Tag Archives: property taxes

The Impact of Tax Reform on The Real Estate Sector

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photo by Sergiu Bacioiu

Congress passed the tax reform act on December 20, 2017 and President Trump is supposed to sign it by the end of the week. A lot of ink has been spilled on the impact of tax reform on homeowners, but less on real estate as an investment class. It will take lawyers and accountants a long time to understand all of the in ands outs of the law, but it is pretty clear that commercial real estate investors will benefit significantly. Most of the provisions of the act are effective at the start of the new year.

Homeowners and the businesses that operate in the residential real estate sector will be impacted in various ways (the net effect on any given taxpayer will vary significantly based on a whole lot of factors) by the increase in the standard deduction; the limits on the deductibility of state and local taxes; the shrinking of the mortgage interest deduction; and the restrictions on the capital gains exclusion for the sale of a primary residence. There are tons of articles out there on these subjects.

The impact on real estate investors has not been covered very much at all. The changes are very technical, but very beneficial to real estate investors. There are a couple of useful resources out there for those who want an overview of these changes. The BakerBotts law firm has posted Tax Reform Act – Impact on Real Estate Industry and the Seyfarth Shaw law firm has posted Tax Reform for REITs and Real Estate Businesses.

To understand the impacts on the real estate industry in particular, it is important to understand the big picture.  The new law lowered the highest marginal tax rates for individuals from 39.6% to 37% (some individuals will also need to pay unearned income Medicare tax as well). The highest marginal tax rate applicable to long-term capital gains stays at 20% for individuals. The other big change was a reduction in the corporate tax rate to 21%. Because qualified dividends are taxed at 20%, the effective tax rate on income from a C corp that is distributed to its shareholders will be 36.8% (plus Medicare tax, if applicable).

Benefits in the new law that particularly impact the real estate sector include:

  • REITs and other pass-through entities are eligible for as much as a 20% deduction for qualified business income;
  • favored treatment of interest expense deductions compared to other businesses;
  • Real estate owners can still engage in tax-favored 1031 exchanges while owners of other assets cannot; and
  • Some types of commercial real estate benefit from more favorable depreciation provisions.

While it is clear that real estate investors came out ahead with the new tax law, it is not yet clear the extent to which that is the case.

Republicans and the Mortgage Interest Deduction

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There is a lot to hate in the Republican tax reform plan contained in the proposed Tax Cuts and Jobs Act. (click here for a summary and here for the text of the bill itself). Overall, the bill is extraordinarily regressive, heavily favoring the wealthy. There will, of course, be all sorts of compromises to this proposal as Republicans work to get it passed. But it is worth highlighting what is good about the bill as it would be a shame to lose sight of it while the sausage is being made in Congress.

The best real-estate related provision from a policy perspective is the reduction of the mortgage interest deduction. In a section of the summary with the Orwellian title, Preserving the Mortgage Interest Deduction, the Republicans outline how they will slice the deduction in half:

For so many Americans, buying a home is often the largest investment – and perhaps most important – investment they will make in their lifetime.

The Tax Cuts and Jobs Act will continue to support the American dream of homeownership by preserving the Mortgage Interest Deduction.

This ensures that hardworking families can continue to access this important tax relief as they buy, own, and maintain their home.

Policy Specifics

• Increasing the standard deduction means a simpler, fairer, and flatter tax code in which fewer taxpayers need to go through the trouble of determining whether they should itemize.

• Under the Tax Cuts and Jobs Act, taxpayers will still be able to deduct mortgage interest in excess of the standard deduction, in combination with other remaining itemized deductions, including charitable contributions and property taxes.

• The mortgage interest deduction would be available for interest paid on new mortgages for up to $500,000 in home acquisition indebtedness on principal residences.

• For existing mortgages, the plan allows for current law deduction on indebtedness of up to $1,000,000 and up to $100,000 in home equity to help taxpayers who may have relied on the current mortgage-interest deduction.

How This Policy Helps the American People

Preserving the home mortgage – and the deduction for state and local property taxes – will help more Americans of all income levels achieve the American dream of homeownership. (15-16)

This plan would cut the principal amount of a mortgage that would be eligible for the mortgage interest deduction from the current maximum of $1,000,000 to $500,000. Given that wealthy households generally take the mortgage interest deduction more often and get more bang for their buck from it, it is a regressive aspect of the tax code.

It is striking that a provision with such broad support such as the mortgage interest deduction is actually on the table. It will be interesting to see how special interests in the real estate industry will respond. My bet is that at the end of day the deduction will remain mostly untouched, even though this particular Republican proposal makes good policy sense.

Reverse Mortgage Drawbacks

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US News and World Report quoted me in 6 Drawbacks of Reverse Mortgages. It opens,

For some seniors, reverse mortgages represent a financial lifeline. They are a way to tap into home equity and pay the bills when meager savings won’t do the job. Others view this financial product with suspicion and point to stories of seniors losing their homes because of the fine print in the paperwork.

Amy Ford, senior director of home equity initiatives and social accountability for the National Council on Aging, says regulatory changes were made in recent years to eliminate many of the horror stories associated with reverse mortgages gone wrong. Home equity conversion mortgages – as reverse mortgages through the Federal Housing Administration are known – now incorporate many consumer protections. These help seniors ensure they can afford the loan and are aware of its potential consequences.

“It’s a magic credit line,” says Jane Bryant Quinn, AARP Bulletin personal finance expert, when asked why people would want a reverse mortgage. “It increases every year at the same rate as the interest you pay.” She recommends that seniors consider taking out a HECM line of credit and then borrowing against it sparingly. That way, retirees have protection against inflation and a source of income in the event of a down market.

Despite their appealing benefits, some financial experts urge caution. “I wouldn’t say there is no place for reverse mortgages,” says Ian Atkins, financial analyst for Fit Small Business. “But that doesn’t make a reverse mortgage a good option for everyone.”

Here are six drawbacks to reverse mortgage products.

1. Not every reverse mortgage has the protections of a HECM. While HECMs are the dominant player in the reverfederally insured

consumer proptection

se mortgage market, seniors could end up with a different product. Atkins says single purpose reverse mortgages are backed by a state or non-profit to allow seniors to tap home equity for a specific purpose, such as making home repairs or paying taxes. There are also proprietary reverse mortgages, sometimes called jumbo reverse mortgages, available to those who want a loan that exceeds the HECM limits.

These proprietary reverse mortgages make up a small portion of the market, but come with the most risk. They aren’t federally insured and don’t have the same consumer protections as a HECM.

A reverse mortgage can be a lifesaver for people with lots of home equity, but not much else.

“Another common issue with [proprietary] reverse mortgages is cross-selling,” Atkins says. “Even though it may not be legal, some companies will want to push investments, annuities, life insurance, home improvements and any other number of products on their borrowers.”

2. Other people in the house may lose their home if you move. HECMs are structured in such a way that once a borrower passes away or moves out, the balance on the loan becomes due. In the past, some reverse mortgages were taken out in one person’s name and the non-borrowing spouse’s name was removed from the title. When the borrowing spouse died or moved to a nursing home, the remaining husband or wife often needed to sell the house to pay off the loan.

“There are now some protections for those who were removed from titles,” Ford says. However, the protections extended to non-borrowing spouses do not apply to others who may be living in the house.

A disabled child, roommate or other relative could wind up without a place to live if you take out a reverse mortgage, can no longer remain in the home and don’t have cash to pay off the balance. “If it’s a tenant, you might not care,” says David Reiss, a professor at Brooklyn Law School and author at REFinBlog.com. “But if it’s your nephew, you may care.”

3. Your kids might be forced to sell the family home. If you’re hoping to pass your home on to your children, a reverse mortgage can make that difficult. Unless they have cash available to pay off the loan, families may find they have no choice but to sell once you’re gone.

That isn’t necessarily a reason to rule out a reverse mortgage, but Ford encourages parents to discuss their plans with family members. Everyone with a stake in the home – either emotional or financial – should understand what happens to the property once the borrower can no longer live there.

4. The mortgage balance might be due early if you have trouble paying your property taxes, insurance or homeowners association fees. Reiss says the marketing for some reverse mortgages can make seniors feel like the product is a cure-all for money problems. “There’s this promise that reverse mortgages will take care of your finances,” he says. “What they don’t mention is that your mortgage doesn’t cover your property taxes.”

If a borrower fails to pay taxes, maintain insurance or keep current with homeowners association dues, the lender can step in. Ford says many companies will try to work with a borrower to address the situation. However, repeated missed payments could result in the loan being revoked.

Financial counseling requirements for HECMs are designed to prevent these scenarios. Quinn says some companies will take additional precautions if warranted. “If the lender thinks there’s a risk you’ll run out of cash, it will set aside part of the loan for future taxes and insurance,” she says.

5. Fees can be high. The Consumer Financial Protection Bureau notes reverse mortgages are often more expensive than other home loans. “Don’t just assume that because it’s marketed to seniors without a lot of money, that it is the most cost-efficient way of solving your [financial] problem,” Reiss says. Depending on your needs, a traditional line of credit or other loan product may be a cheaper option.

Retired With A Mortgage

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U.S. News & World Report quoted me in Rethinking a Mortgage While Retired. It opens,

It’s one of the cardinal rules of retirement planning: pay off the mortgage before quitting work. Giving up your income while still supporting a big debt can mean chewing away at your retirement savings way too fast, and can leave you in a tight spot if something goes wrong.

But paying off a mortgage years early is easier said than done, and the Center for Retirement Research at Boston College says way too many pre-retirees are too far behind schedule, largely because of borrowing before the housing bust and financial crisis.

On the other hand, some experts say carrying low-interest debt into retirement is not always such a bad thing, especially if it means leaving money in investments that perform well.

“In 2013, almost 40 percent of all households ages 55 and over had not paid off their mortgages, up from 32 percent in 2001,” the Center reports, citing a study using data from the Federal Reserve’s Survey of Consumer Finances in 2013. “These borrowers were also carrying a lot more housing debt by 2013.”

“I’ve been advising clients for over 20 years and on just an anecdotal level, I can tell you that more clients are retiring with mortgage balances than in years past,” says Margaret R. McDowell, founder of Arbor Wealth Management in Miramar Beach, Florida.

A.W. Pickel III, president of the Midwest division of AmCap Mortgage in Overland Park, Kansas, says many baby boomers traded up as their families grew, then took second mortgages to help fund college costs.

In the years before 2008, homeowners were encouraged to take out big loans when home values appeared to be soaring, the center says. They bought expensive homes or tapped home value through cash-out refinancing or home equity loans, it says.

When home prices collapsed, millions were left “underwater” – owing more than their homes were worth – and were unable to get out from under because they could not sell for enough to pay off their loan. McDowell believes many homeowners also concluded their home was not the rock-solid asset they’d thought, so they felt it unwise to pour more money into it by paying down the mortgage early.

So many just hung in there. By taking on too much debt, and monthly payments so large they could not afford extra payments to bring it down, they left themselves with too much debt too late in the game.

The center says “that 51.6 percent of working-age households were at risk of having a lower standard of living in retirement,” largely because of mortgage debt.

“In recent years, U.S. house prices have started to really improve, to the benefit of homeowners and retirees,” the center says. “But it’s difficult to predict whether the other factor that has reduced retirement preparedness – more older households with big housing debts – was a boom-time phenomenon or represents the new normal.”

But is the situation really as dire as it seems? David Reiss, a professor at Brooklyn Law School in New York City, thinks it may not be.

“According to the National Association of Realtors, the median sales price of an existing home increased from $197,100 in 2013 to $232,200 in October of 2016,” he says. “That is a roughly 15 percent price increase and about $40,000 of additional equity for the owner of the median home.”

Many homeowners who were underwater may not be any longer.

Also, he adds, it’s not necessary to be absolutely debt free at retirement so long as income is large enough to cover expenses and leave a cushion.

“Often, paying off a mortgage gets a retiree where he or she needs to be in terms of that balance, but it is not always necessary,” he says.

The key, he says, is to not be underwater. Once the remaining debt is smaller than the home value, the homeowner is better able to sell. One option is downsizing, selling the current home, then using cash from the sale or a new, smaller mortgage to buy a cheaper home. A less expensive home will also likely have lower property taxes and maintenance costs.

Preparing for Surprise Closing Costs

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The Wall Street Journal quoted me in Buying a Home? Prepare for Surprise Closing Costs. It opens,

Note to house hunters on a budget: A home’s sale price isn’t really the sale price—there are lots of closing costs and expenses that jack up the final number.

According to online real-estate listings site Zillow, buyers typically pay between 2% and 5% of the purchase price in closing costs. So if a home costs $300,000, that buyer can expect to pay between $6,000 and $15,000. Since the financial crisis, there’s more transparency on the part of lenders when disclosing the costs associated with a mortgage, so buyers know in advance how much they’ll need for the closing. But experts say that might not be enough.

Lender fees are only one part of the total cost of homeownership. Buyers must also pay appraisers, home inspectors and settlement agents, as well as the cost of title insurance, homeowners insurance and property taxes. And the fees don’t stop at the closing. Utilities, regular home maintenance and unexpected repairs add up as well—and can derail even the most experienced buyer.

*     *    *

Here are a few considerations to help you avoid surprises at the closing table.

Stash your cash. There is no real rule of thumb as to how much money buyers should put aside in addition to the balance of the purchase price and closing costs. But the more, the better. “You definitely want an emergency fund,” says David Reiss, a Brooklyn Law School professor who specializes in real estate. “Appliances have a habit of breaking right after you buy a house.”

Close on the last day of the month, or just before. One of the fees due at closing is prepaid interest, the daily interest charge accruing between the closing and the day on which your first mortgage payment is due. Closing on the last day of the month reduces this upfront cost.

Get an estoppel letter from the association. Your real-estate agent or attorney may obtain this letter, which lists the maintenance fee, when it’s due, any required escrows or membership fees and whether a special assessment has been levied. Review this letter carefully, and compare it with the purchase contract to make sure all fees are apportioned accurately between buyer and seller.

Clintons’ October Permitting Surprise

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Realtor.com quoted me in Final October Surprise: Clintons Make Untimely Mistake Renovating Their New Home. It opens,

This is proving to be the year that redefines the notion of the presidential campaigns’ “October Surprise.” First Donald Trump‘s hot mic/hot mess “Access Hollywood” tape surfaced, followed by the ugly after affects. Then with just over a week to go before Election Day, Hillary Clinton‘s email woes returned, this time on Anthony Weiner‘s computer. Talk about lousy timing! Now, on the final day of October, one last surprise is rearing its head. Remember when the Clintons bought the home next door to their own in Chappaqua, NY, a few months back? Well, it turns out they renovated it without permits.

Breaking news alert!

According to public records, government officials received a complaint in early October about excavation happening at the Clintons’ new home. When an inspector arrived, he saw that a number of unpermitted upgrades were taking place, including a kitchen remodel and the installation of a new HVAC system.

Conspiracy theorists take note: Once the Clintons learned of this oversight, they took steps to fix it. And to be fair, the inspector on the case, William Maskiell, concedes that architects or contractors typically file for permits rather than the homeowners themselves. Still, he points out, “If you own the house, you’re responsible on everything that goes on with that house.”

In other words, the buck stops with the Clintons.

Granted, this blooper might seem small compared with the much larger problems on Hillary Clinton’s plate right now. Still, it can serve as an important lesson to all homeowners—many of whom might be tempted to sneakily sidestep those annoying permits before they start renovating. Honestly, are those little pieces of paperwork all that important?

It turns out they really are.

“I can’t believe a contractor working on a multimillion-dollar home wouldn’t pull permits,” says Mark Clements, a contractor at MyFixItUpLife.com. “It’s very much the contractor’s responsibility to gain those permits, and nearly unthinkably stupid not to.”

Here’s why: “On the surface, permits are inconvenient, but their value vastly outweighs what it takes to obtain them,” Clements explains. “They ensure everything from zoning variances to proper building practices are followed. And they make sure there is another set of expert eyes on the work being done, checking for everything from proper structure to code-approved electric to fire stops are safely installed.”

Once that’s done, a final inspection and certificate of occupancy, or “C of O,” is issued. The home may be reappraised—which could raise property taxes—”but it will also mean that when you list it for sale with three bathrooms, you can do so legally,” Clements adds.

A Stronger America, One Permit At A Time

So what’s the worst that could happen if you don’t bother with permits before you embark on a home improvement project? For one, if you’re caught, you could face fines.

“In some jurisdictions the penalties can be heavy, but it’s the stop-work order than can really hurt,” says David Reiss, a professor of Law at Brooklyn Law School and editor of REFinBlog.com. “Not only does it delay the completion of the work, but it may lead to additional costs from the contractor and subcontractors working on the project. And to top it off, it may interfere with the homeowners’ plans to leave their current home and move into their new one. The cascade effect among the affected parties can be painful.”

And even if you’ve already completed your renovation off the radar, you aren’t in the clear. If you decide to sell your home one day, unpermitted renovations can discourage buyers from biting—if they’re discovered.

“When buying a home, you always want to pay attention to any signs that there was unpermitted work done on the house,” says Reiss. “Is the certificate of occupancy for a one-family home, but there is a mother-in-law unit in the back? Are all of the houses on the block one story but your house is two stories? In such cases, you definitely want to dig a little deeper so you are not left holding the bag.”

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