Tuesday, July 31, 2007

If You Pay Somebody Else's Mortgage, Can You Deduct Interest?

In another good bit from the Kiplinger Tax Letter, according to the IRS, the answer is no. Even if you actually paid any of it yourself. You have to be liable on the loan and an equitable owner to be eligible.

But Kiplinger's points to a limited exception based on a ruling back in 1997. It says that a couple could deduct interest that they paid on a home loan, that their relatives signed for. The reason was that the couple had poor credit, and the relatives stepped in to help. But the occupants of the home made the payments, lived in the house, and made all repairs and improvements. They experienced all benefits and burdens of ownership.

I guess the IRS does not concern themselves with risk of foreclosure as one of the 'burdens' of ownership. The charitable relatives took on this burden, but Uncle Sam doesn't seem to mind.

San Francisco Real Estate Professionals And The IRS

When it comes to defining a Real Estate Professional for tax purposes - which comes in handy if you are a high income earner and have passive losses on rental property - the IRS essentially says that you need to have an active role in managing the property, and spend at least 750 hours a year in doing so (That's about 1/3 of your 40 hour work week). Then your losses are not 'passive', and there is no limit to the detectability. Otherwise, your cap is $25k per year. Oh, but if your income is over a certain limit, you lose the write-off...

...still with me? One more step, and its key. If you cannot deduct losses based on income being too high, you can defer these losses until the sale of the property, and reduce your gain by the exact amount of losses racked up over the years.

In San Francisco, and California in general, this is a big deal. Incomes here are on the high end, and rental losses are as well, as the rental cost vs ownership costs for property are at a historical gap. Gaining access to the 'Real Estate Professional' treatment has potentially significant implications.

According to the Kiplinger Tax Letter a recent IRS ruling has clarified a deeper-level detail of this test, which helps tax payers gain the 'Real Estate Professional' status. It allowed a couple to have extra time to elect to treat multiple properties as a single entity, thereby working around the time test for each property individually.

More info on the IRS Real Estate Professional test can be found here. Please also consult with your tax planner if you think you need to navigate this test or have any landlord or passive loss issues related to real estate.

Thursday, July 26, 2007

Foreclosure Chart, The Return Of The Investor?



RealEstateJournal posted this chart courtesy of Realtytrac showing the foreclosure data monthly in a quick article with tips for buying foreclosure homes. You can note a slight drop from May to June, but I don't think many are expecting that the housing market has 'bottomed-out' just yet. Today's release of New Home Sales data was a disappointment, and showed that we are still not eating away at the inventory.

I see continued optimism from real estate insiders, one notable exception would be Angelo Mozilo, CEO of Countrywide, who has made a few comments over the last 6 months relating this housing recession to the Great Depression, that this is the worst market he has seen, and enacted layoffs and cost-cutting measures. He has also been under the microscope for selling $118 million of his company's stock - a clear sign of lowered expectations... what are you gonna do...

I posted here back in May of 06 that the caliber of real estate investor had significantly changed, and that the pros had vanished. Soon after, the amateurs disappeared as well, and the only investor activity we have seen recently has been folks looking to capture a good gain on an inflated property, and 1031-Exchange it into something different.

In the last few weeks however, I have seen quite a bit more investor interest. Folks who are not afraid and who know that a market like this has "deals". They embrace the Warren Buffett's mantra of "We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful." But I wonder if they are premature and if the market is going to deteriorate significantly further before things settle down. I know those builders do not want to hold inventory into a declining market, so I expect to see further cuts in prices, and increased incentives. I'm not buying into the media's doom & gloom rhetoric, but I do not think there is any reason to be anxious just yet... Deals are certainly out there...
John C. Glynn, CMPS
Real Estate Finance & Mortgage Planning
San Francisco Bay Area

Saturday, July 14, 2007

Has Been Stein Seen the Light?

Somebody forwarded to me an article by Ben Stein recently, and I noticed a stark contrast to the tone of the last Ben Stein article I recall reading back in January. I remember thinking when I read the first article that he was missing a key component of understanding housing as an investment. I assumed that he was not ignorant, but rather opted to deliver a streamlined and simplified message to his audience.

In the first article, Stein misses the concept of leverage when discussing return on housing. With leverage, you have to shift the focus to return on investment, not return on asset. I know he knows this, but now you can get an idea of why I had not - until the other day - read another of his articles.

So in the recent article, his tune changes a bit. He isn't as suggestively sour on the financial aspects of house-as-investment, and focuses on pre-paying mortgage debt. But comparing the two pieces provides a great example of the fact that the decision to 'buy the house' and the decision to 'pay off the mortgage' need to be looked at as wholly separate investment decisions. They are totally unrelated. Stein seems ho-hum about buying a house for financial reasons (again, ignores the leverage component), but once you own the home, he suggests liquidity is more important than retiring debt.

I like the direction he is heading in...


John C. Glynn, CMPS
Real Estate Finance & Mortgage Planning
San Francisco Bay Area

Monday, July 02, 2007

Dead Fish Don't Have A Mortgage Plan

I knew this kid in High School who was about as anti-establishment as they come. Pretty interesting guy, but somewhat difficult to get to know or get a good read on. When the senior year yearbooks came out, the quote beneath his name read: "Only dead fish follow the stream". It captured what I perceived to be at the core of his personality. And the message was clear. What's a worse thing to be than a dead fish? And what could be more true an image?

... 14 years later, it remains one of the more memorable from that sea of inside jokes, cliche inspiration, failed attempts at humor, and so on. It popped into my head again recently when I read a headline about a mortgage survey administered by Re/MAX in the Detroit area. It made the case that some 2/3 homeowners with a 'nontraditional' mortgage were planning to refinance. This was yet another media criticism of the mortgage industry, and the 'nontraditional' loan type. The media has made the terms 'exotic' and 'nontraditional' synonymous with 'dangerous' and 'rip-off' in the context of the mortgage industry.

This got me thinking, as the 2/3 number seemed extreme to me. I can't imagine that 2/3 of the people with 'nontraditional' loans need to refinance into a market that is close to its 5 year high water mark. Generally, the media refers to anything that isn't a 15 or 30 year fixed loan as 'nontraditional', but it would help to have clarification.

Refinancing always involves a cost/benefit analysis and can be viewed as a snapshot of one's financial and credit profile as well as of the marketplace for money at any given point in time. "Based on where I am today, does the market offer me something better?" Something has to improve. It is unlikely that loans originated in the last few years are eligible for lower rates today - credit is at/near its tightest and most expensive levels in the last 5 years (though there are some cases). So this statistic has to refer to people who are looking for more protection in the form of longer fixed rate periods. They are likely rolling into a higher rate, higher payment or both.

Of people who need to refinance, there are a few possible motivations: they were misguided when they took out their current loan, they are misguided about what they need going forward, or more innocently, things have just simply changed.

Among those who intend to refinance based on changes in life, those who are not taking out cash are going to be refinancing specifically to change the terms of their loan. And if this specific sector is equal to 2/3 of those with 'nontraditional' mortgages, then this would indeed be worthy of a news headline with a story about how 'nontraditional mortgages' are bad for your financial health.

But I doubt this is the case. Cash-out refinancers would be re-financing regardless of the current loan (to a degree). The misguided folks are not adequately understanding how to evaluate the cost/benefit proposition, or they didn't when they took out that last loan.

The key takeaway here is that life does in fact change. Among this 2/3 figure, there are likely those who knew life would be changing around this time, and took out a mortgage that fit the timeline of expected change, and saved a bundle in the process. They are the guided ones. The 'dead fish' are the folks who are letting the current push them around.

Living fish also follow the stream for the most part, but they navigate. They know when to resist the current, move to the side, etc, as opposed to banging into rocks and driftwood - and washing up on shore.

Let's face it. Resistance can get you in trouble. Defiance can get you hurt. But if there is a stampede headed for a narrow escape, sometimes you'll be better off figuring out a different way out rather than trying to squeeze through that door with the rest of them - or better yet - knowing how to avoid being stuck in the first place. Don't be a dead fish. Get a plan in place.

John C. Glynn, CMPS
Real Estate Finance & Mortgage Planning
San Francisco