Code §121; Housing Assistance Tax Act of 2008 (H.R. 3221).

from

The Exchange Update

A Newsletter For 1031 Tax-Deferred Exchanges by First American Exchange Company

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Short-sale debt collection draws ire – Why are banks getting tax break while also pursuing discharged debt?

Homebuyers may be attracted to the big bargains that foreclosures and preforeclosures can offer. But distressed properties can involve tricky, lengthy transactions, and there’s a lot to think about before jumping in.

In fact, some home shoppers have shunned short sales altogether, preferring a more reliable process to a reduction in price. Getting all parties to agree to a short-sale price can be problematic, and lenders have been known to change their minds when more bidders surface.

Given the difficulty and uncertainty of negotiating a short-sale transaction, you would think lenders would bend over backward to make things easier for the consumer once the deal is finally done.

But it appears some lenders are seeking an additional pound of flesh long after the frustrated, exhausted and often financially drained seller has moved on.

Short sales occur when owners, often in distress, sell their homes for less than the amount they owe their lenders. The lender may then write off the remainder of the debt and receive tax benefits.

Some lenders, however, will also assign or sell the remaining debt obligation to third-party debt collectors, often for pennies on the dollar. The third-party debt collector can then use the legal system to continue to pursue the former homeowner for the balance owed.

This has become such an issue that legislators in Olympia, Wash., have taken action. Senate Bill 6337, proposed by David Frockt, D-Seattle, would protect short-sale sellers from being pursued by lenders or their assignees for the difference between the sale price and remaining loan balance.

“The banks will basically have to make a choice,” Frockt said, “to either write off the amount and take the tax benefit, or pursue the owner — but they cannot do both.”

When a lender agrees to a short sale, it can either retain the ability to collect from the short-sale seller the amount of mortgage debt owed by the seller that is not satisfied by the purchase price, or it can discharge all or a portion of the unsatisfied debt amount.

If a lender discharges debt, it reports this discharge of debt to the Internal Revenue Service on a 1099-C Cancellation of Debt Form. The issuance of the 1099-C allows the lender to take a tax deduction for the loss represented by the amount of debt discharged, and this same amount of debt discharged becomes taxable income to the short-sale seller.

After the taxpayers bailed out the mortgage industry, many borrowers are still unable to get a loan modification to stay in their homes. Now the industry has a sketchy-to-lousy national reputation, and more stringent qualifying standards are not helping their case.

In light of all this, how can some lenders knowingly seek both a tax deduction for the mortgage debt not paid while also seeking to collect that same mortgage debt?

“Yes, we have heard of this happening,” said Deborah Bortner, director of consumer services for the Washington state Department of Financial Institutions.

“I hear it mostly from attorneys or others who assist those in obtaining a short sale. I understand that the documentation provided by the institutions doesn’t always make it clear whether they will pursue a short sale or not. The consumer only finds out later when contacted by someone trying to collect the deficiency.”

In some instances, mortgage debt collection rights have been referred to third-party debt collection companies, even though short-sale sellers have paid income tax on the amount of this discharged debt.

“This is another step to help the short-sale process that is keeping many homeowners from the tragedy of foreclosure,” said Faye Nelson, president of the Washington Association of Realtors. “Nearly 40 percent of the inventory in the Puget Sound region right now is short sales. State legislators recognize that protecting this process is critical to homeownership and the housing market.”

By Tom Kelly, Wednesday, March 7, 2012.

Inman News®Tom Kelly’s new e-book, “Bargains Beyond the Border: Get Past the Blood and Drugs: Mexico’s Lower Cost of Living Can Avert a Tearful Retirement,” is available online at Apple’s iBookstore, Amazon.com, Sony’s Reader Store, Barnes & Noble, Kobo, Diesel eBook Store, and Google Editions.

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Top 5 tax breaks for homeowners

Q: We bought a house this year! We put $33,000 down and the bank financed $28,000. Can I write this off on my 2011 taxes? How much of it?

A: First things first: Congratulations! You’ve become a homeowner, and seem to have done so using an enviable financial arrangement. But now that you own a home, you might need to shift the way you think and look at some things, including your taxes and other financial matters.

Owning a home is one of those landmarks that signify financial adulthood. And one of the things that responsible financial adults do is get professional help when the situation requires it. Taxes are one of those areas that often do warrant calling the pros in.

I’m not just shilling for the tax prep industry here, either: The ultimate aim of using a tax professional is to make sure you get every deduction, credit and other tax advantage for which you qualify, without jacking up your chances at triggering the universally dreaded Internal Revenue Service audit by claiming dubious deductions.

Your mortgage debt is fairly small, as was your home’s purchase price, though I don’t know whether they are large or small in the context of your overall financial picture (i.e., income, assets, investments, etc.).

The fact that you saved or somehow came up with such a sizable chunk of change to put down makes me hesitate to assume that your finances are as simple as your mortgage balance might otherwise lead me to believe.

So, it might be the case that you can easily handle your own taxes — in fact, it’s even possible that your real estate-related deductions won’t even outweigh the standard deductions, so that filing a simple form without even itemizing your deductions is actually the financially advantageous move.

Whether that’s the case cannot be determined in a vacuum — you may have other financial and tax issues going on. But with software and tax preparation services as inexpensive as they are, starting at under $20 for simple returns, I think it behooves you to get some professional advice and ensure you get the deductions you need.

Hiring a tax preparer might be a worthwhile investment to make, even if just this year, so he or she can brief you on what records you should keep and strategies you should do moving forward, like home repair and improvement receipts, or documentation of your use of an area of the home as a home office.

Now, let’s talk more substantively about the deductions that are available to you, in the event you do decide to itemize your taxes (IRS Publication 530 offers a more nuanced view into Tax Information for Homeowners):

1. Mortgage interest deduction. Assuming this home is your personal residence, 100 percent of the mortgage interest you owe and pay before Dec. 31, 2011, is deductible on your 2011 taxes. In January, your mortgage lender will send you a form documenting the precise amount of interest you paid, although most lenders also now make this form immediately available to borrowers online.

Chances are good that you paid some amount of advance interest on your home loan at closing — expect to see that on your statement from your lender, but you should also be able to find it on the HUD-1 settlement statement you received from your escrow agent at closing.

2. Property tax deductions. Again, assuming that this is the home you live in most of the time, you should be able to deduct 100 percent of the property taxes you’ve paid to your state and/or local taxing agency this year.

3. Closing-cost deductions. Discount points and origination fees paid to your mortgage lender and/or broker at closing are frequently deductible, but there are rules around this, which tax software and/or professionals can help you make sure you meet. Note that, according to Internal Revenue Service Publication 530, “You cannot deduct transfer taxes and similar taxes and charges on the sale of a personal home.”

There are various home improvements (especially those that increase your home’s energy efficiency), state and local tax credits for buying a foreclosure, and other tax advantages that might be available to you.

My advice is to work with an experienced, local tax preparer or, at the very least, use reputable tax preparation software to ensure that you get the maximum tax advantages available to you as a result of your new role as a homeowner.

By Tara-Nicholle Nelson, Thursday, January 5, 2012.

Inman News®

Tara-Nicholle Nelson is author of “The Savvy Woman’s Homebuying Handbook” and “Trillion Dollar Women: Use Your Power to Make Buying and Remodeling Decisions.” Tara is also the Consumer Ambassador and Educator for real estate listings search site Trulia.com. Ask her a real estate question online or visit her website, www.rethinkrealestate.com.

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8 things you should know about down payments

Q: What is the down payment?

 

A: The down payment is the property value less the loan amount. It is not the same as the borrower’s cash outlay if some of that outlay is used for settlement costs. On a newly constructed home, the land value can be part or all of the down payment.

Q: If the appraised value of a home exceeds the sale price, can the difference be applied to the down payment?

A: No, the property value upon which down payment requirements are based is the lower of sale price and appraised value. An appraisal higher than the price is disregarded.

Q: What is the down payment?

 

A: The down payment is the property value less the loan amount. It is not the same as the borrower’s cash outlay if some of that outlay is used for settlement costs. On a newly constructed home, the land value can be part or all of the down payment.

Q: If the appraised value of a home exceeds the sale price, can the difference be applied to the down payment?

A: No, the property value upon which down payment requirements are based is the lower of sale price and appraised value. An appraisal higher than the price is disregarded.

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But there is an important exception, called a gift of equity, where the home seller is someone near and dear, usually a family member, who is willing to sell below market value. In such cases, the lender will probably require two appraisals, and the seller must follow Internal Revenue Service rules to avoid gift taxes, but those are minor nuisances.

Q: Can a home seller contribute to the buyer’s down payment?

A: No, because of a presumption that such contributions will be associated with a higher sales price. However, subject to limits, home sellers are allowed to pay purchasers’ settlement costs. This reduces the cash drain on purchasers, allowing more of it to be used as down payment.

Q: Can the lender contribute to the buyer’s down payment in exchange for a higher interest rate?

A: No, but lender rebates or “negative points” can be used to pay settlement costs as a possible alternative to seller contributions.

Q: Can cash gifts be used as a down payment?

A: Only if the gift comes from a relative or live-in partner who can document its source. Gifts from parties to the transaction such as home sellers or builders are not acceptable as down payment funds because of the presumption that the gift affects other parts of the transaction, especially the sale price.

The lender must also be convinced that the gift is not a disguised loan with a repayment obligation that might reduce the borrower’s ability to repay the mortgage.

Borrowers who receive undocumented cash gifts can include them as part of their own funds if they can show that the funds have been in their account for at least 60 days. They should have two monthly statements issued after the funds are deposited in the account.

<a href="http://www.shutterstock.com/gallery-264874p1.html" mce_href="http://www.shutterstock.com/gallery-264874p1.html">House and calculator image</a> via Shutterstock.com.House and calculator image via Shutterstock.com.

Q: What is the down payment?

 

A: The down payment is the property value less the loan amount. It is not the same as the borrower’s cash outlay if some of that outlay is used for settlement costs. On a newly constructed home, the land value can be part or all of the down payment.

Q: If the appraised value of a home exceeds the sale price, can the difference be applied to the down payment?

A: No, the property value upon which down payment requirements are based is the lower of sale price and appraised value. An appraisal higher than the price is disregarded.

Article continues below

Advertise with Inman

But there is an important exception, called a gift of equity, where the home seller is someone near and dear, usually a family member, who is willing to sell below market value. In such cases, the lender will probably require two appraisals, and the seller must follow Internal Revenue Service rules to avoid gift taxes, but those are minor nuisances.

Q: Can a home seller contribute to the buyer’s down payment?

A: No, because of a presumption that such contributions will be associated with a higher sales price. However, subject to limits, home sellers are allowed to pay purchasers’ settlement costs. This reduces the cash drain on purchasers, allowing more of it to be used as down payment.

Q: Can the lender contribute to the buyer’s down payment in exchange for a higher interest rate?

A: No, but lender rebates or “negative points” can be used to pay settlement costs as a possible alternative to seller contributions.

Q: Can cash gifts be used as a down payment?

A: Only if the gift comes from a relative or live-in partner who can document its source. Gifts from parties to the transaction such as home sellers or builders are not acceptable as down payment funds because of the presumption that the gift affects other parts of the transaction, especially the sale price.

The lender must also be convinced that the gift is not a disguised loan with a repayment obligation that might reduce the borrower’s ability to repay the mortgage.

Borrowers who receive undocumented cash gifts can include them as part of their own funds if they can show that the funds have been in their account for at least 60 days. They should have two monthly statements issued after the funds are deposited in the account.

Q: Are there any substitutes for a down payment?

A: In principle, any collateral acceptable to the lender could serve as a substitute for a down payment. The only such substitute found in the U.S. is securities, which must be posted as collateral with an investment bank that also makes mortgage loans. Borrowers who do this are betting that the return on the securities will exceed the mortgage rate.

Mortgage insurance and second mortgages can also be viewed as substitutes for down payment. They do not provide the first mortgage lender with additional collateral, but they shift a major part of the risk of the low-down-payment loan to a third party who is paid by the borrower for assuming it. The payment is either a mortgage insurance premium or a relatively high interest rate on a second mortgage.

Q: Is it wise to withdraw funds from a 401(k) to make a down payment?

A: Withdrawing funds is very unwise, as you would be hit with taxes and penalties, but borrowing against your account might make sense, provided your employer allows it. The cost of borrowing against your 401(k) is not the loan rate, which you pay to yourself, but the return the money would have earned if left in the account.

The risk is that if you lose your job, or change employers, you must pay back the loan in full within a short period, often 60 days. Otherwise, the loan is treated as a withdrawal and subjected to taxes and penalties. Loans from a 401(k) cannot be rolled over into a 401(k) account at a new employer.

Q: What are the costs and benefits of making a larger down payment than is required?

A. The cost is measured by the rate of return you could earn on the money if you invest it rather than use it for a larger down payment. The benefit is measured by the mortgage interest rate, as that rate determines the interest savings on the amount you don’t borrow.

If you increase your down payment by $10,000 on a 4 percent mortgage, you earn 4 percent on the $10,000 you didn’t borrow.

A possible additional benefit arises when the larger down payment reduces the cost of the loan by lowering either the mortgage interest rate or the mortgage insurance premium.

My calculator 12a shows the total rate of return on investment in a larger down payment taking account of any such cost reductions.

By Jack Guttentag, Monday, December 19, 2011.

Inman News®

The writer is professor of finance emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.

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