Surprising Real Estate Tax Consequences

It’s no surprise that owning a home automatically opts you into a new realm of tax advantages. In fact, in a recent survey of people who bought homes in 2012, 79 percent said the mortgage interest and property tax deductions were "extremely important" factors to their decision to become homeowners in the first place.  

But these two deductions are just the tip of the iceberg of all the real estate-related tax guidelines, advantages and disadvantages.  Because others get less press, it can be relatively easy for an individual American taxpayer to unwittingly trigger tax liabilities they might have been able to minimize or plan for, or to unwittingly trigger tax perks and fail to claim them.

This is why its essential to touch base with your tax pro before any and every real estate move you make, no matter how minor you think it might be. Sometimes planning and timing makes a major difference to the financial impact of a real estate-related tax; other times, just knowing the size and scope of the tax implications will impact the real estate decision you make. 

Here is a short list of real estate moves that trigger surprising tax issues, pro and con:

1.  Refinancing.  American homeowners have been on a refinancing spree this year, spurred by continually low interest rates and a new resurgence in home values and equity. When you refinance into a lower interest rate mortgage than you previously had, the focus tends to be on the fact that your monthly payment is lower or that you can pay your home loan off faster with the same payment every month.  

What many fail to calculate for is that the tax deduction based on your mortgage interest is the largest tax perk of home ownership. Most homeowners are eligible to deduct 100% of the interest they pay on a mortgage up to $1 million on their primary residence.  So, if you reduce the interest you pay, you also reduce your mortgage interest deduction.

Here’s some perspective on this.  Less than 30 percent of homeowners take their mortgage interest deduction every year. This is thought to be because at lower income and home price levels, the standard deduction is higher than the itemized deductions for which many homeowners would be eligible. That said, if you do itemize every year and/or you have a relatively high (or growing) adjusted gross income, you might be surprised at your tax bill the year after you refinance to a lower interest rate. 

The best practice is to loop your tax professional in so they can help you plan for this and adjust your withholdings, if necessary, to avoid big surprise tax bills post-refi.

2.  Becoming a landlord.  Smart real estate investors get up to speed on capital gains tax laws, as its no surprise that selling a rental property at a profit triggers taxes, unless you exchange it for another. What’s trickier is when you become a more or less “accidental landlord.”  It’s not obvious to people who are renting out a room for a few nights here or there, or who decide to rent out part or all of their own home for the longer term (e.g., deciding to hold onto your starter home when you move up, versus selling it) that there are tax implications for being a landlord that should be researched and respected.

For example, rental income is subject to all the regular income taxes, federal and state (if applicable).  As well, in some cities, you might also be required to obtain a business license and pay business taxes, as a landlord.  Additionally, some municipalities are cracking down and requiring people who rent their home or portions of it for very short time frames to pay hotel taxes, which might be a cost you can pass down to your short-stay tenants. 

3.  Remodeling. The conventional wisdom is that when you remodel your home, whatever you do, for the love of all that is sacred, save your receipts. And this is not a ‘save them until tax time’ recommendation, it’s a ‘save them until you sell the place’ mandate!  The money you invest into improving your home over time gets added to your purchase price, or cost basis, when you sell, bringing down the amount the IRS considers to be profit or gain and reducing your chances of incurring capital gains tax. (Single home owners can realize $250,000 of “gains” above the cost basis of their home tax-free; marrieds, $500,000.)

This is no surprise to most homeowners. 

Here’s where many of us do get surprised - many remodeling projects popular with homeowners these days trigger local and state tax credits. This is especially the case for home improvements that increase your home’s efficiency, from low-flow toilets and shower heads, to dual-paned windows and insulation - even solar systems and tankless water heaters. If you are remodeling and improving your home’s efficiency at the same time, visit your state, county and city websites to see what tax credits or other financial incentives you might qualify for.

And whether or not your remodeling projects are eco-friendly, if you use a home equity line to finance them, chances are good that you can deduct the interest from that loan (up to $100,000) on top of your home mortgage interest deduction.  Again, don’t forget to mention this to your tax professional.

4.  Renting. Here’s the thing - most of us just don’t think about renting as an intentional decision.  It’s something many people do until they can afford to buy a home, or know where their career will take them geographically speaking.  But there are people out there who have sufficient income, assets and stability to own a home, yet haven’t developed any sense of urgency around it, for various reasons.

I don’t believe in suggesting that someone who truly doesn’t want to own a home should do so, simply for tax reasons.  But if you’ve been ambivalent about it or have been thinking about it and procrastinating, you should at least be aware of the tax implications of your fence-sitting. Some personal finance experts estimate that the average American renter works through the end of April just to earn enough income to pay taxes, federal, state, local and sales.  As you move up the income ranks, consult with your tax professional about whether home ownership might get you some tax relief.

More and More Homeowners Say Now Is The Time To Sell

In Fannie Mae’s most recent housing survey, consumers maintained their optimism toward home prices, while the share of consumers who said now is a good time to sell reached a record high. However, consumers in the survey were less optimistic about the economy and their own financial situation.

Nearly half, or 48 percent, of respondents in the February survey said they expect home prices to rise in the next 12 months, up from 45 percent in January. On average, consumers expect prices to rise by 2.9 percent over a year, up from 2.4 percent the month before.

Seventy-three percent of respondents said now is a good time to buy, an increase from 69 percent the month before. At the same time, 25 percent also believe now is a good time to sell, the highest level since the survey’s June 2010 inception.

“Despite fiscal headwinds and political uncertainty, consumer sentiment toward housing is robust and continues to gather strength,” said Doug Duncan, SVP and chief economist at Fannie Mae. “We expect home prices to firm further amid a durable housing recovery, gradually reducing the population of underwater borrowers and helping to boost the share of consumers who say that now is a good time to sell.”

Along with the increase in prices, more consumers also think mortgage rates will go up, with 44 percent of respondents expressing this view last month compared to 41 percent in January. Only 7 percent believe rates will go down.

With the year-end HARP deadline looming ahead, Duncan explained rising rate expectations should prompt some borrowers to refinance soon to take advantage of more favorable mortgage terms. As a result, Duncan said this should “add to their disposable income, helping to offset ongoing fiscal drag.”

As for views on rent prices, 50 percent of consumer expects rent prices to go up in the next 12 months, unchanged from the month before and at the highest level since the survey began.

A large majority of respondents, 67 percent, said they would buy if they were to move rather than rent, up from 65 percent the month before.

When asked about the economy, 53 percent of respondents said the economy is on the wrong track, unchanged from January.

Consumers were more pessimistic about their personal financial situation, with 41 percent believing it will get better, down from 43 percent the month before. More respondents said they think their financial situation will stay the same, with 41 percent of consumers expressing this view, up from 37 percent.

The share of respondents who said their household income is significantly higher compared to a year ago decreased over the month to 21 percent from 23 percent. However, 31 percent said their expenses are significantly higher, down from 38 percent in January.

Fannie Mae’s survey polled a representative sample of over 1,000 respondents.

Five Tips From Sellers to Buyers

The conventional wisdom is that buyers and sellers go together like oil and water. That is to say, they don’t go together at all. Some say they are at odds simply by virtue of sitting across the bargaining table from one another, which - along with negotiation and legal issues that are par for the home buying course - create the presumption that they want totally different things.

The prime example of competing buyer and seller interests is this: the buyer wants to pay as little as possible, while the seller wants to get top dollar for the place. But there is another way to look at this entirely.  In fact, there’s a point of view from which the buyer and the seller want exactly the same thing:  the buyer wants to buy the place, and the seller wants to sell it to them!  And I’ve seen many buyers and sellers act cooperatively to achieve just that result.

Nevertheless, there are things that sellers can see from their side of the table that you cannot. Sellers have insights into their own mindsets that, if revealed, can be very powerful tools in helping buyers optimize their approach, offer and interactions with the seller to both buyer’s and seller’s benefit. So, in the interest of helping both buyers and sellers move closer to an outcome that helps them both achieve their mutual goal, here are a few of the insider secrets from the seller’s side of the bargaining table that they would tell buyers, if they could.

    1.    Trashing my house doesn’t make me want to sell it to you at a discount.  To a seller, their home is their castle. It’s the place where they’ve raised their children, and has been the backdrop for many of their memories. It’s the asset into which they’ve invested the lion’s share of their time and money, sometimes for years.  It’s an intensive expression of their personal tastes.  And it’s also the asset they must convert into as much money as possible to move forward with the next phase of their lives.

All that said, the average seller knows most things about their home that you can see with the naked eye.  So if you, as a buyer, think trash talking a home, pointing out obvious flaws or issues is a good strategy for getting the price down, rest assured that you are not telling the seller anything they didn’t already know when they set the list price. In fact, you might very well be doing your case more harm than good, as this “strategy” is highly likely to alienate and insult the seller whose cooperation you seek.  

If you feel strongly that something about a place makes it less valuable than the comparables the seller seems to have based the list price on, work with your agent on how best to communicate your offer price rationale to the listing agent in a way that is diplomatic and fact-based.

    2.    Knowing that you have cash makes me feel comfortable taking your offer.  With distressed properties, over-asking multiple offers, and the generally warm-to-hot seller’s market in many areas, it has become increasingly common for sellers to request proof of a buyer’s “cash to close.” (This usually takes the form of bank or other asset account statements, with the sensitive account number information blacked out for security purposes.)

Some buyers in competitive situations have begun to proactively offer such proof, even when it hasn’t been requested, and even for non-cash offers.

Other buyers, though, take offense. Why shouldn’t the mortgage pre-approval letter be enough?  Why should you have to jump through yet one more documentation hoop?  Is the seller just plain nosy? Why are they all in your business?

One word: comfort. Over the last few years, the number of home sale transactions that went into - and fell out of - escrow due to last minute loan problems of pre-approved buyers hit a record high. While this is awful for buyers to go through, it’s even more disruptive for sellers, who are relying on the transaction to close in the time frame the buyer provided to move forward with their own lives. It’s also a worst case scenario for a seller who had 5 offers on the table to choose one and then have it fall out of escrow later on.

And sellers’ agents know this - often, the issues which derail a buyer’s loan can be resolved with money, extra cash down, extra cash at closing, extra cash to put in escrow for post-closing repairs required by the lender or the city.  So, proving that you have more cash than you appear to need to close the deal doesn’t necessarily set you up for the seller to ask for more cash - but it might help them feel that you’re the buyer most likely to sidestep mortgage obstacles and seal the deal.

    3.    It’s all about the Benjamins - but close-ability is a close second.  Buyers be on notice - all the love letters, cute dog pics and cookies in the world will not make your offer win out over others that are offering significantly higher than yours, financially speaking.  Now, please don’t write in telling me about the case of your cousin’s dog groomer’s tarot card reader who got a home for less than 10 other offers because she helped the little old lady seller take her garbage cans to the curb - most little old ladies need cash to get through their later years.

There is always an exception to the rule, and it does sometimes happen that a seller will take a slightly lower offer than the highest for one reason or another.  But if you’re trying to create a plan that stacks the decks in your favor in a multiple offer situation, your first priority should be to offer as much as you can, without spending beyond what is affordable for you and beyond the home’s fair market value.

That said, sellers also care - a lot - about how likely the offer they accept is to close escrow.  And when multiple offers get so numerous and so frenzied that buyers seem to be throwing money at a home, smart sellers pay attention to the fact that their home might very well not appraise at a crazily high price and focus on offers that seem realistic and close-able, which can mean offers below the highest.

Approval letters, proof of cash to close, the professionalism with which the offer is prepared and presented (see below), and even things like your credit score, your choice of mortgage broker/professional - all these things contribute to or detract from a seller’s estimation of how close-able your offer is.  If you’re competing against other offers, you should be maxing out both your price and your offer’s close-ability, as evidenced by these characteristics.

    4.    Your agent represents you to the world of sellers.  Choose wisely.  See above. A buyer’s broker or agent has a lot of influence on whether the transaction closes, and how smooth or bumpy the ride is. If your agent’s level of professionalism is lacking, it will show - and listing agents might actually rank your offer below others, in terms of close-ability.  If your agent’s level of professionalism is stellar, the opposite can occur.

Before you choose an agent, ask around your circle of friends and do a little online searching or even calls to past clients to see what you can find out about their reputation for professionalism.

    5.    Ask nicely - the old “flies with honey” adage is true. The conventional narrative about buyers and sellers is that they are adversaries. But I’ve been around this block a few times, and I think the average buyer would be absolutely gobsmacked at the number of times sellers are actually ready, willing and able to agree to their requests throughout a transaction. This is especially the case where:

1. the buyers’ requests are reasonable and not nickel-and-dime nitpicks
2. the buyers phrase their requests nicely, and
3. the buyers have been living up to their end of the bargain throughout the course of the transaction.

Compare this with buyers who try to hold sellers hostage to their requests with the threat that they’ll kill the deal if the seller doesn’t do every single penny-ante thing the buyer wants.  

I’ve seen sellers agree to leave valuable personal property behind, have repairs made, give thousands of dollars in repair credits or price reductions after a concerning inspection report - despite a hot seller’s market - all because they were good people, could afford to, and the buyer’s approach was more sweet than it was sour.