Paying cash for a home seems like a huge advantage to qualifying for a mortgage and an appraisal. However, for the fortunate few who don’t need a mortgage, there is a question they should answer before they make that decision: Do you think at any point in the future, you might put a mortgage on this property?
It’s important because paying cash for a home could affect the ability to deduct the interest if the homeowner should place a mortgage on the home at a later date.
Most homeowner’s know they can deduct the interest on up to $1,000,000 of acquisition debt on their principal residence but they may not understand the limitations of such debt.
Acquisition debt is the amount used to buy, build or improve a person’s principal residence. The amount is not static but changes over time. An amortized loan reduces the principal owed with each payment made and the acquisition debt is reduced accordingly. If a person stays in a home long enough to retire the loan, the acquisition debt is reduced to zero.
Our current federal law allows a homeowner to deduct the interest on the acquisition debt plus the interest on up to an additional $100,000 home equity debt. If a person pays cash for a home, the acquisition debt would be zero and the only interest deduction allowed would be for home equity debt.
If you answered yes or even maybe to the question, before you pay cash to buy your home, you should discuss your situation with your tax advisor.
94% of purchasers last year opted for a fixed-rate mortgage at some of the lowest rates in home buying history. Yet, some of them will pay more in interest than necessary based on the time they’ll own the home.
If a person only plans to be in the home a few years, the adjustable-rate can offer significant savings.
Not only is the interest rate on the adjustable-rate lower than the fixed in the initial period, amortization on a lower interest rate amortizes faster than a higher interest rate.
In the example shown below, a $200,000 mortgage for 30 years is compared using a 4.25% fixed-rate to a 3.25% 5/1 FHA adjustable rate. The first five years of the ARM generates a $113.47 a month savings which accumulates to $6,808.20. In addition, due to faster amortization on lower interest rate loans, the unpaid balance at the end of five years will be $3,001 lower on the ARM for a total savings of $9,801.
Assuming the adjustable-rate mortgage was to escalate the maximum allowed at each period, the breakeven would occur in 8 years and 6 months. If a person were to sell the home prior to this point, the ARM would provide a lower cost of housing for the homeowner.
For some people, the uncertainty of how the interest rate may change is not acceptable. On the other hand, for the risk tolerant individual who may be more confident in financial matters or who may know when they’ll be moving next, the ARM can be a smart choice.
To make projections using your individual numbers, see the Adjustable Rate Comparison.
Section 1031 exchange for rental and investment real estate is a tool that allows investors to move the gain from one property to another without immediate income tax consequences.
An instant benefit is to postpone the tax due which gives the investor a larger amount of proceeds to invest. In the example shown, the investor has 21% more proceeds to invest and grow over time than if he had paid the taxes due instead of exchanging.
A legitimate long-term goal might be to make qualified exchanges from one property to another until the investor dies. The heirs would then receive a stepped-up basis on the property based on the market value at the time of the decedent’s death and possibly avoiding taxes altogether.
There are specific requirements to be met in order for the exchange to qualify. For more information on exchanges, see IRS publication 544. In addition to enlisting the services of a real estate professional familiar with investment property, seek the help of Qualified Intermediary to facilitate the intricacies of the exchange. Your real estate agent can help you locate one.
With interest rates lower than they’ve been in over 40 years, it may be difficult to think of a “window of opportunity” closing. However, it isn’t difficult to understand that it may very probably cost more to live in a home in the near future due to rising interest rates and prices.
Zillow recently reported results from a nationwide study that home values are expected to appreciate by 4.5% through the end of the year. Coupled with Freddie Mac’s projection that rates are going up, the cost of housing for buyers by the end of the year will be higher than it is now.
While uncertainty of the future can stagnate some people, the fear of loss can be much more devastating when a person realizes that the amount they pay to live and enjoy a home could have been considerably lower had they acted when prices and mortgage rates were lower.
The following example considers a $250,000 purchase today with a FHA mortgage compared to what it might be at the end of the year with a higher price and interest rate as discussed earlier. The net effect is that it will cost $191.87 more each month to live in the very same home based on the cost of waiting to buy.
To see what the cost might be for your price range, use this Cost of Waiting to Buy spreadsheet.
IRS allows taxpayers the option to take the standard deduction or the itemized deduction. The astute taxpayer will compare to see which one will result in the greatest deduction and the election can be made each year.
The 2013 standard deduction for a married couple filing jointly is $12,200 and $6,100 for a single taxpayer. It doesn’t require any proof of actual expense and has no requirement for home ownership.
Items that can be included on Schedule A for itemized deductions include:
- Certain taxes paid for state and local income tax, general sales tax, real estate property taxes, personal property taxes or other taxes paid
- Qualified home mortgage interest, investment interest or possibly, mortgage insurance premiums
- Charitable contributions
- Casualty or theft losses
- Medical and dental expenses that exceed 7.5% of adjusted gross income if born before 1/2/49 or 10% if born after 1/2/49
- Job expenses and other miscellaneous deductions that exceed 2% of adjusted gross income
A non-homeowner taxpayer who has been taking the standard deduction needs to consider that it isn’t just the ability to deduct the mortgage interest and property taxes.
While the standard deduction might be the obvious choice for a non-homeowner, the combination of the mortgage interest and the property taxes plus other allowable deductions not recognized previously such as charitable contributions, now makes taking the itemized deductions significantly more advantageous.