My interest in taxes is both economic and genetic. My late father was a CPA for more than 60 years and at age 90 or thereabouts was renowned both for driving an Alfa Romeo and for auditing complex corporate books.

At an early point my father took me aside to explain the facts of life. I’m not sure I remember all the details, but in the midst of this discussion he mentioned something about the necessity of paying taxes, and to help in this endeavor he provided a calculator.

Now you might think, aha, a “calculator,” one of those electronic thingies that are now so cheap they’re given away in cereal boxes. Nope. This was before electronic calculators and not much after the invention of writing.

My father endowed me with a 12-pound Brunsviga-Midget, a 1910 device that requires neither batteries nor electricity. Instead, it consists of a sturdy oak board topped with a crank-powered collection of steel cogs and gears. By adjusting studs on a series of metal tumblers, turning the crank and moving a sliding registry, one can add, subtract, divide and multiply up to 18 places with absolute accuracy.

Thus armed with vast computational power, I have attempted over many years to violate the norms of financial sanity and common sense by doing my own tax returns. Each April I dutifully review all receipts and records assembled in a suitable shoe box, then sort and re-sort into various categories, enter the results by hand onto whatever forms the government suggests, add and subtract as appropriate and pay whatever it is I owe.

This system worked fairly well at the beginning of my adulthood. However with each passing year, the process has become less effective. While early returns could be mailed with a single stamp, the latest models vie with a Stephen King novel in terms of heft and complexity.

And although the part about the shoe box and the receipts remains largely unchanged — I’m sure Enron used the same system — figuring out what it all means has become decidedly more tangled. In an effort to spare the Brunsviga, I have sometimes resorted to paid assistance. But this year I decided to do something different: I broke down, spent $29.95 and bought the software necessary to complete my federal and state tax returns.

I’m not convinced that the results produced by this electronic wonder are especially different, or different at all, from the final figures that might have emanated from the Brunsviga. However, even I am awed by the ability of such software to automatically fill in lots of forms at once, write legibly and instantly generate 26 pounds of financial reportage.

It’s the end of an era. But although there is much to recommend the newest technological advances, I’m not certain society benefits.

Government is powered by taxes, and the more we know about who pays and who doesn’t, the better we understand how government works and what it really costs. When taxes are calculated on the dining room table with much sweating, cursing and irritation, we at least partake in the system; the usual distance between government and the governed disappears.

For instance, this year you can write off state sales taxes if you do not deduct state income taxes. This is a benefit largely for folks who live in areas without a state income tax. Makes sense — until you read the rules.

“State taxes on motor vehicles,” says one government directive, “also are deductible as a general sales tax if the tax rate was more than the general sales tax rate, but the tax is deductible only up to the amount of the tax that would have been imposed at the general sales tax rate.”

Right.

Do your taxes using a computer program and you may not notice that medical bills equal to 7.4 percent (or less) of your gross adjusted income are not deductible — you need to be sicker to get write-offs. Given that we live longer, isn’t it time we reserved an extra write-off for those age 75 rather than comparative youths who have just turned 65? Why are there special write-offs for farmers, day-care providers and the clergy — but not for nurses or ambulance drivers? Who do you really need if your appendix bursts?

The issue is not so much that such limitations exist; rather it is the fuzzy process that produces them, the evidence of who has political power and who doesn’t.

Great industries have been created from single and obscure paragraphs hidden within the tax code, a body of rules so complex no one fully understands what’s been written or why. Truth is, automating returns undermines the common good. Rather than speed and efficiency, perhaps we need a tax system that makes citizens ask tough questions and causes political leaders to squirm every time they spend our dollars.

The time has now come to pass on a great tradition. Shall it be the Brunsviga or the software? Oh, children, Daddy wants to talk to you . . .

————————————
Published originally by the author in The Washington Post, April 18, 2005.

April 15th: The Right Way To Figure Taxes is a post from: Refinance, Home Mortgage Loans & Rates, Home Equity Loan

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The lender selling REOs (real estate owned by a bank or other lender) does actually care how you own title, What it does care about is that you buy the property for as much as possible (good luck) and from there on out you’re the owner.

Foreclosure Title

In basic terms you can hold title as:

An individual.

In a tenancy by the entireties. This is a form of ownership reserved for married couples. Each spouse owns 100 percent of the property, meaning if one dies there’s nothing to inherit (because ownership is already held by the living spouse) and if one is sued the property cannot be lost if the other party wins the suit. Alternatively, real estate acquired during the term of the marriage may be held as community property in several states.

The property can be bought by several people as tenants in common. In this case ownship interests need not be equal, there is no automatic right of survivorship, individual owners can sell their interests individually.

Lastly, title may be held in the form of a joint tenancy. Such a tenancy requires four unities — the unity of interest (the same form of ownership for each owner), the unity of time, the unity of title (all owners make their investment at the same time) and the unity of possession (equal access to the property).

Title options can vary according to the jurisdiction where the property is located. Because important matters may be involved — inheritances, survivorship, liability, taxes, etc. — foreclosure buyers should always consult with a knowledgeable real estate attorney for specific advice when determining the right way to hold title.

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In terms of prices, NAR says for all of 2009, the median price for a single-family existing home was $173,200, down 11.9 percent from 2008. This compares with a 2008 price drop of 9.3 percent.

Translation: Existing home values actually fell more in 2009 than in 2008, though prices did rise 1.4 percent in December 2009 when compared with a year earlier.

Inventory

“Total housing inventory at the end of December,” says NAR, “fell 6.6 percent to 3.29 million existing homes available for sale, which represents a 7.2-month supply at the current sales pace, up from a 6.5-month supply in November. Raw unsold inventory is 11.1 percent below a year ago, is at the lowest level since March 2006, and is 28.2 percent below the record of 4.58 million in July 2008.”

It Could Have Been Worse

The obvious saving grace of 2009 was the introduction of a real tax credit for first-time homebuyers. The “credit” introduced in 2008 under the Bush Administration was actually an interest-free loan that had to be repaid to Uncle Sam. The 2009 version under the Obama Administration was an outright tax credit of up to $8,000 for buyers and $6,500 for homesellers. It’s not a loan of any sort and there’s nothing to pay back for those who qualify. Look here for tax-credit specifics.

There’s no doubt that the tax credit for first-time homebuyers boosted sales. The worry is this: What happens when the credit ends, supposedly for contracts made before the end of April. Will the market.

NAR says “distressed homes, which accounted for 32 percent of sales last month, continue to downwardly distort the median price because they generally sell at a discount relative to traditional homes in the same area.”

If it’s true that distressed homes downwardly distort the market, then is it not also true that first-time homebuyer and existing home seller credits upwardly distort the marketplace? What about foreclosure moratoriums which kept homes off the foreclosure rolls? How about the government’s Make Home Affordable program which has delayed hundreds of thousands of foreclosures and saved a number of homes with new financing? And interest rates below 5%? Surely that’s an upward distortion….

Looking Toward 2010

What about 2010? Given the continuing steep rates of unemployment, massive numbers of option ARMs that will be re-cast this year and next, and huge numbers of unsold foreclosures — that shadow inventory which has been in the news — look for both tax credits to be extended and high rates of foreclosure to continue during the coming year.

As to prices, for what it’s worth, I expect to see more metro areas with rising prices in 2010, areas outside such major foreclosure centers as California, Florida, Arizona, Nevada, Michigan, Georgia, Ohio, Texas, and Illinois.

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The investor double standard is hardly hidden. It appears everywhere and is never challenged, as if real estate investors are somehow disposable players in the foreclosure mess.

Alan S. Blinder, a professor of economics and public affairs at Princeton University and a former vice chairman of the Federal Reserve, could not be more clear: He suggests that the government should develop a federal program to buy out mortgages from lenders, just as it did during the Depression — to “refinance only owner-occupied residences. Speculators can fend for themselves — or go into default.” (See: From the New Deal, a Way Out of a Mess,, The New York Times, Feb. 23, 2008)

Our Secretary of the Treasury, Henry Paulson, says “as our economy works through this difficult period, we will look for additional opportunities to try to avoid preventable foreclosures. However, none of these efforts are a silver bullet that will undo the excesses of the past years, nor are they designed to bail out real estate speculators or those who committed fraud during the mortgage process. These efforts are to help American families who both want to and can, through a loan modification or re-financing, stay in their homes.”

Introducing the Hope Now program in August 2007,  President Bush said ”we’ve got a role, the government has got a role to play — but it is limited. A federal bailout of lenders would only encourage a recurrence of the problem. It’s not the government’s job to bail out speculators, or those who made the decision to buy a home they knew they could never afford.”

Why is someone who invests in real estate a “speculator” while corporations that lose billions of dollars hedging mortgage-based securities can count on the Federal Reserve to reduce short-term interest rates to bail them out?

The idea that we can pick and choose among borrowers with toxic loans produces several false notions.

• Misconception #1: If we only make owner-occupants whole then local real estate markets will recover. This is untrue. Why? Because investor properties lost to foreclosure will continue to flood the market, driving down all home values.
• Misconception #2: It’s not a public policy problem if large numbers of real estate investors fail, they should have known better. This also is untrue. Why? Because when buyers look at recent home sales they do not distinguish between homes sold by owners and homes sold by investors, they merely look at sale prices.
• Misconception #3: Real estate investors who fail are universally frauds and thieves. Mr. Paulson equates real estate investors with those who commit fraud, an outrageous comparison. When Mr. Paulson worked on Wall Street and earned millions of dollars, did he once say that those who invested in stocks and bonds were also swindlers?

Who Is A Real Estate Investor?

Economists believe there are four basic sources of wealth: land, labor, capital and entrepreneurial ability. There’s no shortage of seminars, books and tapes which explain in glowing detail how you too can become rich with real estate, even if you lack experience, cash or credit. While program developers always have success stories to share, they never say what percentage of their readers, attendees or listeners actually become rich. The reason, of course, is that the real money is not in real estate, it’s in seminars, books and tapes.

But get-rich-quick plans aside, real estate has been a major source of personal wealth for many people. Long-term holders of real estate have commonly benefited from property prices which have increased faster over time than the rate of inflation, thus creating increased buying power and real wealth. According to the National Association of Realtors, the median price of an existing home rose from $124,800 in 1998 to $201,100 as of January 2008.

It’s not just individuals who benefit from real estate investing, it’s also local communities.

Why Investors Count

The Census Bureau says that in the third quarter of 2009 there were 130.3 million housing units in the U.S. These units can be divided into two categories, the 75.2 million that were owner-occupied and the 52.8 million that were not. In latter group we have second homes and investment property.

Imagine the cost of housing if we discouraged real estate investment. Does anyone seriously think that the government would — or could — step in to create the housing stock required to replace millions of investor-owner units?

The value and importance of investment real estate is obvious and overt: In many communities there’s a homestead deduction for owner-occupants but not for identical properties owned by investors. In other words, investors commonly pay higher tax rates than homeowners for properties that are exactly alike. Does it make sense to drive away those additional tax dollars by discouraging investment?

Lenders, of course, gleefully finance investor properties with higher rates and tougher qualification standards than they require from owner-occupants. They would not make such loans if they produced ongoing losses, and they surely would not originate such mortgages without proper underwriting and appraisals.

Government policies encourage the purchase of investment real estate by allowing investors to depreciate property over time; engage in tax-deferred exchanges; and deduct mortgage interest, property taxes, insurance and repairs. In many cases small investors can write off paper losses against ordinary income.

Given the enormous fall in home sales, would it not be smart to encourage investors to enter the marketplace, absorb inventory and increase the number of buyers looking for properties? Alternatively, if unit sales continue to plummet, does anyone doubt that home values will follow?

“The exclusion of investors from government programs needs to be reconsidered,” says Jim Saccacio, Chairman and CEO at RealtyTrac.com, the leading online marketplace for foreclosure properties. “Saving investors from foreclosure would keep additional properties off the market, thus reducing inventories and perhaps returning home values to normal more quickly than would otherwise be possible. In addition, we should encourage investors to enter the marketplace to absorb as much inventory as possible. By increasing the pool of potential buyers there would be less pressure to reduce home prices.”

_________________________________

Published originally by RealtyTrac.com in 2008 and posted with permission.

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But for those with real estate the load is made lighter by tax rules which encourage the ownership of homes and investment property. Such rules are not only good for homeowners, they’re also good for the country: About 20 percent of all economic activity nationwide is related to real estate, so policies which encourage real estate activity help everyone.

It seems that almost every year changes to the tax code require the production of new forms and a re-education process. That said, the real estate basics remain in place and they’re good news for buyers, sellers, borrowers and owners.

Mortgage interest is generally deductible.

The IRS says there are three categories of deductible home mortgage interest:

1. Mortgages you took out on or before October 13, 1987 (called grandfathered debt).
2. Mortgages you took out after October 13, 1987, to buy, build, or improve your home (called home acquisition debt), but only if throughout 2005 these mortgages plus any grandfathered debt totaled $1 million or less ($500,000 or less if married filing separately).
3. Mortgages you took out after October 13, 1987, other than to buy, build, or improve your home (called home equity debt), but only if throughout 2005 these mortgages totaled $100,000 or less ($50,000 or less if married filing separately) and totaled no more than the fair market value of your home reduced by (1) and (2).

Substantial profits can be sheltered when a prime residence is sold.

When a prime residence is sold, up to $500,000 in profits can be sheltered from federal taxes if married, $250,000 if single, providing the home has been used as a prime residence for two of the past five years. Generally this deduction cannot be used more than once every two years, according to the IRS.

There are also provisions which may be helpful to individuals who must sell a prime residence in less than two years. Under the 2004 safe harbor rules, individuals may be able to get some capital gains relief under certain circumstances, such as being forced to move because a job has been relocated at least 50 miles or a home that must be sold because of multiple births resulting from the same pregnancy.

Also, individuals in the Armed Forces and the Foreign Service may be entitled to special consideration under the Military Family Tax Relief Act of 2003 (MFTRA). For instance, you may have longer to take a capital gains deduction or to amend a tax return. There are other provisions under MFTRA that also may be helpful, so check with a tax professional for specifics.

Lastly, please see the information below regarding the new tax credit of up to $6,500 which is available to certain owners who obtain a contract to buy their current residence before April 30, 2010 and close before June 30, 2010.

Points may be deducible by both buyers and sellers.

Picture a situation where a home is sold for $500,000 and the owner — to help close the sale — offers to pay 1 point for the buyer. If the property was financed with a $350,000 mortgage, a point would be worth $3,500. According to the IRS, “the seller cannot deduct these fees as interest. But they are a selling expense that reduces the amount realized by the seller.”

Interestingly, in this situation the buyer can also deduct the points when the home is sold.

“The buyer,” says the IRS, “reduces the basis of the home by the amount of the seller-paid points and treats the points as if he or she had paid them.”

In effect, the seller gets to write-off the $3,500 cost by reducing any profit from the sale. The buyer essentially lowers the purchase price of the property when the home is sold at some point in the future — thus increasing the size of any profit. However, since up to $500,000 in sale profits may be untaxed, most buyers will effectively never pay a tax on the seller’s contribution for points.

If a prime residence is refinanced then the deal with points is different: The expense of a point must deducted over the life of the loan. If the home is sold before the loan term ends, then any cost not deducted for points can be used to reduce owner’s profit from the sale.

Home offices may be deductible.

If a portion of your home is used regularly and exclusively as your principal place of business or for the convenience of your employer it may be possible to write off a portion of such costs as mortgage interest, property taxes and utilities. There are a number of tests which must be met to take this deduction, see IRS Publication 587, Business Use of Your Home for details.

In some cases there may be tax advantages associated with not deducting your home office in the year or two before you move. Speak with a tax professional for specifics.

Mortgage insurance premiums may be deductible.

Mortgage insurance premiums should be deductible. The catch? Not all mortgage insurance premiums are deductible by all borrowers. In general, the rules look like this:

• The deduction applies to loans made after January 1st, 2007.
• The deduction applies to both private mortgage insurance (MI) as well as mortgage insurance through the Federal Housing Administration (FHA), the Veterans Department (VA) and the Rural Housing Administration.
• The deduction applies to acquisition indebtedness, meaning debt used to acquire a home.
• If you refinance remaining “acquisition indebtedness” then you can write off mortgage insurance on the new debt.
• You can take the deduction if you’re married, file jointly and have a gross adjusted income of $100,000 or less. If you’re single or married and filing separately the income limit is $50,000.
• The deduction phases out once income limits are passed. For married couples, the deduction is reduced by 10 percent for each $1,000 in income over $100,000. This means there is no deduction for incomes above $110,000. For singles and those married and filing separately, the deduction is reduced by 10 percent for each $500 in additional income — this means there is no deduction above $55,000.
• The mortgage premium write-off begins January 1, 2007 and is scheduled to end December 31st, 2010. However, the program is likely to be extended.
• Speak with a tax professional for specifics.

Natural Disasters

The Katrina Emergency Tax Relief Act of 2005 provides extensive tax benefits and assistance to those who were victims of hurricanes Katrina, Rita and Wilma. For details, go to the IRS Katrina relief page or call 1-866-562-5227.

If you have been in a natural disaster — a flood, hurricane, tornado, etc., contact your local congressional office to see if special tax help is available. Links to congressional offices can be found by pressing here.

Mortgage Forgiveness Act

Traditionally if you do not pay off a mortgage in full when a home is sold or foreclosed any money not repaid is regarded as “imputed” income — income which is taxable. However, with the passage of the Mortgage Forgiveness Debt Relief Act of 2007, if you can negotiate a partial pay-off with a lender, the amount forgiven will not be taxed by the federal government.

This legislation makes sense because people who have lost their homes, been foreclosed or gone bankrupt have no money to pay. However, the maximum write-off is limited to forgiveness worth no more than $2 million (not a problem for most folks) and — more importantly — the rule applies only to a principal residence.

Some questions to ask: When does this law end? Are home equity loans covered? What about state rules?

The $8,000 Tax Credit For First Time Buyers Extended Until April 30, 2010

Under the FHA reform package passed by the Congress during the summer of 2008, first-time home buyers could be entitled to a tax credit equal to 10 percent of the purchase price of the residence. This credit is limited to $7,500 for married couples and single taxpayers but can be no more than $3,750 for married individuals filing separately.

Since most homes are valued at more than $75,000 the credit will likely be used up with the purchase of a home or condo. The property must be occupied after April 9, 2008 but before July 1, 2009 to qualify. Also, a “first-time” buyer is defined as someone who has not held title to real estate for at least three years. The credit phases out for married couples earning above $150,000 a year and for singles earning more than $75,000.

The catch.

The $7,500 is a credit against taxes due to Uncle Sam. If you owe $10,000 to the IRS you can deduct up to $7,500. But, when you sell the property the $7,500 must be repaid over 15 years — that’s just $500 a year at some point in the future.

Okay, it’s really a $7,500 loan — without interest and when you really need it.

2009 First-Time Homebuyer Credit (Part 1)

In 2009 the deal changed. Under the American Recovery and Reinvestment Act of 2009 the credit amount was raised to $8,000 and NO repayment is required if a first-time homebuyer purchases a residence before December 1, 2009. There is still an income phase out and buyers must own their homes for at least three years.

2009 First-Time Homebuyer Credit (Part 2)

In November 2009 the deadline for the first-time homebuyer credit was extended under the Worker, Homeownership, and Business Assistance Act of 2009 from December 1, 2009 to include contracts made before April 30, 2010 and closed before June 30th.

Also, the income cap to get the full credit was raised from $75,000 if single or $150,000 if married to $125,000 for singles and $225,000 for joint filers. Above the $125,000/$225,000 levels the credit phases out to nothing at $145,000 for singles and $245,000 for couples.

New Credit for Existing Home Sellers

The November 2009 legislation also created a new tax credit for existing home sellers. In basic terms, if you have owned your home for five consecutive years out of the last eight you can get a tax credit for 10 percent of the purchase price but not more than $6,500. The contract to sell your replacement residence must be signed before April 30, 2010 and the deal must be closed before June 30, 2010. The sale price of the property cannot exceed $800,000.

For specifics regarding the November 2009 changes, speak with a tax professional and get a copy of IRS Form 5405. Also, see the IRS first-time homebuyer site for details regarding the new legislation.

Tax Credit For Military Personnel, Foreign Service Personnel and the Intelligence Community

The National Association of Home Builders points out that “the law provides qualified service members who served on official extended duty outside of the United States for 90 days or more at any time between Jan. 1, 2009, to April 30, 2010, another year to buy a home and claim the credit. They have until April 30, 2011, to sign a sales contract, and until June 30, 2011, to settle and close on the home. Both the $8,000 first-time and $6,500 repeat home buyer tax credits are included in the rule.”

“Qualified service members” are defined as a member of the uniformed services of the United States military, a member of the Foreign Service of the United States, or an employee of the intelligence community, according to the association.

For additional information, please speak with a tax professional and see: http://www.federalhousingtaxcredit.com/service_mem.php

Investment real estate can generate substantial write-offs.

If you own rental property you must seek a fair market rental for your property. You may generally deduct mortgage interest, property taxes, repair costs, management by an outside party, depreciation, advertising, insurance, utilities, legal services and other expenses.

It’s possible with rental properties to have both a positive cashflow and a loss for tax purposes. However, the ability to use real estate losses to reduce overall taxes may be phased out as income rises above $100,000.

If a rental involves relatives special rules and restrictions may apply. Check with a tax pro for details.

A 1031 exchange may allow investors to defer all capital gains taxes.

With a 1031 transaction, investment property is exchanged for “like” real estate. The basic requirements are that within 45 days after the “relinquished” property has been sold, a “replacement” property must be identified. The identified replacement property must then be acquired within 180 days after the sale of the relinquished property.

What’s important about a 1031 exchange is that the capital gains tax on the relinquished property is deferred — but it does not disappear. What really happens is that the basis for the new property (the “replacement property”) is reduced by the adjusted value of the “relinquished property” (the old property).

A 1031 exchange is complex and requires the services of a “qualified intermediary.” Among other tasks, a qualified intermediary holds the money from the sale of the relinquished property and applies it to the purchase of the replacement real estate. This must be done because under the rules for 1031 exchanges, the seller of a relinquished property cannot touch money from the sale — it must be held by the qualified intermediary.

Accounting for a 1031 exchange is also complex. Good sources of information include IRS Form 8824, IRS Publication 544, the website www.1031.us and tax professionals.

Death of a Spouse

The capital gains write-off for the sale of a home is $500,000 if married and $250,000 if single. But what happens if a spouse dies?

For years the rule has been that if the couple’s home was not sold by December 31 of the year when the spouse passed then the surviving spouse would be treated as a single home seller. In other words, the maximum write-off would go from $500,000 to $250,000.

There is a certain logic to this approach — and also a certain cruelty. If a spouse dies on November 30th the surviving spouse would have about four weeks to sell the home. This hardly seems right but now the rule has been changed.

Under new legislation passed by Congress, after December 31, 2007 surviving spouses will now have two years from the date of passing to sell the property and still qualify for the $500,000 write-off.

Gifts

For 2009 you can give someone as much as $13,000 per year, tax free. This is up from $12,000 in 2008. For gift information from the IRS, press here.

Sources and Publications

You can be certain that the information presented here is not a substitute for professional advice. As always with taxes, nothing is ever simple or easy. Speak with a qualified tax professional for specific advice — an enrolled agent, a CPA or an attorney who specializes in tax issues.

Also, the IRS itself has excellent information at its website, www.irs.gov, by phone at 1-800-829-1040 and with specialized publications such as those below:

• Publication 523, Selling Your Home
• Publication 527, Residential Rental Property
• Publication 530, Tax Information for First-Time Homeowners
• Publication 535, Business Expenses
• Publication 587, Business Use of Your Home
• Publication 936, Home Mortgage Interest Deduction
• Publication 946, How To Depreciate Property

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The original HUD-1 was developed as a by-product of the Real Estate Settlement and Procedures Act of 1974 — or, as it’s usually called, RESPA. Prior to 1974 settlement forms could be different, meaning that it was very difficult to compare costs or to know what was deductible for tax purposes in the year of the transaction.

So what do we get after 36 years? The new HUD-1 is a vast improvement over the old model. It’s three letter-sized pages long rather than two legal pages, but there’s much more information in the new HUD-1. Buried in the form is an accounting of closing costs and perhaps even some write-offs. Buyers will find the full and complete cost of buying real estate while sellers will see how much cash (if any) they’re getting from the transaction.

Page One

The first page of the form is a summary of the transaction. In effect, it translates the sales contract between buyers and sellers into hard numbers.

At the top of the form we first have administrative data such as:

• The type of loan (conventional, VA, FHA, etc.).
• The place and date of settlement (the date can be very important for tax purposes).
• The mortgage insurance case number (important if you’re ever facing foreclosure).
• The street address of the property. This is a concern because for great clarity and assurance the form would be better if it also included the legal address of the property.
• The name of the settlement (or closing) agent. The party that conducts the settlement is typically regarded as an agent of the settlement process. In other words, they do not represent you.

Page One, Buyer’s Side

The HUD-1 shows transaction costs for both buyers and sellers — you get to see what the other person’s information. More important you get to see your own.

On the right side of the first page we have buyer costs grouped by sections.

Section 100 — This is where buyers see the cost of the property and the cost of settlement (the figure found on line 1400). Combine the two and you get the gross amount — but not the final amount — due from the purchaser.

Notice that there can be some adjustments in this section. For instance, it may be that the seller has paid local property taxes in advance — those payments would be a credit to the seller and a cost at closing to the buyer.

Section 200 — As a buyer you may have certain credits to offset your gross costs. Credits include such things as your deposit, your new loan (for closing purposes the mortgage is a credit to the borrower because it represents money brought into closing) and any additional financing.

In the 200 section you can also see adjustments which are a credit to the buyer. For instance, maybe the seller still owes some property taxes.

Section 300 — This is a re-cap of all costs and credits. If you take the gross amount due from borrower (line 120) and subtract the buyer’s credits and cash you then get the total cash due to — or from — the borrower.

Most buyers, of course, will need to bring “cash” to settlement. By “cash” what most settlement agents really want is a certified check or a cashier’s check. Also, it may be possible to wire funds to the closing agent. Always ask the settlement provider well in advance of closing how payment can be made.

Gifts: To assure lenders that you are not somehow getting a secret loan from someone, it’s best to have closing funds in your name and on deposit for at least 90 days. If you are getting a gift to close, ask your lender how the gift is to be documented and precisely follow the lender’s instructions.

Page One, Seller’s Side

Settlement is a moment of truth for owners, the time when you find out exactly how much or how little you’re getting from your sale.

Section 400 — The sale price of the house, plus the cash paid for any personal items, are shown here as credits to the owner.

Also in this section are adjustments — credits for property taxes and other costs paid in advance.

Section 500 — If any mortgage debt remains unpaid it shows up here as a cost to the seller. Also, the costs of closing (line 1400) are here as a deduction as well as any adjustments for such costs as unpaid property taxes.

Section 600 — If we take the gross amount due to seller (line 420) and subtract the seller’s closing costs (line 520) we can then see how much cash the owner will get from closing (or, how much cash is needed to close if the seller is upside-down).

Practices around the country regarding cash to owners at closing vary. In some areas there are “wet” settlements where the owner gets a check at closing, in other areas there are “dry” closings where it takes a few days to get a check because it takes time for the lender to fund the transaction and paperwork to be recorded. In some jurisdictions there are rules requiring the disbursement of cash with a few days. For specifics, speak with your settlement agent.

Page Two

On the second page of the new HUD-1 we have a series of sections which show costs that may be paid by either buyers or sellers — or split between them. In other words, these are costs which can be negotiated when a sale offer is made. For instance, in a slow market a seller might agree to pay all transfer taxes. In a hot market, the buyer might pay.

Section 700 — If one or more real estate brokers are involved in the transaction, this section will show the compensation to each broker and the cost, if any, to buyers and sellers.

Section 800 — Getting a mortgage is hardly free. When the buyer applied for financing the lender provided a Good Faith Estimate of Closing Costs (GFE) on the new form developed by HUD. This section shows such costs as points, origination charges, appraisal fee, credit report and tax service. Borrowers should check the numbers at closing with the estimates provided in the GFE. The costs shown on lines 801 (origination charge), 802 (points), and 803 (adjusted origination fee) must be the same as the GFE.

Please see our guide to the new Good Faith Estimate form to see how it’s coordinated with the equally-new HUD-1.

Section 900 — Closing is scheduled at a time which is mutually-agreeable to the buyer and seller. That time, however, will mean that for such items as interest, mortgage insurance premiums and homeowner’s insurance there will likely be a need to make some payments for daily costs in advance until the next billing period.

Section 1000 — If you purchase a home with less that 20 percent down the lender will likely require that you pay additional amounts each month for property taxes and insurance. This money is held in an escrow or trust account and then paid out as the bills come due.

If you will have an escrow account then the lender will typically collect money in advance from borrowers to assure that the escrow account is properly funded.

Section 1100 — As part of the buying process, sellers typically promise to deliver good, marketable and insurable title — and buyers should want nothing less. This section shows the costs for title insurance — both lender’s and owner’s coverage.

Lender’s cover — which is required by lenders if you finance the purchase — protects you up to the remaining loan balance in the event of a title claim. In other words, it protects the lender.

Owner’s coverage protects you if there is a title claim up to the purchase price of the property — in other words the loan amount plus your equity. Be aware that some title insurance policies have an inflation rider so that the value of the coverage can actually increase over time. For specifics, speak with your title agent.

Also, take a look at line 1107. This shows the commission paid to the settlement agent for providing title insurance.

Section 1200 — This is where you can see how much state and local governments are getting from the transaction. Governments are elated when homes are sold because such transactions are a major source of revenue. Government taxes can includes such things as deeds, releases, transfer taxes, state taxes, stamps, etc. Call it what you will, a tax is a tax.

Section 1300 — This is where you can find additional settlement costs.

Section 1400 — The total costs to close — this number also appears on lines 103 and 502 on the first page.

Page Three

The third page of the new HUD-1 is partially a confirmation that the costs outlined in the Good Faith Estimate are what you’re actually paying — or pretty close.

Some quoted costs on the GFE cannot be changed, some can be changed as much as 10 percent and some can simply change with the winds.

Also shown on page three is a recap of your loan including the mortgage amount, interest rate, loan term, ARM-related terms (if any), prepayment penalties (if any), balloon payments built into the loan (if any) and related matters.

IMPORTANT: Always keep your closing papers in a safe place for tax reasons and to assure that your loan terms are actually the same as disclosed on the HUD-1. For questions regarding closing issues, speak with your real estate broker, mortgage lender and closing agent. Be aware that some costs found on a HUD-1 may be tax deductible — for specifics speak with a tax professional.

How To Read The HUD-1 is a post from: Refinance, Home Mortgage Loans & Rates, Home Equity Loan

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Ugh. You can see where this is going.

“The first alternative would reduce the maximum mortgage eligible for the interest deduction from $1.1 million in 2012 to $500,000 in 2018 by annual decrements of $100,000 each. That change would boost revenues by only $400 million in 2013 but by $41 billion over 10 years. The $500,000 cap would affect more homeowners in later years as incomes increase and housing prices rise.

“The second alternative would replace the deduction with a 15 percent tax credit for interest on mortgages below the declining limits in the first alternative. (In 2005, the President’s Advisory Panel on Federal Tax Reform proposed a variant of that approach.) The change would reduce taxes for some owners and raise them for others, with a net increase of $13 billion in 2013 and $388 billion over the period from 2013 to 2019.”

Here’s an easier way to raise tax revenues: How about taxing overseas profits? How about having hedge fund operators pay income taxes rates and not capital gains rates on their compensation? How about doubling the tax on any company that sends U.S. jobs overseas?

Real Estate: Will Mortgage Interest Write-Offs Be Reduced? is a post from: Refinance, Home Mortgage Loans & Rates, Home Equity Loan

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But for those with real estate the load is made lighter by tax rules which encourage the ownership of homes and investment property. Such rules are not only good for homeowners, they’re also good for the country: About 20 percent of all economic activity nationwide is related to real estate, so policies which encourage real estate activity help everyone.

It seems that almost every year changes to the tax code require the production of new forms and a re-education process. That said, the real estate basics remain in place and they’re good news for buyers, sellers, borrowers and owners.

Mortgage interest is generally deductible.

The IRS says there are three categories of deductible home mortgage interest:

1. Mortgages you took out on or before October 13, 1987 (called grandfathered debt).
2. Mortgages you took out after October 13, 1987, to buy, build, or improve your home (called home acquisition debt), but only if throughout 2005 these mortgages plus any grandfathered debt totaled $1 million or less ($500,000 or less if married filing separately).
3. Mortgages you took out after October 13, 1987, other than to buy, build, or improve your home (called home equity debt), but only if throughout 2005 these mortgages totaled $100,000 or less ($50,000 or less if married filing separately) and totaled no more than the fair market value of your home reduced by (1) and (2).

Substantial profits can be sheltered when a prime residence is sold.

When a prime residence is sold, up to $500,000 in profits can be sheltered from federal taxes if married, $250,000 if single, providing the home has been used as a prime residence for two of the past five years. Generally this deduction cannot be used more than once every two years, according to the IRS.

There are also provisions which may be helpful to individuals who must sell a prime residence in less than two years. Under the 2004
safe harbor rules, individuals may be able to get some capital gains relief under certain circumstances, such as being forced to move because a job has been relocated at least 50 miles or a home that must be sold because of multiple births resulting from the same pregnancy.

Also, individuals in the Armed Forces and the Foreign Service may be entitled to special consideration under the Military Family Tax Relief Act of 2003 (MFTRA). For instance, you may have longer to take a capital gains deduction or to amend a tax return. There are other provisions under MFTRA that also may be helpful, so check with a tax professional for specifics.

Points may be deducible by both buyers and sellers.

Picture a situation where a home is sold for $500,000 and the owner — to help close the sale — offers to pay 1 point for the buyer. If the property was financed with a $350,000 mortgage, a point would be worth $3,500. According to the IRS, “the seller cannot deduct these fees as interest. But they are a selling expense that reduces the amount realized by the seller.”

Interestingly, in this situation the buyer can also deduct the points when the home is sold.

“The buyer,” says the IRS, “reduces the basis of the home by the amount of the seller-paid points and treats the points as if he or she had paid them.”

In effect, the seller gets to write-off the $3,500 cost by reducing any profit from the sale. The buyer essentially lowers the purchase price of the property when the home is sold at some point in the future — thus increasing the size of any profit. However, since up to $500,000 in sale profits may be untaxed, most buyers will effectively never pay a tax on the seller’s contribution for points.

If a prime residence is refinanced then the deal with points is different: The expense of a point must deducted over the life of the loan. If the home is sold before the loan term ends, then any cost not deducted for points can be used to reduce owner’s profit from the sale.

Home offices may be deductible.

If a portion of your home is used regularly and exclusively as your principal place of business or for the convenience of your employer it may be possible to write off a portion of such costs as mortgage interest, property taxes and utilities. There are a number of tests which must be met to take this deduction, see IRS Publication 587, Business Use of Your Home for details.

In some cases there may be tax advantages associated with not deducting your home office in the year or two before you move. Speak with a tax professional for specifics.

Mortgage insurance premiums may be deductible.

Mortgage insurance premiums should be deductible. The catch? Not all premiums are deductible by all borrowers. In general, the rules look like this:

• The deduction applies to loans made after January 1st, 2007.
• The deduction applies to both private mortgage insurance (MI) as well as mortgage insurance through the Federal Housing Administration (FHA), the Veterans Department (VA) and the Rural Housing Administration.
• The deduction applies to acquisition indebtedness, meaning debt used to acquire a home.
• If you refinance remaining “acquisition indebtedness” then you can write off mortgage insurance on the new debt.
• You can take the deduction if you’re married, file jointly and have a gross adjusted income of $100,000 or less. If you’re single or married and filing separately the income limit is $50,000.
• The deduction phases out once income limits are passed. For married couples, the deduction is reduced by 10 percent for each $1,000 in income over $100,000. This means there is no deduction for incomes above $110,000. For singles and those married and filing separately, the deduction is reduced by 10 percent for each $500 in additional income — this means there is no deduction above $55,000.
• The mortgage premium write-off begins January 1, 2007 and is scheduled to end December 31st, 2010. However, the program is likely to be extended.
• Speak with a tax professional for specifics.

Natural Disasters

The Katrina Emergency Tax Relief Act of 2005 provides extensive tax benefits and assistance to those who were victims of hurricanes Katrina, Rita and Wilma. For details, go to the IRS Katrina relief page or call 1-866-562-5227.

If you have been in a natural disaster — a flood, hurricane, tornado, etc., contact your local congressional office to see if special tax help is available. Links to congressional offices can be found by pressing here.

Mortgage Forgiveness Act

Traditionally if you do not pay a mortgage in full any money not paid is regarded as “imputed” income — income which is taxable. However, with the passage of the Mortgage Forgiveness Debt Relief Act of 2007, a bill sponsored by Rep. Charles Rangel (D-NY), if you can negotiate a partial pay-off with a lender, the amount forgiven will not be taxed by the federal government.

This legislation makes sense because people who have lost their homes, been foreclosed or gone bankrupt have no money to pay. However, the maximum write-off is limited to forgiveness worth no more than $2 million (not a problem for most folks) and — more importantly — the rule applies only to a principal residence.

Some questions to ask: When does this law end? Are home equity loans covered? What about state rules?

$8,000 Tax Credit For First Time Buyers

Under the FHA reform package passed by the Congress during the summer of 2008, first-time home buyers may be entitled to a tax credit equal to 10 percent of the purchase price of the residence. This credit is limited to $7,500 for married couples and single taxpayers but can be no more than $3,750 for married individuals filing separately.

Since most homes are valued at more than $75,000 the credit will likely be used up with the purchase of a home or condo. The property must be occupied after April 9, 2008 but before July 1, 2009 to qualify. Also, a “first-time” buyer is defined as someone who has not held title to real estate for at least three years. The credit phases out for married couples earning above $150,000 a year and for singles earning more than $75,000.

The catch.

The $7,500 is a credit against taxes due to Uncle Sam. If you owe $10,000 to the IRS you can deduct up to $7,500. But, when you sell the property the $7,500 must be repaid over 15 years — that’s just $500 a year at some point in the future.

Okay, it’s really a $7,500 loan — without interest and when you really need it.

In 2009 the deal changed. Under the American Recovery and Reinvestment Act of 2009 the credit amount was raised to $8,000 and NO repayment is required if a first-time homebuyer purchases a residence before December 1, 2009. There is still an income phase out and buyers must own their homes for at least three years.

For specifics, speak with a tax professional before you go house hunting.

Investment real estate can generate substantial write-offs.

If you own rental property you must seek a fair market rental for your property. You may generally deduct mortgage interest, property taxes, repair costs, management by an outside party, depreciation, advertising, insurance, utilities, legal services and other expenses.

It’s possible with rental properties to have both a positive cashflow and a loss for tax purposes. However, the ability to use real estate losses to reduce overall taxes may be phased out as income rises above $100,000.

If a rental involves relatives special rules and restrictions may apply. Check with a tax pro for details.

A 1031 exchange may allow investors to defer all capital gains taxes.

With a 1031 transaction, investment property is exchanged for “like” real estate. The basic requirements are that within 45 days after the “relinquished” property has been sold, a “replacement” property must be identified. The identified replacement property must then be acquired within 180 days after the sale of the relinquished property.

What’s important about a 1031 exchange is that the capital gains tax on the relinquished property is deferred — but it does not disappear. What really happens is that the basis for the new property (the “replacement property”) is reduced by the adjusted value of the “relinquished property” (the old property).

A 1031 exchange is complex and requires the services of a “qualified intermediary.” Among other tasks, a qualified intermediary holds the money from the sale of the relinquished property and applies it to the purchase of the replacement real estate. This must be done because under the rules for 1031 exchanges, the seller of a relinquished property cannot touch money from the sale — it must be held by the qualified intermediary.

Accounting for a 1031 exchange is also complex. Essentially there is a need to figure out the sale value of the relinquished property, add back depreciation and account for financing. Ed Horan, a well-known exchange authority and the author of How To Do a Like Kind Exchange of Real Estate, has posted a free 13-page exchanging guide with an accounting worksheet that’s well worth reviewing before meeting with a tax pro.

Death of a Spouse

The capital gains write-off for the sale of a home is $500,000 if married and $250,000 if single. But what happens if a spouse dies?

For years the rule has been that if the couple’s home was not sold by December 31, 2007 then the surviving spouse would be treated as a single home seller. In other words, the maximum write-off would go from $500,000 to $250,000.

There is a certain logic to this approach — and also a certain cruelty. If a spouse dies on November 30th the surviving spouse would have about four weeks to sell the home. This hardly seems right but now the rule has been changed.

Under new legislation passed by Congress, after December 31, 2007 surviving spouses will now have two years from the date of passing to sell the property and still qualify for the $500,000 write-off.

Gifts

For 2009 you can give someone as much as $13,000 per year, tax free. This is up from $12,000 in 2008. For gift information from the IRS, press here.

Sources and Publications

You can be certain that the information presented here is not a substitute for professional advice. As always with taxes, nothing is ever simple or easy. Speak with a qualified tax professional for specific advice — an enrolled agent, a CPA or an attorney who specializes in tax issues.

Also, the IRS itself has excellent information at its website, www.irs.gov, by phone at 1-800-829-1040 and with specialized publications such as those below:

• Publication 523, Selling Your Home
• Publication 527, Residential Rental Property
• Publication 530, Tax Information for First-Time Homeowners
• Publication 535, Business Expenses
• Publication 587, Business Use of Your Home
• Publication 936, Home Mortgage Interest Deduction
• Publication 946, How To Depreciate Property

2009 Real Estate, Mortgages & Taxes is a post from: Refinance, Home Mortgage Loans & Rates, Home Equity Loan

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Buying with no money down in a rising market can be — with caveats — attractive. The caveats? First, there are no guarantees that either prices or rental rates will eternally rise. Second, less down means more debt and more debt means higher monthly mortgage payments. That’s not a problem — unless income declines or total payments increase and can no longer be carried.

The leverage gained when real estate prices are rising works in the opposite direction when prices and rentals stagnate or actually decline. And declines are possible: Japan, as one example, had what appeared to be a booming economy when the Nikkei reached 38,915 on December 29, 1989. Take a look at it now….

Or, look at various stock market crashes or the U.S. real estate market in 2007 and 2008.

The balance between risk and reward has largely favored those who have maximized risk in recent few years. But the same was once true for those who invested in “sure things” with great track records such as Fannie Mae, Freddie Mac, Enron and Worldcom….

Prepayments

There are surely circumstances where it makes sense to prepay a mortgage — but not always. For instance, before prepaying a mortgage it’s better to first pay off high-interest debt such as credit cards.

Prepaying a mortgage often works because most people in this country are not rich. For most, mortgage amortization — paying down principal over time — and simple real estate ownership are some of the surest ways to increase net worth over time, lower monthly living costs and increase inter-generational wealth.

For most people, putting an extra $50 a month into a mortgage means collecting change at the end of the day or not dining out once a month. In effect, prepayments are simply a better way to use money that might otherwise disappear.

No less important, for most people the choice is not an absolute, either/or decision to either place more money in a mortgage or to invest in stocks, bonds or whatever. Instead, the practical choice is to use some money for mortgage prepayments and other money for other purposes.

At 6 percent, a $100,000 mortgage costs $599.55 a month for principal and interest over 30 years. Add $50 a month and the loan will be repaid in 24.54 years. The potential interest bill will go from $115,838 to $91,292 — a savings of $24,546.

Is this a huge savings? Perhaps not in the context of indicted corporate executives, but $24,546 is a big number in most households.

Imagine that federal, state and social security taxes equal 25 percent of gross income. In such circumstances, an individual would have to earn $32,728 to net $24,546 in cash. Suddenly the persistent saving of $50 a month seems very attractive.

Taxes

Mortgage interest deductions make home financing more affordable because many owners have a greater ability to direct the use of their funds. However, tax deductions — by themselves — cannot justify real estate purchases. No one suggests paying 12 percent interest in a 6-percent market even though the tax write-offs would be greater.

Given a choice of paying mortgage interest with a tax write-off or paying less interest, it’s better to pay less interest. The usual example works like this: If you’re in the 25 percent bracket and pay $100 in interest, you can reduce your taxes by $25. That’s good. However, if you can avoid paying $100 in interest by getting a lower rate or having less debt your taxes increase by $25 because you have $100 less to write-off — but you have $75 extra in your wallet. That’s better.

The value of a mortgage deduction is not the same for everyone. If you’re poor you may not pay much if any income tax so the value of the mortgage write-off is minimal if non-existent. If you’re in the middle class, then mortgage interest deductions make ownership debt more affordable. If you’re doing well, current tax rules reduce your ability to write-off personal deductions once adjusted gross income tops $142,700 (if married and filing jointly) or $71,350 (if single). If there’s no state income tax where you live, there’s nothing to deduct at the state level no matter what your federal tax bracket and mortgage interest in most cases cannot be written off from federal returns for residential financing above $1.1 million. (See a tax pro for details.)

So there are situations where making a downpayment and prepaying a mortgage make real-world sense — and other situations where leverage is best. You have to look at such factors as personal economics, tax obligations, rates of return for alternative investments, risk, local real estate trends, mortgages rates and individual preferences — and then decide what’s right for you.

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Published originally by Realty Times on March 22, 2005 and posted with permission.

Should You Prepay Your Mortgage? is a post from: Refinance, Home Mortgage Loans & Rates, Home Equity Loan

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What’s interesting about the projected tax rises is that they are discriminatory. And because they are discriminatory, the result is that rental rates are bound to rise.

In my area if your home appreciates in value with rocket-like grace you can be certain that property taxes will not follow the same trajectory. The reason is that to save political hides residential property tax increases are limited to 10 percent annually.

Ten percent annually is hardly cheap. Other local jurisdictions have caps as low as 2 percent per year, a figure very much to my liking. And 10 percent a year compounded over a decade means a 259 percent tax increase — an increase which many owners are unable to afford.

One problem with the tax cap is that it does not apply to investment property — that’s where the discrimination comes in. If there are two identical homes side-by-side and one is rented and the other is owner-occupied the tax payments differ, even though there is no difference to the community in terms of road usage, school capacity or anything else; instead what we have is simply an artificial distinction, one designed to further inflate government coffers with as little political cost as possible.

If you want to limit the availability of rental homes, raising property taxes by absurd amounts is the way to go — especially in a community without rental control but with “suggested” annual rent limits — the most recent being 4.5 percent.

You don’t need a degree in finance to figure out that if property taxes rise at twice the rate of suggested rent increases then owning investment property becomes less attractive with each passing year — unless you raise rents to cover increasing costs. In effect, the by-product of discriminatory property tax policies is higher rents, rents justified by counter-productive public policies.

Local government does not build nearly enough affordable housing and every time a rental unit is sold and converted to owner-occupied status the situation gets worse. In effect, property tax policies are creating the very shortage of affordable rentals that every politician bemoans.

Moreover, those 10 percent tax increases may be acceptable for some residential owners, but surely that’s not the case for people with fixed incomes or limited incomes. For them, huge property tax increases virtually assure that they must move to a lower-cost community.

The end result of discriminatory taxing policies is both bigger government and fewer people who can afford to rent locally. We’re freezing out the teachers, nurses, tree cutters and plumbers that every community needs. The honest and trusted tradesman who fixes many homes on my street is a good example: He lives 80 miles away.

We can’t do anything about changing home prices, but combine rising home values with slanted taxing policies and perhaps the public will figure out that we cannot afford ever-expanding government services.

The issue is not that government is somehow evil, rather government is simply a special interest and like all special interests it seeks more for itself. Discriminatory property taxes hide the true cost of government and discourage real estate investment — two results which benefit the few at the expense of the many.

What to do? A 5 percent annual tax cap on all properties sure seems like a good issue for a referendum….

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Published originally by Realty Times on January 11, 2005 and posted with permission.

How Investment Discrimination Powers Real Estate Taxes is a post from: Refinance, Home Mortgage Loans & Rates, Home Equity Loan

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