Housing

Rules You May Not Know About When You Use Your Home As An ATM

June 7, 2007 By Teri Newton Leave a Comment

The state of California recently reviewed a sample of state tax returns which claimed large mortgage interest deductions and found that 75% of the tax returns had claimed excessive interest deductions. There are rules that limit how much interest you can deduct for your mortgage and other monies borrowed against your house. However, historically, only the extremely wealthy would run up against these rules. Today with so much home equity, particularly in some of the more expensive coastal areas, many people are running afoul of the rules and don’t even realize it.

Most notable is that you can only deduct the interest on the first $100,000 that you borrow against your house for things other than home improvements. Also, when it comes to Alternative Minimum Tax (AMT), home equity interest deductions are completely disallowed. The state of California is cracking down on these deductions and is starting to do a large amount of audits on taxpayers with large mortgage interest deductions. It is likely that other states and the Federal government will follow suit, so it is a good idea to make sure you are aware of the rules. If you have been using your house as an ATM, that is when you really run into trouble. Here is a quick rundown of the rules when it comes to mortgage deductions.

In order to deduct home mortgage interest, the interest must be either acquisition debt or equity debt. If you borrow money against your home for investments or for business, you may be able to deduct the interest accordingly, as investment or business interest. It does get tricky and this method generally will be best if you borrow money solely for one purpose.

When it comes to borrowing money against a home for a mixture of uses, it can start to get really ugly. If nothing else, you need to keep the monies completely separate, and track the interest separately. Overall this is just meant to be a mention that this exists and is far beyond the scope of this article.

For purposes of this article, I will focus on what you can deduct on your Schedule A as home mortgage interest. The first type of mortgage interest I mentioned is acquisition debt. For mortgages taken out on or before October 13, 1987, the rules are a little different (this was the date of the last major change when it comes to home mortgage interest rules), but for the most part these mortgages will pass without meeting all the new rules.

For mortgages taken out after October 13, 1987, home acquisition debt is any money borrowed against a home to buy, build or improve the home, for a total amount of $1 million or less. Basically if the total of all your outstanding loans, secured against your home, to buy, build or improve said home, and the total is $1 million or less, then the entire interest is tax-deductible.

As a bonus, you can actually use acquisition indebtedness to cover a second home as well. A second home could include a boat or a trailer if it has a toilet and cooking facilities. So for example, you could take out a $1,000,000 mortgage to pay for a house and a motor home, and still be able to deduct all of the interest.

In reality, not very many of us are going to come up against the above mentioned threshold, but it is the home equity portion that is getting many taxpayers into trouble. Qualifying equity debt includes any mortgage taken out after October 13, 1987 that is not used to buy, build or improve a home. Only the interest paid on the first $100,000 of this debt is tax-deductible as regular mortgage interest. Anything beyond that is pretty much treated as non-deductible consumer debt.

Of course you read in the papers time and time again taxpayers are borrowing far more than $100,000 against their home for cars and vacations and other fancy things. This is common in areas like California where so many middle-wage earners have so much equity in their house which they can burn through.

Time and time again I see claims that is a great idea to borrow against your house for cars and to pay off consumer debts, because the interest is low and tax-deductible. This is the case for most people, but too many people are returning to their house as a constant source of cash, and over time don’t even realize their mortgage interest above a point is no longer even tax-deductible.

Also, keep in mind that these are the rules for married taxpayer. For single taxpayers, acquisition indebtedness caps at $500,000 and home equity caps at $50,000, or in other words these are half of the amounts stated above for married taxpayers filing jointly.

Overall, Turbo Tax and other similar programs are really not equipped to help you out in this area, as it does get complex. If you are concerned that you may run up against these rules, I suggest you meet with a CPA to make sure you are filing your tax returns correctly and to help you figure how much of your interest is truly tax deductible. IRS Publication 936 – Home Mortgage Interest Deduction – is also a wonderful resource for studying up on the home mortgage interest rules and how they apply to you.

The Fastest and Safest Way to Real Estate Wealth

May 26, 2007 By Amy L. Fontinelle 3 Comments

Since I live in an area of the country where housing prices are higher than what I can afford, I was considering buying property in a very affordable state where I used to live and renting the property out. That city has a lot of available duplexes and quadraplexes, so I decided to read up on the subject. Investing in Duplexes, Triplexes, and Quads by Larry B. Loftis, Esq., promises to teach you “the fastest and safest way to real estate wealth.” The author makes a very good case for his point of view.

Real estate provides a unique set of benefits which includes cash flow, appreciation, tax benefits, equity buildup, and leverage. With many other types of investments, you will only have one or two of these advantages. For example, a Roth IRA provides tax benefits and appreciation, but it doesn’t provide cash flow. As a second example, you can make money in real estate by putting up very little or sometimes even none of your own money (this is leverage)–you can’t do this with other kinds of investments. You can’t buy $10,000 worth of stock unless you have $10,000. The author says that everyone he knows who is wealthy accumulated their wealth through real estate, and that convinced him to enter the market.

Here’s his reasoning behind choosing a residential multifamily property (what duplexes, triplexes, and quads are called) over a single family home or a commercial multifamily property (one with five or more residential units):

If you only have one unit (a traditional house), any vacancy means a 100% vacancy, which means no cash flow and no help covering the mortgage or any of the home’s expenses until you fill the vacancy.
There is less competition to buy multifamily units because the only interested buyers are investors, whereas with a house you are competing with investors, people who want to live there, and flippers.
You get multiple rent checks while only having to manage one piece of property.
Transaction costs are low because you are buying and holding (as opposed to flipping).
You have the ability to put 0% to 10% down and get a fixed rate mortgage at a low rate (commercial requires 20% down and the loan is more expensive).
Residential multifamily properties will often be priced similarly to houses with the same square footage, meaning that if you can afford a decent sized house, you can afford a residential multifamily unit. But you can get more rent for the latter because while you probably can’t rent the house for the same amount as the mortgage (because almost anyone who could afford it would buy their own house instead of renting) you can rent a residential multifamily unit out for more than the mortgage since it is divided into multiple units.
They are easier to improve because you don’t have to leave the whole building vacant while you improve it. You can improve one unit at a time as tenants decide to leave. And when they leave, you can also raise the rent for that unit to its new, rehabbed market value. Cosmetic rehab will force appreciation for your building.
When you buy a residential multifamily property (or a commercial multifamily property), it will already have tenants–you walk right into the cash flow. That doesn’t happen if you buy a house as an investment property.

There are also significant tax benefits from owning a residential multifamily property. Earning money that is taxed at a lower rate (i.e. through selling your real estate investments) is key to achieving wealth, according to the author. Since the building has multiple units, you can live in one unit as your primary residence. This means that if you live there for at least two years, when you sell, you will be taxed the same way as homeowners are and you will not have to pay taxes on the first $250,000 of profit (or $500,000 if married filing jointly). (This tax break has a few more stipulations, but those are beyond the scope of this article.) If you don’t want to live in the property, as long as you wait at least a year before selling it, your gains will be taxed at the long-term capital gains rate of 15%, which is a significant savings over paying the short-term rate (which would be the rate of whatever tax bracket you’re in–presumably a high one if you can afford to own property).

The book breaks down the steps you’ll need to take and teaches you how to do the financial calculations you’ll need to do to choose successful investment properties. There are chapters teaching you how to:

Value your property
Find your property
Use a broker to your advantage
Conduct due diligence
Make an offer
Understand and manage closing costs
Manage your building
Sell your building
Find tenants

Another benefit of this book is that since the author is a lawyer, you get his legal expertise thrown in with his real estate experience, which is great since there are plenty of legal issues involved in buying, managing, and selling property, not to mention dealing with tenants. The book does have a few drawbacks, the biggest one being its unbridled optimism about owning real estate. I realize that the author has had great real estate success and the book’s tone reflects his own experiences, and that the book probably wouldn’t sell as well if it had a more balanced tone (i.e. you can make a ton of money in real estate, but you can also lose a ton of money). The author will occasionally allude to the possibility of losing money–for example, he’ll say things like that leverage can eat you alive if used improperly, but he won’t explain that further–he only explains how he’s used leverage to make incredibly successful investments. I think it would be helpful if he discussed his failures more so we could learn from his mistakes. Sometimes it’s hard to understand why a certain way is the right way unless you are familiar with the wrong way. Additionally, the book can be confusing at times if you are not a math person and don’t have the business background to understand things like leverage and return on investment. Though the book does try to explain it, I still had a hard time understanding these concepts.

Overall, I really enjoyed this book. I found it to be mostly very easy to understand for the beginning real estate investor and a real page turner (as far as investing books go). I would definitely recommend this book, as long as you take its unbridled optimism with a grain of salt.

What Should I Know About Taking In A Renter? (Your Advice)

May 21, 2007 By Jeffrey Strain 4 Comments

If you have extra space in your house, you may have considered renting out a room to bring in some extra cash and share the utility bill costs. One reader is thinking about doing such a thing, but wants to know if there are any hidden costs that he should be aware of:

I am curious about the hidden costs associated with renting out a room (from the perspective of a landlord). While I have managed property in the past, I was never responsible for the income, I just made sure there were enough people renting, that they paid rent and utilities on time, and kept the unit(s) in good condition. As a result, I’m not sure what to expect on the financial side of renting.
The reason I ask is that I am about to close on a condo purchase, and the condo I’ve found is somewhat larger than I need, so I will have space to rent a room. (I’m confident that purchasing is the right decision for me at this time, despite the state of the market. My mortgage will be very comparable to my current rental expenses, and the associated costs are not high enough to have a drastic impact on my lifestyle. The location I’m buying in is also one of the few that actually shows signs of growth in the near future.)
While the condo is within my abilities, I will be draining my savings significantly in order to make the down payment, and it will take some time to recover. I’m hoping that a renter can help shorten that recovery period. However, I’m concerned that the amount I can expect to get for the room (~$450-550 / month, based on the rental rates of similar rooms in the area) will be reduced so much for various reasons that the end contribution will not be worth the inconvenience of sharing a condo.
What can I expect to actually take home each month from a rental situation like this? Is this income going to be taxed just as my standard income, or is that treated as some small business, and taxed differently? When is it worthwhile to create a personal corporation and use the rental income to pay expenses pre-tax? (I’m assuming it’s *not* worthwhile for this, but I’m still curious.) Will having a renter make a significant change in insurance? (Am I liable if they
slip in the shower and become injured, for example?)

Would you consider renting out a room to bring in extra money? If you have experience with this, are there hidden costs or other issues which a first time renter should be aware of before proceeding?

Free Lodging When You Travel? Yep, It’s Possible.

May 12, 2007 By Jeffrey Strain 2 Comments

With the price of hotels eating up a larger piece of overall travel expenses, finding good accommodations at reasonable prices has become an important factor when planning any vacation. It is no longer unusual to have accommodation expenses amount to more than half of the total cost of a vacation. Not having to pay for a beautiful place to stay during your next vacation in not only a great deal, it’s also easily accomplished. It’s possible to stay in southern France, downtown New York or any other place in the world you’d like to visit without paying a single cent for the accommodations. All you need to do is look into one of the many vacation home exchange programs.

The basic rational behind these programs is that your house or apartment is an asset which people on vacation in your city would like to use. Instead of leaving this asset empty and unused while you are traveling, you lend it to someone else who happens to live in an area of the world you want to visit. A vacation home exchange allows you to trade your house with someone else so neither party will have any accommodation expenses while on vacation.

Home exchanges are not geared for the weekend traveler. People interested in these exchanges usually plan a minimum stay of two weeks, although shorter exchanges are possible. Not only does a home give an excellent base to take short day trips or longer weekend excursions, but it also gives you the advantage of instantly making you a part of the community in the city or country you’re visiting. This enables you to enjoy your vacation from a unique perspective unavailable to the average tourist.

The greatest worry most people have is whether or not their home is going to be in good hands. Although there are no guarantees, the odds are good that your house will be taken well care of. The families that exchange houses are usually well traveled and will have the exact same anxieties about their own house. House exchange agencies report that even minor complaints are rare, with lack of housekeeping topping the list. Frequent correspondences by mail or phone should build a trust which will ease the anxiety. It also never hurts to plan a meeting with your trading partner at one of your homes to begin the exchange.

Attempting to arrange a home exchange by yourself is possible, but troublesome. It usually entails taking out an advertisement in a local newspaper or magazine in the place where you want to travel. A much easier way is to go through one of the many home exchange companies which have thousands of listings all over the world. You list your house in their directory and receive a directory with periodic updates for a fixed price. It is also possible to receive the directories without listing your house for a small fee.

The home exchange company doesn’t actually arrange the home exchange. These services give you like minded contacts who may be willing to exchange accommodations with you. It is up to you to contact and make the arrangements with the individuals listed in the guides. The home exchange companies will provide useful information to help make the home exchange easy and thorough, as well as advice on how to avoid the most common problems.

Planning as far ahead as possible is essential and being flexible will greatly increase your chances of finding a good exchange. Participants are largely concentrated in north America and western Europe, with participants in other parts of the world much more scarce. No matter where you live, keep your expectations realistic. A person with a large house in a prime tourist city will have many more opportunities than a person with a small house in the countryside. The more attractive your home to other exchangers, the more opportunities you’ll have.

To increase your chances of finding an exchange partner, contact all the listed houses which you are interested in instead of each individually one at a time. The more letters you write, the better your chances are of finding an exchange partner. Also take the time to consider exactly what your house has to offer and what you expect in an exchange house. The more in tune you are with your expectations, the more likely you are to find the right partner for a house exchange.

With the continual rise in hotel prices, house exchanges are becoming extremely popular. It makes perfect sense. Not only do your receive quality accommodations exactly where you want them, you significantly cut your overall vacation expenses allowing for more time to get to know the city or country you decide to visit.

Why I Say Buy A Big New House

April 30, 2007 By Teri Newton 31 Comments

Hanging around the frugal online personal finance communities I see the general advice to buy the cheapest house you can afford. I disagree with this pretty heavily. We moved to a lower cost of living area in our early 20s because it was frankly the only way we could have the lifestyle we wanted to live and own a house. But we chose a large house in an upscale community and has turned out to be a wonderful investment.

Sometimes I regret not buying more (if we had taken the $400k house instead of the $300k house I would be on the beach sipping margaritas today, since those are worth over $1 million today). Obviously this just comes from market and timing more than the average housing market most of us face. But then again I never regret having bought more and seeing our house appreciate at a far faster clip than smaller homes.

Another thing is that I don’t necessarily view my house as an investment at face value, to me it is a place to live, and odds are I won’t cash it out in this life. But all the same, when you are in a high cost of living area and you have to plunk down a significant chunk of change, I think it is important to protect that investment. You want to protect your initial investment best you can, and you also want to make sure you can keep your mobility. If you go small and cheap with little regard for resale value, you might just find yourself stuck. Why not invest a little more in something that will give you a decent return and with high odds of keeping up with the market?

I also notice a lot of people buy a starter home in their 20s or 30s and then when they feel they have the money they upgrade to a much larger house in their 40s. I see this happen a lot. Maybe those of us in the personal finance community are more content to live in a modest house forever, and that is probably good. But I know people did not understand why we bought a 5-bedroom house when we had no kids, but we were planning ahead. We just didn’t want to have to move and settle again when it was time for kids. With our buying power we could have settled for something really small and cheap, but we really did search for value and hopefully something we would never want to upgrade. Just to simplify and help advert the mid-40s upgrade down the road.

Not only did we buy big, but we bought brand new. I would do it again in a heartbeat. We get a lot of assumptions, that a big, new house is very expensive to upkeep, the utilities and maintenance must be insane. Quite the opposite. Our first home was actually a newly renovated condo that we lived in for 2 years. Since it was all but new we never had any maintenance or repairs. We are now five years strong in our second home in the same situation.

The friends and family who went for the smaller cheaper houses have regular large repair and maintenance expenses. We have found it far more useful to limit those expenses the first few years of home ownership, so we could build a cash reserve as the house ages and the repairs begin to come up. Personally I expect it to be a long while. Materials and building techniques today are so advanced from decades past. Our roof is rated to last 50 years and the copper piping is expected to last even longer. These are just a couple of examples.

You could argue that we put a much larger initial outlay buying a bugger home. But when we bought the price differential was pretty small. Today it is huge, but we have just had far more appreciation because we bought a little more than the bare minimum. An aspect of a unique market perhaps.

Another strange assumption we find is that we must have insane utility bills. Actually, quite the opposite is true. Many homes built today meet very strict energy efficiency standards. We have found it pennies on the dollar to heat and cool this house where there is usually someone home 24/7, as opposed to when we merely spent nights and weekends in our condo, and the bills were far worse. Our average electric/gas bill is $50 per month. We don’t use the heat or air conditioning half of the year because the house self regulates in the milder months.

Another big plus is I don’t see any remodeling in our near future, everything is as we chose it and is brand new. I know too many people who bought the cheaper house but then sunk much into remodeling over the years.

I know buying bigger and newer is not always the smartest solution, but wanted to share another point of view. One thing I will admit that has backfired from our plan is that we have come accustomed to a big, fancy house, pretty quickly. It is amazing to me that this house was more than we know what to do with five years ago, and just a few years later we are starting to entertain another move for more house. Maybe our plan has backfired as we have come accustomed to a lot of luxury in a house, at a very young age. But for the most part, we have hardly sunk a dime into our home since we purchased it, and don’t plan to for a long while. In the long run we have saved a lot more money going for value rather than cheapness.

That is the point I really want to get across. It amazes me how sometimes when it comes to a purchase as big as a house, people throw their ideals of value out the window. To me, the bigger the purchase, the more something like value becomes important. Just some things to think about next time you are house shopping.

8 Steps To Prepare For A Fire

April 18, 2007 By Amy L. Fontinelle 8 Comments

Many of us feel like there’s little point in preparing for a disaster because we never know when something might happen and it’s impossible to be perfectly prepared. If you back up your computer every Friday and it gets stolen on a Thursday, you’ve still lost an entire week’s worth of work. Or maybe you keep emergency food in your car in case of a natural disaster, but your car is in the shop when that disaster hits. Even though there’s a chance that your efforts won’t pay off, some preparation will always be better than nothing. The following tips won’t take much time or effort to implement, but they will make a big difference should your home ever suffer a fire.

Check your smoke alarms: Start by taking the most obvious but often overlooked step of making sure you have smoke alarms and making sure they work. Most alarms have a light that stays solid or blinks to let you know it’s working, but it’s still a good idea to test them every three months using the alarm’s test button just to be sure. Some folks say you should have smoke alarms in every room, but if you can’t manage that you should at least put them near the kitchen and in your bedroom or the hallway near your bedroom.

Have fire extinguishers: You should have at least one home fire extinguisher. You’ll want to keep one in an easily accessible spot in the kitchen for sure, and make sure you have the right type of extinguisher for the type of fire that’s most likely to occur in that location.

Run emergency exit drills: Most of us have never practiced how we would exit our homes in an emergency. If you have children or pets, this is an especially important step to take. Do your kids know what to do when the smoke alarm goes off or they smell smoke, especially in the middle of the night? How will you coax your cat out from under the bed in an emergency?

Always know where your purse/wallet and keys are: It’s a good idea to develop a habit of keeping these items in the same place at home so that you can find them in the event of an emergency, fire or otherwise. That being said, if a fire has engulfed the part of your home that contains these items, don’t try to get to them–the most important thing to rescue in a fire is always yourself.

Have emergency money: Store some cash, checks, and an extra credit card in a secure location outside of your house (and not in your car, which could be lost in a fire as well). A safe deposit box at the bank is a good option, as is storing these items with a very trustworthy friend or relative who lives in your city. A fire-rated safe that you keep at home is another (just don’t expect it to deter burglars), though if your home is structurally unsound after the fire, you’ll have faster access to these items if they’re off site.

Take inventory of your home’s contents: This will help you to file a claim with your homeowner’s or renter’s insurance company and get money to replace everything you’ve lost. Make sure to update your inventory after making a major purchase or once a year. Keep copies of your inventory in a secure form of online storage and in your safe deposit box.

Make sure your homeowner’s or renter’s insurance policy provide replacement cost coverage: This increased level of protection will barely make a dent in your premium, but it will make a huge difference if you ever need to file a claim. The alternative is actual cash value insurance, which will only give you cash for the value of your possessions at the time of the loss (i.e. you won’t be getting much for your 1970’s couch).

Keep your computer backed up regularly and keep the backups outside your home (that bank safe deposit box will come in handy again here). You can easily back up important files by emailing them to yourself and/or storing them on a flash drive that you keep in a separate location. It’s also a good idea to scan important documents like tax returns and other important forms related to your finances and your health so that you’ll have electronic backups if you need them. A great way to back up your photos is to upload them to an online photo storage and printing company like Kodak Gallery or Winkflash. Just make sure to follow any requirements for keeping your account active so you don’t lose your pictures.

Dealing with a major loss like a fire is always distressing, but with a little preparation you’ll be better equipped to handle the situation. For more information on what you can to do prepare for a worst-case scenario, check out how to prepare a financial emergency kit, which will also help you prepare for major disasters like hurricanes or earthquakes.