Converting a Home to a Rental

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A simple decision to rent your current home instead of selling it when moving to a new home could have far reaching consequences.

If you have a considerable gain, in a principal residence and you rent it for more than three years, it can lose the principal residence status and the profit must be recognized.

Section 121 provides the exclusion of capital gain on a principal residence if you own and use it as such for two out of the last five years. This would allow a temporary rental for up to three years before the exclusion is lost.

Let’s assume there is a $100,000 gain in your principal residence. If it qualifies for the exclusion, no tax would be owed. If the property had been converted to a rental so that it didn’t qualify any longer, the gain would be taxed at the current 20% long-term capital gains rate and it may incur a 3.8% surcharge for higher tax brackets. At least $20,000 in taxes could be avoided by selling it with the principal residence exclusion.

Depreciation, a tax benefit of income property, is determined by the improvement value at the time of purchase or at the conversion to a rental whichever is less. If the seller sold the home and took the exclusion and then, bought an identical home for the same price, he would be able to have 60% more cost recovery and avoid long term capital gains tax.

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It is always recommended that homeowners considering such a conversion get advice from their tax professional as to how this will specifically affect their individual situation.

Get Ready to Garage Sale

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A well-planned garage or yard sale can make room in your home, get rid of unused items and make some money but it needs some planning to be successful.

  • Start early to research and plan
  • Promotion is key
  • Display items attractively
  • Price items right
  • Organize checkout

Saturdays are generally the best day but there may be some exceptions. Experienced garage-salers believe that a well-planned one-day event will do as well as a multi-day event. Serious purchasers will look for the “new” sale and most people don’t come back multiple days.

Advertise in local newspapers and free online classified sites like craigslist. If several families are going together for the sale, mention that in the ad; it will be a big draw. Mention your bigger-ticket items like furniture, equipment and baby items.

Garage sale signs can be purchased or made at Staples, Fedex Office or Kwik Signs. Signs need large lettering so they’re easy to read while people are driving. Most important info: Garage or Yard Sale, address, date and time. Directional signs are also important. Balloons and streamers to attract attention to the signs are very helpful.

Consider using the service Square so that you can take credit cards. The cost is 2.75% per swipe and can be done on your smartphone or iPad. You’ll need to sign up at least two weeks in advance to receive your reader.

Unless you’re having an estate sale, keep your home locked. You don’t want people wandering through your home while you’re outside. If you start to accumulate a lot of money, take some of it inside. Don’t discuss how much money you’ve made during the sale or how successful it has been.

People will want to bargain; it’s the nature of the game. Consider this strategy: less negotiations early in the sale and possibly, more toward the end of the sale.

Downsizing Might Make Sense

downsizing.pngWith roughly 12.5% of the population over 65 years of age, it is understandable that some of them are thinking of downsizing because they may not need the amount of space they did in the past. There is something to be said for the freedom acquired by divesting yourself of “things” that have been accumulated over the years but are no longer needed.

Moving to a less expensive home, could provide cash that could be invested for additional income or savings for unanticipated expenditures.

Savings can also be recognized in the lower utility costs associated with a smaller home, not to mention, the lower premiums for insurance and property taxes.

Going from the home where you reared your family to one of the new tiny homes may be a bit extreme but downsizing to 2/3 or 50% of your current home may certainly be reasonable. In some situations, your interests may have changed so that a different area or city might be a possibility.

At one time, IRS had a once-in-a-lifetime exclusion of $125,000 of gain from a principal residence but it was changed so that homeowner’s are eligible for an exclusion of $250,000 of gain for single taxpayers and up to $500,000 for married taxpayers who have owned and used their home two out of the last five years and haven’t taken the exclusion in the previous 24 months.

Homeowners should consult their tax professionals to see how this may apply to their individual situation.

Reducing Interest Expense

Debt Free Home.png0% financing has induced car buyers into taking the plunge because it doesn’t cost anything to use someone else’s money. While mortgage rates are not at zero, they’re close enough that many buyers are applying similar logic.

Qualified mortgage interest is deductible on taxpayers’ returns subject to the maximum acquisition debt of one million dollars. For the fortunate homeowners who have paid off their mortgage, their acquisition debt was reduced to zero and only the interest on a maximum home equity debt of $100,000 is deductible.

If you have to pay interest, deductible interest is preferable because it reduces your actual cost.

Consider the following example of a taxpayer with a $500,000 debt-free home. If they did an 80% cash-out refinance of $400,000, $100,000 would be considered home equity debt and the interest on that would be deductible on their income tax. The other $300,000 of debt is considered personal debt and the interest is not deductible.

However, because the rates are currently so low, the loss of deductibility of the interest doesn’t have as much impact as if the rates were higher. The key is to have a good purpose for the money that would offset the actual cost of the interest.

Paying off a higher rate debt such as credit cards, student loans, possibly, business debt could all have significantly higher interest rates. Refinancing a home and eliminating debts like these could be a big savings.

All lenders are not the same. Call for a recommendation of a trusted mortgage professional.

Homeowner Tax Benefits

tax benefits.pngThere are many reasons for wanting to have a home of your own like a place to raise your family, share with friends and feel safe and secure. While investment opportunities rank high for most people based on the fact that homeowners’ net worth is over forty times higher than that of renters, so do the tax benefits that reduce tax liability.

  • Taxpayers who have owned and used a home for at least two out of the last five years, can exclude a maximum of $250,000 of gain as a single taxpayer and up to $500,000 of gain for married taxpayers filing jointly.
  • If the gain on a principal residence exceeds the allowed exclusion, the balance is taxed at the lower long-term capital gains rate rather than the marginal tax rate of the homeowner.
  • Homeowners can deduct the interest paid on up to $1,000,000 of acquisition debt used to buy, build or improve their first or second home. They may also deduct the interest on up to $100,000 over acquisition debt that is a recorded lien on their first or second home.
  • IRS will allow taxpayers to decide each year whether to take the higher of the itemized deductions or the standard deduction.
  • Points paid on new loans for home purchases are considered interest and can be deducted in the year paid. On the other hand, points paid for refinancing a home must be amortized over the life of the mortgage.

For more information, talk to your tax professional and see IRS publication 523 and IRS Publication 936.

ICE Can Save Lives

ICE.pngEveryone knows that ice can make a drink cool or reduce swelling, but if you put it on your cell phone, it might just save your life.

The concept is simple. Make a contact record in your address book with the name “ICE”, which stands for In Case of Emergency. In the note section of the record, you would list your name, blood type and medical conditions along with prescriptions and physicians. You’d also list the people and their phone numbers that can be contacted in case of an emergency.

Several years ago, a British first responder came up with the idea when his emergency unit responded to a call where the victim was unable to communicate due to illness or trauma. The victim’s wallet didn’t indicate specific persons to be notified in an emergency. The fireman went through his cell phone to try to identify a relative and wasn’t successful.

That’s when he came up with the idea of a universal entry into the address book for ICE where the necessary parties and special information could be kept. The story received a considerable amount of publicity and spread across the pond to the United States and into many other countries.

While it isn’t recognized everywhere, it is becoming increasingly more popular. Even if emergency technicians didn’t find it, the slight possibility that they would find it and it would make a difference would justify the few minutes it will take to create it. Click here to download a card to carry in your wallet or purse.

Don’t Consider Appreciation or Tax Savings

iStock_000004701496XSmall.jpgAppreciation and tax savings are legitimate contributors to an overall rate of return on rental real estate but what if you didn’t consider them at all. If you only looked at one or two, very conservative measurements, you might decide to invest especially knowing that there are more benefits that will accrue to your investment.

If we bought a property for cash, collected the rent and paid the expenses, the amount left would be called Net Operating Income. In the example below, if would generate $7,200 a year which would be a 7.02% cash on cash rate of return which is considerably higher than the current 10 year treasury rate of around 2.3%.

If we place a mortgage on that property, the rate of return actually increases due to leverage. After the principal and interest are paid, the net operating income obviously decreases but the cash on cash rate of return increases to 9.10% because the borrowed funds means less cash invested.

Another contribution to the investment’s rate of return occurs with the mortgage due to amortization: the principal reduces with each payment made which increase the investor’s equity. In this example, the equity build-up divided by the initial investment yields a 5.25% rate of return in the first year.

Single family homes for rental purposes offer the investor high loan-to-value mortgages at fixed interest rates for long terms on appreciating assets with tax benefits, reasonable control and an opportunity to earn higher than normal rates of return. Call if you’d like to talk about what kind of rental opportunities are available.

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