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Our tax system works in such a way that if you make money, you owe taxes.  Surprise.  However, while you have to pay the taxes on the money you make from working every year, when it comes to real investment income you may not have to pay taxes at all – at least not right away if you’ve invested in real estate.

If you are investing in real estate, then you’ll want to learn about the tax deferral options available that can protect your investment profits.  You don’t need to be an expert on the code, but you should understand the basics and how a 1031 Exchange can benefit you. This section of the tax code covers income (gain) earned from selling investment real estate.

1031 Exchange – Summarized

When selling a rental property for a profit, taxes are due on any gain made while you owned it. Gain can be both profits from the property appreciating in value, or from depreciation deductions taken while holding the property. When investment property is sold, taxes are calculated by taking the property’s original purchase price, adding in any capital improvements and subtracting all the depreciation deducted while you owned it.

This capital gains tax can take a large chunk of your investment profits. If you’ve owned the property for less than one year, the gain will be subject to short-term capital gains tax (the most expensive) and over one year it will be subject to long-term capital gains tax.

The 1031 Exchange allows you to defer taxes on any gains indefinitely, as long as you purchase another ‘like kind’ property to replace the one you sell, within a specified timeframe and cost structure. It’s critical that you follow all the conditions of this tax code exactly or you’ll owe the entire taxes due.

Qualifying for a 1031 Exchange

To qualify for the 1031 Tax Deferred Exchange, you need to structure the sale and purchase of the property correctly – or properties because it can be more than one on either end of the transaction. For instance, you need to pay attention to the exact timing allowed in the tax code, which gives you 45 days, from the date of closing on the sale of your investment property, to identify a property, or list of three properties, you may purchase to replace it.

Also, once you close on the sale of your investment property, you have exactly 180 days to complete the purchase of one or more replacement properties from the list you created by day 45. Miss either of these deadlines and the capital gains tax will be due immediately. But those aren’t the only things you need to comply with to defer your taxes.

The title holder on the replacement property(s) must be the same as the title holder on the property that was sold to qualify for the 1031 Exchange. You must also invest all the proceeds from the sale into the replacement property(s), but the replacement must be equal or greater in value to the property that was sold. If there was a mortgage on the property you sold, the new mortgage must be the same amount or higher as well. If the new property costs less than the one sold, or if the new mortgage is less, the difference is termed “boot,” and capital gains taxes will be calculated on the “boot” amount.

Section 1031 also states that you can’t have control of the any of the proceeds from the sale of the old property. That means any associates, employees, your attorney, real estate agent, or accountant/CPA are prohibited from holding the proceeds.  Also, the money can’t be left in an escrow account while you complete the replacement transaction. The law requires a Qualified Intermediary, also known as the 1031 Exchange Facilitator, hold the money. They help manage the transaction timing, complete necessary legal documents, and facilitate earnest money deposits from exchange proceeds for you.

Like-Kind Replacement Property

There is a lot of confusion about one part of Section 1031 – namely, what does the IRS mean by like-kind property? It doesn’t mean that selling a two-unit property must be replaced with another two-unit property, nor that a shopping center must be replaced by buying another shopping center. The definition of like-kind property is broader than the actual type of property.

Like-kind property refers to how the investment property being sold was used. The replacement property must match the use (i.e. rental property, land, business) of the property that’s sold in the exchange to qualify for the tax deferment.

My Advice

The best advice to follow as a real estate investor is to work with an accountant or CPA to make sure you’re taking the right steps when buying and selling. And of course, please let me know if you have any other home financing questions.

Chris Ulrich – United Home Loans
NMLS #215735

Now that you’ve decided to start the home-buying process, it’s time to figure out which loan program is best for you. Since everybody’s situation is completely different, you’ll want to have a discussion with a mortgage professional help provide direction. After months of online browsing, it’s likely you’ve run into a jumble of curious letters, acronyms, and confusing names like FHA, VA, Fannie Mae, and Freddie Mac. What do they all mean and how do you know which one is right for you?

First off, lets look at the primary differences between an FHA loan and conventional loans, which includes Fannie, Freddie, and Jumbo loans. Even if it’s not your first time purchasing a home, it’s important to familiarize yourself once again since many historical differences between these types of loans have changed in recent years. The remaining differences have to do with mortgage insurance and a few underwriting guidelines.

Loan-Level Price Adjustments
Two very similar individuals with similar income might be better off on two completely different loan programs. One reason is because of Loan-Level Price Adjustments charged on conventional loans. These are risk-based fees assessed to mortgage borrowers using conventional financing. Since these fees are built into loan pricing (the premiums lenders earn by delivering your loan to Fannie Mae and Freddie Mac), the borrower typically doesn’t pay in the form of money but their interest rate gets adjusted. For example, an individual with an 800 credit score will have a better interest rate than somebody with a 660. Makes sense, right? Well, there are several other price adjustments. A condo or multi-unit property will likely have a higher interest rate than a single-family home. Your down payment percentage and whether or not you are buying a primary residence, second home or investment property can also impact your interest rate.

For a “vanilla” loan scenario where somebody has 5% down, a 780 credit score and purchasing an owner occupied single family detached home, this person would qualify for the best pricing possible. Their interest rate and monthly mortgage insurance would be the lowest available, keeping their monthly payment as low as possible with just 5% down payment. So, a conventional loan would be the best program for this particular borrower. However, FHA has far less pricing adjustments and is a bit more forgiving when it comes to your credit history and current credit scores. If the person in this above scenario had a 620 credit score, their interest rate and mortgage insurance would be substantially higher on a conventional loan due to the Loan-Level Price Adjustments. In this case FHA might be the better option since there total monthly payment would be lower.

Derogatory Seasoning, Credit Scores and & Debt Leniency
FHA has always been known as a “first-time homebuyer” program, even thought it’s not. People still label it this way because it caters to many individuals who have the some of the characteristics of a person who might be buying for the first time. Whether it’s a recent grad needing Mom and Dad to co-sign, somebody with very little savings or a person just starting to build up their credit, FHA can be very accommodating. However, there are many reasons why FHA might be the right program for move up buyers.

FHA has a much shorter seasoning period than conventional loans for people who are recovering from a bankruptcy, foreclosure or short-sale. FHA will allow for individuals with compensating factors to purchase with a credit score as low as 500, where as the minimum allowed by conventional is 620. FHA may also allow for debt-to-income ratios (the percentage of your gross monthly income allocated towards all your month debts) above 50% where conventional typically caps people around 45%.

Mortgage Insurance
The Federal Housing Authority (FHA) is a government agency created in 1934 to help more Americans own homes. Specifically, it provides mortgage insurance to the lender making the loan in case the borrower defaults (fails to pay) on the mortgage. The insurance premium is due no matter what size of a down payment the borrower makes.

FHA loans require a portion of the premium upfront (or at the time the mortgage is made) and monthly for the life of the loan (in most cases) and stays in place no matter how much equity accumulates in the property.

Conventional loans require mortgage insurance for the same purpose as an FHA mortgage (to protect the lender in case of a default on the mortgage), but only for loans with less than 20% down payment. The insurance is provided by private companies, which is where the term PMI comes from (private mortgage insurance.) PMI on a conventional loan only carries a monthly premium and no ‘upfront’ portion is due, and it can be removed based on the equity in the property. Through a combination of paying down the mortgage and property appreciation, borrowers can contact the lender when they have at least 22% equity and request the insurance cancelation.

Compared side by side, mortgage insurance on an FHA loan will end up costing the homebuyer more money over the life of the loan. The portion of the insurance premium that is due upfront on an FHA loan is typically added to the original loan balance, and the monthly payment is made on the total amount. While FHA interest rates generally are lower than rates for conventional loans (with less than 20% down payment), the payment on the FHA loan is likely to be higher for the same property.

More Differences Between FHA and Conventional Mortgage
FHA used to stand out as the best option for buyers with less cash available for a down payment because it allowed a down payment of a minimum of 3.5% of the purchase price. Now, however, Fannie Mae and Freddie Mac have programs that will enable borrowers to make a down payment as low as 3% of the purchase price.

While both FHA and conventional both have monthly PMI for low down payment loans, conventional loans allow the borrower to pay for the monthly mortgage insurance by increasing their interest rate above the lowest prevailing rate. This is called ‘lender paid mortgage insurance.’ Typically, a slight increase in the rate of one eighth to a quarter percent eliminates the need to pay a separate MI premium monthly. Since mortgage insurance premiums are tax deductible at lower income levels, some borrowers may find that paying a higher interest rate (mortgage interest to deduct) is preferable to a lower rate and the MI payment. Talk to your tax advisor to find out if this might be a beneficial option for you.

While all mortgages require a property appraisal, FHA appraisals were traditionally more detailed as the appraiser was required to note any “health and safety issues” they saw while inspecting the property. After 2010, however, the requirements for all appraisals have been unified. If the property condition poses a health or safety issue, as noted by the appraiser, an FHA loan will require correction or repair before the loan closing. Conventional loans need the same; however, there may be a small amount of flexibility.

What’s Best For You?
It’s hard to imagine choosing an FHA loan after reading all of this, but it may be the best option for some borrowers. In general, the underwriting guidelines for an FHA loan are more lenient than those for conventional loans. Specifically, FHA may allow a higher debt-to-income ratio than a conventional loan. Credit guidelines are also more flexible both with past delinquencies and more serious derogatory credit events, as well as the depth of a borrower’s credit history.

With property values increasing across the country, along with interest rates, waiting for a credit score to improve or a delinquent record to drop off your report may not be attractive. FHA loans will allow some borrowers to buy a home sooner than they may otherwise have been able to with conventional financing options. If interest rates drop in the future, you can refinance using the FHA streamline, which reduces the usual process and won’t require a new appraisal. Conventional loans can only be refinanced by starting over at square one and going through the full loan qualifying and process again.

The more you know going into the home buying process, the better questions you can ask and the better decisions you can make. But nothing replaces the benefit of working with an experienced lender to fully evaluate your situation and give you the options that will work best for you. There’s so much more to it than the interest rate.

Written By: Chris Ulrich – United Home Loans
NMLS# 215735

You found the perfect home. It’s exactly what you’ve been looking for. It sits on a cozy street in a safe neighborhood within a great school district. There was some negotiating on price, but in the end the seller accepted your offer. Finally, you can rest easy as you’ve come to terms with the seller for your dream home! Or have you?

Whether it’s during those initial negotiations or after the offer is accepted, there are still several reasons why negotiating a seller credit is not uncommon. Here are a few things that every buyer and seller should know when it comes to seller credits.

1. Buyers and sellers; A credit is a useful way for the seller to market their home and useful for the buyer who may not have the cash needed for closing costs.

As a seller, you know the lowest you’ll take for your home. You likely listed your home a bit higher than what you’re willing to take because you know buyers will offer you less. Hypothetically, let’s say you list your home for $315,000 and you know the least you’ll take is $300,000. As a seller you could market the home with a $5,000 seller credit towards closing costs or points to buy down their interest rate, and it still leaves room for negotiating. There is no difference whether you sell the home for $300,000 with no credit or for $305,000 and give a $5,000 concession. You are still netting your $300,000.

As a buyer for the same scenario above, you can contract on the home with a seller credit of any dollar amount – Click here for how much a seller can credit. The seller may or may not budge. It’s very common to negotiate credits with your offer, but if it’s a competing offer situation, you may not look like the strongest buyer. Your realtor will know the best way to approach the situation.

2. Buyers may request credits for property inspection items.

In the early days following the accepted contract you will have your attorney review period in which you typically have 5 days to have a home inspection completed. It is within this time frame that you must notify the seller or seller’s attorney of any defects for which you request the seller to cure. Whether it’s sewer line, roof, water heater or electrical issue, it is VERY common for further negotiations to take place. The seller may have to fix these items prior to closing, but if the issue doesn’t affect the safety or habitability of the home, you may request a credit in lieu of the seller fixing the item themselves.

3. Sellers can avoid credits for inspection issues by fixing the problems themselves.

Sellers should consider having a property inspection before listing the home. As the seller, your goal is obviously to avoid anything that will impact your bottom line, giving you the most sale proceeds as possible. By having a home inspection prior to listing your home, you might find a few items that you weren’t aware needed to be fixed. Some of these items might be so minor that you can fix them yourself. For any larger items like a failing furnace or a roof near the end of it’s life will likely be caught by the buyer’s inspection. Having the inspection completed up front will give you some extra time resolve major issues.

By making the inspection report available to buyers, it can also be a good way to show good faith to those considering to purchase your home that you have taken additional steps to assure a safe home without any major issues.

If you have an inspection, or otherwise assuring that your property is in great shape, you could request the home to be sold “as is”. This sends a strong message to any buyers that the you aren’t open to further negotiations once the contract is executed.

4. Buyers, be reasonable.

You made an offer on a home, negotiated back-and-forth with the seller. Finally, you’ve come to an agreement. Don’t just concede to the purchase price thinking that you can get an additional concession after a property inspection.

You may be weeks into the process, completed a series of inspections and feel that the seller has mentally committed to moving. This doesn’t mean the seller has to accept any credit requests. If you can’t come to terms during the attorney review or you request an unreasonable credit, the seller may very well call your bluff and terminate the contract, especially in a seller’s market.

5. Sellers, be reasonable.

You may have come to terms on your home sale at a fair price, but it doesn’t mean the buyer has to go through with the deal. They can still cancel within the attorney review. They agreed to your price assuming there are no inspection issues. If the buyer cancels the deal because of a safety issue or other major defect, chances are that the next buyer that comes along will likely find the same issue and request that it be cured. Save yourself the trouble of relisting the home, going through the negotiations all over again and eventually running into the same issue by just resolving it the first time.

6. Buyers nearly always ask for credits, so sellers should leave room for further negotiations.

Sellers should cushion their final sales price because buyers typically ask for credits once they complete their home inspection. They will likely come back with a concession request, even if there aren’t any major issues. Leaving yourself a little room will give you the ability to meet some of their requests and you’ll feel better about “giving in” to them.

The last thing you want is to be blindsided, unexpectedly giving up a couple thousand dollars after thinking the deal is finally done.

Written By: Chris Ulrich – United Home Loans
NMLS# 215735

Everybody wants a deal. As they should, but don’t let getting a “good deal” prevent you from purchasing your dream home. Of course you have to feel comfortable with your payment and be able to afford the home, but I am referring to losing a home because you were out bid by a few thousand dollars or didn’t offer what the seller is asking for. This is even more important in a market where interest rates are on the rise. Paying more for a home today could actually have a lower monthly mortgage payment than a much less expensive home next month as rates continue to trend upward.

First things first. I’m not referring to a home that’s been sitting on the market for months. Bid whatever you want on that home and you’ll likely be able to find a fair compromise with the seller during the negotiation process. This article is geared towards people looking to buy that new listing that’s in a good location that is going to get multiple bids the weekend it hits the market. What’s the right amount to bid in a best-offer situation? Less than asking price? Asking price? Higher than asking price?

Talk to your lender and have him/her show you the difference in your monthly payment at various price points. Then talk to your realtor and have them pull sales comparisons to make sure your making an educated offer at a fair valuation. Then determine how bad you want the home and how long you see yourself living there. Because in a competitive market/location, it’s typical for values to rise. So you’ll likely feel better about making that strong offer when the return on your investment is much higher down the road.

You likely won’t overpay for a home. There are contract items that will prevent this from happening. For example, if you contract on a home at $420,000 but it appraises out for $400,000, you have an out. You also have ammo to go back and renegotiate with the seller. Appraisals are done by using recently sold homes comparable to the one you are purchasing, and there is a lot more data in these reports than there used to be. If the home doesn’t appraise out, you are protected by the language in your contract to cancel.

What’s the difference in payment? Assuming a 20% down payment on a home at $420,000 and $400,000, the difference is about $80/month. So do you love the home enough to pay an extra $80 per month? Is it worth losing the home for the cost of filling up your gas tank? Maybe, but most people home searching at that price point can afford the slightly higher payment. What people are forgetting to take into consideration are interest rates. People are so caught up on the dollar amount that what they fail to realize is that their monthly payment would have been lower at $420,000 today then at $400,000 next month if rates go up 0.5%. The longer you wait for the perfect home at your set purchase price, the higher your payment could go and lower your purchasing power becomes.

Are you somebody that has lost in a bidding war? Would you like me to show you a loan comparison for a specific property you are going to view this weekend? Call or message me today and I’m happy to provide you with a detailed loan comparison at multiple price points. Don’t get me wrong, price is important, but I encourage you to put more weight on payment than price.

Written By: Chris Ulrich – United Home Loans
NMLS# 215735