TAXES, FEES & ALTERNATIVES

 Taxes, fees and regulations are a fact of life in the United States (and, arguably throughout the world). Each state will have a specific set of fees and tax requirements – including property tax. Additionally, tax regulations at the federal level tend to shift with legislative policy. Therefore, it’s beyond the scope of this book to dive deeply into taxes, fees and regulatory policies of home ownership. We highly recommend consulting a tax professional to understand your situation and advise you accordingly.

Tax Deductions

Home mortgage and property improvement deductions depend on many factors both at the federal and state level. While home ownership is attractive for certain tax deductions, you will need to have a conversation with a tax professional to understand what can and cannot be deducted concerning your home.

For a personal residence, depreciation is generally not allowed. What is allowed is a capital gain limit of $250,000 for individuals or $500,000 for married couples. If the profit made from a sale is under that amount, the federal capital gains tax is waived. The capital gains will only affect the amount of profit over those limits.

With investment properties, the personal residence allowance doesn’t exist. Instead, all profits made by the company are subject to taxes. The government will allow you to subtract deductions to lower that liability. Deductions include improvements, repairs and depreciation of the property.

Depreciation

In certain instances, the IRS allows an income tax deduction for recovering the depreciation of property. Depreciation is a theoretical loss of usable value. In plain English, it’s a write off that is based on the assumption that the building only has a fixed number of years that it can be used. For residential properties, that time period is 27 ½ years while for Commercial properties that time period is 39 years.

Home mortgage and property improvement deductions depend on many factors both at the federal and state level. While home ownership is attractive for certain tax deductions, you will need to have a conversation with a tax professional to understand what can and cannot be deducted concerning your home.

Fortunately, the IRS provides up to date and specific information at their website under Topic 704 – Depreciation and A Brief Overview of Depreciation.

Tax Deferred Installment Sale

Those of us who own real estate assets are often reluctant to sell because of capital gains taxes. When a property is sold, federal, state and local taxes may come due when there is a significant profit on the sale. Are there any alternatives to paying the capital gains immediately after the sale? The answer lies in the existing tax code in section 453.

The process starts when a property owner sells their property to a trust owned by a third-party during escrow. The trust then sells the property during the same escrow period. The trust “pays” you with a payment agreement called an “installment contract.” The contract promises to make payments to you over an agreed period of time. There are zero taxes to the trust on the sale since the trust “purchased” the property from you for what it sold it for. The payment is made with an installment contract, which makes payments to you over an agreed period of time.” The capital from the sale is then available in the trust to be reinvested in order to grow your wealth.

The options on when and how payments can be made are flexible. You may have other income and don’t need the payments right away. The tax code doesn’t require payment of the capital gains until you start receiving installment payments. The capital gains tax is paid to the IRS with an “installment plan” since only that portion of capital gains is due in proportion to the number of years established in the term of the installment agreement.

Federal Regulations

Federal regulations are a reality of property transactions. This is particularly true if the buyer is using a HUD (U.S. Department of Housing and Urban Development) program for the home purchase. Furthermore, due to the financial disaster of 2007-2008, which was predicated on nefarious mortgage lending practices, federal regulations have been installed to prevent predatory lending. Additionally, individual states have also enacted legislation regarding real estate property transactions. With that in mind, it’s important to research both Federal and local (state) laws regarding the buying and selling of real estate.

The Fair Housing Act

In order to protect buyers of real property, the United States Federal Government passed the Fair Housing Act, which was contained in Title VIII of the Civil Rights Act of 1968. This provided an expansion to the original bill of rights and made it illegal to discriminate on the basis of race, color, religion, sex and national origin.

This applied to all homeowners and representatives in the purchase or lease of real property. In 1974, sex was also added as a protected characteristic.

Seller Carried Financing

Seller carried financing is, as the name describes, where the seller becomes the mortgage lender. The upside of this scenario is when a seller is motivated to sell a home to a particular buyer but there are additional obstacles in terms of financing. Certainly, there are legal ramifications and additional regulatory requirements that need to be addressed on a case-by-case basis. Hiring a lawyer to draw up the legal documents is definitely a good idea.

Also, the best-case scenario for this type of financing is when the home is fully owned by the seller, meaning there is no mortgage (it has been paid in full or the home was a cash purchase). Usually, seller carried financing is short term – although 30-year loans aren’t unheard of.

Reverse Mortgage

Homeowners age 62 years or older have the opportunity to shift whatever equity they have in their home to cash. Summarily, the homeowner exchanges the equity for regular – usually monthly – cash payments. Initially, the program was designed to supplement retirement income.

There are several factors to consider before determining whether or not someone is eligible for a reverse mortgage: home value, interest rates and possible upfront costs. Also, the reverse mortgage must be the primary lien. Only primary residences are considered.

Lease

Leasing the property is another option. This is your usual scenario where the home is leased to renters based on a lease agreement. The property owner will still maintain the responsibility for property tax, repairs and general home maintenance. However, you will still reap the benefits of home ownership via any tax deductions available to you through state and Federal tax laws.

Lease-to-Own

Another option is for the seller to lease the property to a buyer who intends to buy the property after an agreed upon amount of time. There are so many options for this scenario including the seller crediting the monthly rent towards the home purchase. Conditions depend on the specifications within a contract between the seller and the buyer.

Subdivide

State laws and regulations vary regarding the possibility of subdividing a home or other property for rental or other financially beneficial purposes. Essentially, subdividing means dividing the home into several smaller units much like a condominium or an apartment.

Again, not all local laws allow this for single-family residential homes. If it’s a large piece of land, subdivision tends to be more feasible as you would likely build separate units as aligned with the aforementioned regulations.

For any type of subdivision, you will need to obtain official approval from state and local departments.

Renovate

Most of us have seen the home flipping television shows where a crumbling eye sore of a house is transformed into sleek, attractive property. Indeed, renovation is an option for those hard-to-sell homes that need something as simple as updated bathrooms or as complicated as a complete redesign (including knocking down walls and gutting the kitchen).

Always keep in mind that adding square footage to a home or digging out a pool in the backyard often requires approval from local and state bureaucracies. With that in mind, research the laws and converse with trusted contractors before you start swinging the sledgehammer.