Category Archives: Personal Finance

Converting a Home to a Rental

For Rent“It’s not unusual for owners to decide to keep their current homes as investment properties when the move up.  But before you decide to do it, make sure you understand all the implications.  There are both Pros and Cons to this approach and you need to know what’s involved, as well as all your options.”

Denise Buck & Ed Johnson – DC Metro Realty Team

 

 

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.

ICE – In Case of Emergency

ICE In Case of Emergency Contacts“A great tip for everyone regardless of your medical condition.”

Denise Buck & Ed Johnson – DC Metro Realty Team

Everyone 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.

How to measure Returns on Investment Property

Calculator“Buying a rental property can be a great way of getting a strong return on investment (ROI).  What you may not realize is that you don’t have to be an ‘All Cash’ investor to get a good return on your money.  In fact, if you finance your purchase the ROI is even greater because you are leveraging your investment.  Here are a few things know when considering how to invest.”

Denise Buck & Ed Johnson – DC Metro Realty Team

 

Appreciation 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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Verify Your Property Taxes

Taxes“Do you ‘know’ when your mortgage company paid your Property Taxes?  Almost everyone who has a mortgage on their home pays their Property Taxes each month into an escrow account, expecting the mortgage company to pay them.  Be aware of when your lender is paying taxes each year.”

Denise Buck & Ed Johnson – DC Metro Realty Team

 

If you have a mortgage with an escrow account to pay your property taxes and insurance, you expect the company servicing your loan to pay this year’s taxes this year so that you can deduct them on your 2014 income tax return. After all, your monthly payment includes 1/12 the annual amount so there will be money available for them to be paid on time.

IRS requires that expenses must actually be paid in the year that a deduction is to be taken.

The predicament occurs when you’ve made your payments but the mortgage company didn’t pay the taxing authority in the tax year they were due. If they paid your 2014 taxes in January of 2015, they wouldn’t be deductible for you until you file your 2015 income tax return.

Verify with your lender after you make the December payment that they did indeed pay your property taxes. The question for your lender’s customer service is: “Have you or will you pay the 2014 property taxes this year so I’m eligible to deduct them on my 2014 income tax return?”

Realize Tax Savings Sooner

W4 Allowances“Taking extra allowances on my W-4 is something I have practiced for about 30 years now.  At first it was just a way to get a little more money during the year.  But then I realized that I could take a little more, and then afford to ‘save’ more all during the year and earn ‘interest’ all year long!  It’s a balancing act that takes a little practice and tweaking, but it can really pay off once you get it in place.  Most years I only get about $200-$300 back at the end because I’ve already received the rest and invested it.”

Ed Johnson – DC Metro Realty Team

A homeowner’s tax saving benefit is generally realized when they file their federal income tax return after the money has been spent for the interest and property taxes. Some people look forward to the refund as a means of forced savings but some people need to realize the savings during the year.

It is possible to adjust the deductions being withheld from the homeowner’s salary so they realize the benefit of the savings prior to filing their tax returns in the form of more money in their pay checks. Employees would talk to their employers about increasing their deductions stated on their W-4 form.

By increasing the exemptions or deductions, less is taken out of the check and the employee will receive more in each pay check. If a person over-estimates their exemptions and therefore, underpays their income tax, they might incur interest and would have additional tax to pay when they filed their tax return.

Buyers considering this strategy should seek tax advice and discuss it with their human relations department at work. Additional information is available on the Internal Revenue Service website about Completing Form w-4 and Worksheets.

‘Bad’ Rules of Thumb for Retirement

retirement-planning-283x249“We’ve all heard words of wisdom from our parents and grandparents over the years and other friends and relatives.  But was it always right?  What was it based on?  Today and tomorrow are  very different times than when previous generations were preparing for retirement.  Make sure you understand the impacts of some of those old Rules of Thumb for Retirement.”

Denise Buck & Ed Johnson – DC Metro Realty Team

What makes a good rule of thumb? It should be memorable, pithy and, above all, useful. It also shouldn’t overreach; it just gives good guidance. “Measure twice, cut once” is a great example. It doesn’t try to explain carpentry. It just reminds us to take our time, be precise and avoid making a mistake that can’t be undone. (Not bad for four words.)

What makes a bad rule of thumb? How about this: it doesn’t work. Or worse, it brings about exactly the opposite of what you intended. Retirement is full of advice that sound reasonable but may be bad for your retirement health. Here are three to be wary of:

Rule of Thumb #1: Save 3% of Salary for Retirement

The most frequent auto-deferral rate into a 401(k) is 3% of pay, probably because it typically maxes out the company match. Unfortunately, 3% is just not going to get the job done.

Think of it this way: you will likely work for about 40 years and retirement can last up to 30. That means 40 years of pay checks need to be spread across 70 years. Common sense suggests that 3% (even with a company match) is not going to be enough provide the spending you’d like once you’re in retirement.

Our recent research suggests that 10 to 13% is more reasonable. If that sounds like a lot, think of it this way: paying your future self 13% of your current pay can buy you 30 years of retirement spending. It may actually be a bargain.

Rule of Thumb #2: The 4% Drawdown

Let’s say you retire with one million dollars in savings. One of the most common rules of thumb is that the first year you should withdraw 4%, or $40,000. Next year, add a cost of living adjustment, say 2.5%, and take out $41,000. And so on.

The risk here is that if the market moves against you, the odds increase that a rigid withdrawal plan will increase the odds of running out of money. If the market rallies, the opposite can happen and you will leave behind a large unspent surplus. (Great for your heirs, of course, but you would have enjoyed retirement less than you could have.)

So what’s a better rule of thumb? Probably one based on a dynamic amount, a percentage of your portfolio. You may have less to spend some years, and more others, but the risk of spending down your assets is substantially reduced. What’s more, as you get older and have a shorter retirement period to fund, you can increase the percentage.

Rule of Thumb #3: 120 minus Your Age

We know that it makes sense to have a more conservative portfolio as you get older. This Rule says the equity percentage in your portfolio should be 120%, minus your current age. So a 60 year old should have 60% equity while a 75 year old should have 45%. We can quibble over the percentage, but this sounds reasonable, right?

Well, no. And here’s why. Let’s say the 60 year old is retired and the 70 year old is healthy, happy, still working and plans on working until 75. The 70 year old can actually tolerate more risk than the 60 year old because she has five years of future wages to grow her assets and offset market loses. The 60 year old has no more future wages to offset losses and may feel that 60% equity is too high.

This idea of factoring future wage potential into the allocation is actually what some investment strategies do, and why a 30 year old (with 35 years of wages ahead of him) has more equity exposure than a 60 year old with only five years of human capital left.

Originally published in ‘The Street’ By Chip Castille, Managing Director, BlackRock

Save Interest & Build Equity in Your Home

Pay down your mortgage“It’s amazing how much you can save in interest is you pay just a little extra each month on your mortgage.  There are several ways to do this…adding $’s to each payment, or paying bi-weekly instead of monthly are just two examples.  Check this out for more details that may help you.”

Denise Buck & Ed Johnson – DC Metro Realty Team

 

If you invest in a savings account, you’ll make less than 1% and would have to pay income tax on the earnings. On the other hand, contribute something extra to your house payment and you’ll earn at the mortgage interest rate which is certain to be more than you are earning in the bank.

Making additional principal contributions on your mortgage will save interest, build equity and shorten the term. An extra $100 a month in the example shown will save thousands in interest and shorten the term of the mortgage as well.

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Reducing your cost of housing is another way to improve the investment in your home. Becoming debt free is a worthy goal that is achieved with discipline and good decisions. Suggestions like this are part of my commitment to help people be better homeowners when they buy, sell and all the years in between.

Check out what would happen if you were to make additional payments on your mortgage.

Enjoy Your Improvements and Profit by Them

Home Improvement $$“One of the things our clients usually ask about is how they can improve the value of their home.  Different projects have different returns.  Some add value, while others maintain. Want to know more?  Check out this article below for a few quick tips.”

 

Denise Buck & Ed Johnson – DC Metro Realty Team

Homeowners can raise the basis or cost in their home by money spent on capital improvements. The benefit is that it will lower their gain and may save them taxes when they sell their home.

Improvements must add value to your home, prolong its useful life or adapt it to new uses. Repairs are routine in nature to maintain the value and keep the property in an ordinary, operating condition.

Additions of decks, pools, fences and landscaping add value to a home as well as new floor covering, counter-tops and other updates. Replacing a roof, appliances or heating and cooling systems would be considered to extend the useful life of the home. Completing an unfinished basement or converting a garage to living space are common examples of adapting a portion of the home to a new use.

Other items that can raise the basis in your home are special assessments for local improvements like sidewalks or curbs and money spent to restore damage from casualty losses not covered by insurance.

Here’s a simple idea that could save you money years from now.

Every time you spend money on your home other than the house payment and the utilities, put the receipt or canceled check in an envelope labeled “Home Improvements.” Regardless of whether you know if the money would be classified as maintenance or improvements, the receipt or cancelled check goes in the envelope.

Years from now, when you’ve sold your home and you need to report the gain on the property, you or your accountant can go through the envelope and determine which of the expenditures will be adjustments to your basis.

Some people disregard this idea because of the generous exclusion allowed on principal residences. At the unknown point in the future when you sell your home, circumstances may have changed and the proof of these expenditures will be valuable. The tax laws could lower the exclusion amount or eliminate it altogether. Your marital status may change because of death or divorce. The market value of your home may skyrocket.

Since the future is unknown, it is better to keep track of the improvements as they are made and how much is spent on them. Download an Improvement Register and examples or read more in Publication 523 on Increases to Basis.

PMI = Money Down the Drain

money down the drain2“Are you still paying the PMI on your home loan?  Do you know if you can remove it?  Many people don’t realize that they can actually remove the PMI after meeting certain criteria.  Check this out to see if you can save $100’s each month by refinancing.”

Denise Buck & Ed Johnson – DC Metro Realty Team

Private mortgage insurance is necessary for buyers who don’t have or choose not to put 20% or more down payment when they purchase a home. It is required for high loan-to-value mortgages and it provides an opportunity for many people to get into a home who otherwise would not be able.

The problem is that it is expensive and a homeowner’s goal should be to eliminate it as soon as possible to lower their monthly payment and avoid putting good money down the drain.

FHA loans made after 6/1/13 that have 90% or higher loan-to-value at time of purchase have mortgage insurance premium for the life of the loan. FHA loans made prior to 6/1/13, can have the MIP removed after five years and if the unpaid balance is 78% or less than the original loan-to-value.

VA loans do not require mortgage insurance.

Conventional loans, in most cases, with higher than 80% loan-to-value require mortgage insurance. The cost of that insurance varies but with a $250,000 mortgage, it could easily be between $100 and $200 a month.

Your monthly mortgage statement should itemize what your monthly fee is for the mortgage insurance. Unlike interest that is deductible, most homeowners are not able to deduct mortgage insurance premiums.

If you plan to remain in the home or to stay there for a considerable number of years, the solution may be to refinance the home. If the home has increased since it was purchased, the loan-to-value at its new appraised value may not require PMI. You might even be fortunate enough to obtain a lower rate than you currently have.

Real Estate Investing – Cash Flow & Equity

Investor Calcs“If you have ever thought about buying investment properties, now may be a good time with interest rates still low.  Here is a strategy that we are currently helping our investors with in Today’s Market.  Give us a call today and let us help you analyze the numbers to see if this can work for you.”

Denise Buck & Ed Johnson – DC Metro Realty Team

 

Many years ago, Las Vegas hotels would entice customers with inexpensive rooms, meals and entertainment so they would gamble. It may have worked initially but if you’ve been to Las Vegas recently, the bargains are gone. Hotels expect each division to be a profit center on its own. As a consumer, I might not like the changes but as an investor, I’d have to be pleased with increased profitability.

Years ago, real estate investors used to accept negative cash flow buoyed by tax incentives in hopes of making a big payday due to appreciation when they sold it. Today’s investors are focusing on tangible, current results like cash flow and equity build-up.

Cash flow is the amount of money you have left over after collecting the rent and paying the expenses. Since rents have gone up considerably due to supply and demand in the last few years and mortgage rates are at near record lows, income is up and expenses are down, making the cash flows attractive.

If the cash flow is sufficient, you could have a good investment even if the value of the property never increased. Cash on Cash does not consider appreciation and measures the cash flow before tax advantages by the initial investment. A rental with $3,170 CFBT (Cash Flow Before Taxes) divided by an initial investment of $29,000 would generate a 10.93% Cash on Cash rate of return.

Low down payments on investor properties are also a thing of the past. Non-owner occupied mortgage money is available but the investor should expect to put down 25-30%. An advantage of having a smaller mortgage is a lower payment.

Most mortgages are amortized loans with both principal and interest due with each payment. The forced savings of the principal contribution builds equity in the property and can be considered a part of the rate of return.

A $100,000 mortgage at 4.5% for 30 years would have $1,613.29 applied to principal in the first year. Divide that by the same $29,000 initial investment and the amortization would generate another 6%.

Without factoring in appreciation or tax advantages, this rental example generates much more than most alternative investments. There certainly are many different aspects that affect the risk and return on rental investments. If you haven’t scrutinized single-family rental opportunities in a while, you should look again.