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.

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.

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.

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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.

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.

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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.

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.

A common question that we are asked when working with investors contemplating a 1031 tax deferred exchange is:  Can I refinance the property and pull out cash before or after I complete my exchange?  Unfortunately there is no clear cut answer to this question, but hopefully the information in this article will provide you with some clarity. 

 In order to completely defer all tax in a 1031 exchange, you need to acquire property equal to or greater in value than the property you have sold, and you need to reinvest all of the net cash you receive from the sale of the relinquished property.  Because of the rule which requires you to reinvest all of the equity, when you refinance right before or after a 1031 exchange, the IRS may question whether you refinanced to avoid complying with the 1031 rules or whether you did it for a legitimate business purpose. 

Under the step transaction doctrine, the IRS may argue that what you did in several steps (close your exchange as step one and refinance your property as step two) was really all a part of one transaction.  Under that theory, the IRS could take the position that you may be considered to have taken cash boot in your exchange.  If that happens, an exchange that you thought was completely tax-deferred would be at least partially taxable.  It is important to consult with your tax advisor when deciding whether and how to refinance properties that are involved in an exchange. 

Here are a few suggestions that you may want to consider:

• The loan should have a clear business purpose which should be well documented in your files.  For example, the maturity date of the loan may be approaching and you may want to set up a refinance prior to the exchange in case the exchange does not go through.  Other potential business purposes may be to get a lower interest rate or to buy property that is not a part of the exchange. 
• If you schedule your refinance and exchange so that there is as much time in between them as possible, it should make it less likely that you are audited concerning this issue.  It should also strengthen your argument that the refinance was not set up to avoid the 1031 exchange rules.  If you intend to refinance your relinquished property, you may want to refinance it before you list it for sale.  
• Some tax advisors believe that it is better to refinance the replacement property after an exchange rather than to refinance the relinquished property before an exchange.

In any event, it is important to consider the risks and discuss your plans with your tax advisor. 

from the First American Exchange Company October Newsletter “The Exchange Update”

From time to time the IRS releases tips designed to help people with their taxes. Some of these are quite useful.

Last week the agency released “Ten Tax Tips for Individuals Selling Their Home,” (IRS Summertime Tax Tip 2011-15).

As a real estate agent or broker, it is not your job to give home sellers tax advice. Indeed, it is advisable not to, since you could end up getting sued if you give wrong advice.

Instead, refer sellers to this list of IRS tips. It’s a good starting place for them to begin to understand this often complex area of tax law. You could even print it out and hand it to anyone who asks you about these issues.

Here are the IRS’s top 10 tax tips for home sellers:

1. In general, you are eligible to exclude the gain from income if you have owned and used your home as your main home for two years out of the five years prior to the date of its sale.


2. If you have a gain from the sale of your main home, you may be able to exclude up to $250,000 of the gain from your income ($500,000 on a joint return in most cases).


3. You are not eligible for the exclusion if you excluded the gain from the sale of another home during the two-year period prior to the sale of your home.


4. If you can exclude all of the gain, you do not need to report the sale on your tax return.


5. If you have a gain that cannot be excluded, it is taxable. You must report it on Form 1040, Schedule D, Capital Gains and Losses.


6. You cannot deduct a loss from the sale of your main home.


7. Worksheets are included in Publication 523, Selling Your Home, to help you figure the adjusted basis of the home you sold, the gain (or loss) on the sale, and the gain that you can exclude.


8. If you have more than one home, you can exclude a gain only from the sale of your main home. You must pay tax on the gain from selling any other home. If you have two homes and live in both of them, your main home is ordinarily the one you live in most of the time.


9. If you received the first-time homebuyer credit and within 36 months of the date of purchase, the property is no longer used as your principal residence, you are required to repay the credit. Repayment of the full credit is due with the income tax return for the year the home ceased to be your principal residence, using Form 5405, First-Time Homebuyer Credit and Repayment of the Credit. The full amount of the credit is reflected as additional tax on that year’s tax return.


10. When you move, be sure to update your address with the IRS and the U.S. Postal Service to ensure you receive refunds or correspondence from the IRS. Use Form 8822, Change of Address, to notify the IRS of your address change.

These tips can be found on the IRS website at http://www.irs.gov/newsroom/content/0,,id=104608,00.html.

from “Real Estate Tax Talk”  By Stephen Fishman, Monday, August 15, 2011.

Stephen Fishman is a tax expert, attorney and author who has published 18 books, including “Working for Yourself: Law & Taxes for Contractors, Freelancers and Consultants,” “Deduct It,” “Working as an Independent Contractor,” and “Working with Independent Contractors.” He welcomes your questions for this weekly column.

If a taxpayer is considering buying a replacement property from a related party in a 1031 exchange they should always seek good tax council.

from Starker News 2nd Qtr. 2011

For a successful 1031 exchange, it is important to understand and comply with the 1031 exchange identification rules.  These rules are not that complicated, but a failure to follow the rules may ruin your exchange.  Here are the top ten things to remember when identifying replacement property in an exchange:

1. Deadline and General Rules.  The taxpayer has 45 days from the date that the relinquished property closes to identify the replacement property that he intends to acquire in the exchange.  If there is more than one relinquished property in one exchange, the 45 days are measured from the date the first relinquished property closes.  The property identified does not have to be under contract, and the taxpayer does not have to acquire everything that he identifies.  It is important to note, however, that the taxpayer is not allowed to acquire anything other than the property that he has identified, and a failure to comply with the identification rules can ruin the whole exchange.  
2. 3 Property Rule.  There are rules that limit how many properties the taxpayer may identify.  In most cases taxpayers use the three property rule.  The taxpayer may identify up to three replacement properties and may acquire one, two or all three of those.    
3. 200% Rule.  If the taxpayer wants to identify more than three properties, he can use the 200% rule.  This rule says that the taxpayer can identify any number of replacement properties, as long as the total fair market value of what he identifies is not greater than 200% of the fair market value of what was sold as relinquished property.  First American Exchange recommends that taxpayers build in a “cushion” by identifying properties that are worth less than what is permitted, in case some properties are later determined to have a higher value than what was originally estimated. 
4. 95% Rule.  There is another rule that is not commonly used by investors.  The 95% rule says that a taxpayer can identify more than three properties with a total value that is more than 200% of the value of the relinquished property, but only if the taxpayer acquires at least 95% of the value of the properties that he identifies.  Essentially, the taxpayer will need to acquire everything that he has identified to make this work, and that is why it is not relied on too often. 
5. Property Acquired in 45 Day Period.  Any property that is actually acquired during the 45 day identification period is deemed to be properly identified.  It’s important to note that if some property is acquired during this period and some property is acquired later using another one of the identification rules, the property acquired during the first 45 days needs to be counted as one identified property.  For example, if you acquire one property during the first 45 days and you plan to use the 3 property rule and buy more properties after the 45 days, you only have two more properties to identify because you have already used up one. 
6. Manner of Identification.  The identification must be in writing and signed by the taxpayer, and the property must be unambiguously described.  This generally means that the taxpayer identifies either the address of the property or its legal description.  A condo should have a unit number, and if the taxpayer is buying less than a 100% interest, the percentage share of what is being acquired should be noted. 
7. Who Must Receive the Identification.  The taxpayer must send the identification notice either to:
    
   1)  The person obligated to transfer the replacement property to the taxpayer (such as the seller of the replacement property) or;
   2)  To any other person “involved” in the exchange (such as the qualified intermediary, escrow agent or title company), other than a “disqualified person,” such as an agent or family member of the taxpayer.  Most identification notices are sent to the qualified intermediary.
    
8. Replacement Property Must be Same as What Was Identified.  The taxpayer must receive “substantially the same” property as he identified.  The regulations contain four examples to illustrate what “substantially the same” means.  In one example, the taxpayer identifies two acres of unimproved land and then acquires 1.5 acres of that land.  The property acquired is substantially the same because what the taxpayer received was not different in nature or character from what was identified, and the taxpayer acquired 75% of the fair market value of the property identified.  In another example, the taxpayer identifies a barn and two acres of land, and then acquires the barn with the land underlying the barn only.  The IRS says that the property acquired was not substantially the same as the property identified because it differed in its basic nature or character.  
9. Property to be Constructed.  If the replacement property is under construction at the time of identification, the taxpayer must include not only the address or legal description of the property, but also must include a description of what is to be constructed on the property.  
10. Reverse Exchanges.  If the taxpayer is doing a reverse exchange where the accommodator acquires the replacement property before the taxpayer closes on the sale of the relinquished property, the taxpayer must identify in writing what he intends to sell and that identification must be sent no later than 45 days after the accommodator closes on the replacement property. 

from The Exchange Update Newsletter by First American Exchange Company