Team Reba Real Estate

Over the years of working with real estate investors we’ve been involved in several 1031 tax deferred exchange transactions.  Through those transactions as well as through ongoing credit hour classes for my licensing, I’ve come to know Cris Anderson of Asset Preservation, Inc. 

 API sends out, via an email newsletter, various reports about changes that affect this aspect of tax/property and today I am going to share a recent article which they’ve given me permission to reprint here for our reader’s benefit.  Why do I think some of our readers will benefit?  Because we do know of clients that have considered this particular strategy when buying real estate, so it makes sense to keep them up to speed on the changes that may impact their decisions.  As always, be sure to consult your own tax accountant/CPA/tax attorney for your own specific situation, but here at least is some information for you to use to educate yourself on the changes.  The tax consequences will be the same for any type of property used as a private residence and investment so condominiums, single family homes, and multi-family properties with an owner unit, and possibly vacation properties, will be impacted.

“2008 by Asset Preservation, Inc.  Reprinted by permission”

REDUCED §121 GAIN EXCLUSION IN SOME CIRCUMSTANCES 

Internal Revenue Code (IRC) Section 121 permits a taxpayer to exclude gain in the amount of $250,000 or $500,000 for married couples filing jointly on the sale of the a principal residence. A residence is a principal residence if the taxpayer has owned and used the residence as the taxpayer’s residence for any two (2) years during the five year period ending on the date the residence is sold. The Housing Assistance Tax Act of 2008, signed by President Bush on July 30, 2008, amends §121 and may reduce the exclusion available to taxpayers who initially acquired the principal residence in a §1031 tax deferred exchange or used the property as a rental property before converting the rental property into a principal residence. As of January 1, 2009, the exclusion must be allocated between the period the principal residence was used as an investment property or second home, and the period of time the residence was used as the taxpayer’s principal residence. Any portion of the exclusion amount that is allocable to the period the property is not used as the taxpayer’s principal residence is eliminated. How does this change affect §1031 tax deferred exchange planning? Suppose a single taxpayer exchanges into a rental property which is rented for four (4) years, and then moves into this former property and lives in it for two (2) years as a principal residence. The taxpayer then sells the principal residence and realizes $300,000 of gain. Under prior tax law, the taxpayer would be eligible for the full $250,000 exclusion and would pay tax on the $50,000 remainder. Under the new law, the exclusion would have to be prorated as follows (Note: This example does not take into account deprecation taken after May 1997, which is taxable at 25%).

• Two-thirds (4 out of 6 years) of the gain, or $200,000, would be ineligible for the $250,000 exclusion.
• One-third (2 out of 6 years) of the gain, or $100,000, is eligible for the exclusion. [This example was changed to show that the allocation formula takes into account years before the 5 year lookback period in §121(a).]

Non-qualified use prior to January 1, 2009 is not taken into account in the allocation for the non-qualified use period (but is taken into account for the ownership period). Suppose the taxpayer had exchanged into the property in 2007, and rented for 3 years until 2010 prior to the conversion to a principal residence. If the taxpayer sold the residence in 2013, after three years as a principal residence, only the 2009 rental period would be considered in the allocation for the non-qualified use. Thus, only one-sixth (1 out of 6 years) of the gain would be ineligible for §121 tax exclusion.In general, the allocation rules only apply to time periods prior to the conversion into a principal residence and not to time periods after the conversion out of principal residence use. Accordingly, if a single taxpayer converts a principal residence into a rental property and never moves back in, and otherwise meets the two out of five year relinquished under §121, the taxpayer is eligible for the full $250,000 exclusion when the rental property is sold. This rule only applies to non-qualified use periods within the 5 year lookback period of §121 after the last date the property was used as a principal residence. Therefore, if the taxpayer used the property as a principal residence in year one and year two, then rented the property for years three and four, and then used it as a principal residence in year five, the allocation rules would apply and only three-fifths (3 out of 5 years) of the gain would be eligible for the exclusion under §121.

No, I’m not saying “I’m old” because I just turned 40 last month. Rather, I’m feeling pretty good that I’m still in mostly good physical shape for my age and that I don’t have blown out knees or ankles like some of my friends from volleyball. The reason I’m feeling pretty good about that is due to the large number of stairs I’ve been up and down today as we de-staged a 3 story townhome and then carried the majority of the same furniture and “dressings” up to the 3rd story of a condo we are staging to go on market by Friday.

The continual up and down would be tough for anyone who’s joints are starting to get arthritis or have been damaged due to sports or other injury inducing activities.  Those clients that look for elevators find themselves limited sometimes by the inventory that the Seattle/Bellevue and general King County area has available since many of the older condos and apartments (1960’s/1970’s) don’t have these built in to their, typically, lower slung buildings.  Today’s high rise condos always have elevators, but they tend to have a high price tag to go with them since construction costs today have gone up, impacting the builder’s pricing structure to make a decent profit.

As a seller, you really have to think about who you are marketing your home to.  So, it makes sense to stage your home in a way that will appeal to the right demographic that you think will be your end result buyer. In the case of this condo, we’re putting in some sleek styled furniture but adding in some antique-ish pieces to make it not overly “match-y, match-y” and to reflect the up and coming nature of the buyer we expect will be looking at this property as a new home.

For now though I will be happy to have a strong set of legs that get me by pretty well…. they’re getting more workout tonight too as we complete the staging work for tomorrow’s shoot…

As an associate member of RHA, I get a chance to meet a lot of really great local professionals. One of them is Chris Benis, a local attorney who I have much regard and respect for in the Seattle area.  He is teaching an upcoming class for RHA that anyone who is a landlord should consider attending to bone up on issues that could impact them down the road.  You never know when a difficult tenant situation could arise, and the best plan is to have tools and information on your side when it happens.  Info on the upcoming class is noted below.   If you are considering getting into the landlord arena, this and many other RHA classes are items you should check out!

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Frequently I am contacted by  clients and real estate agents asking for help with finding property management companies in Wichita, KS or the Seattle area.  I currently own 2 properties in Wichita, a 4-plex and a duplex, and right now my brother manages them for me. In Kansas you don’t have to have a real estate license to manage property as long as it is 4 units or fewer in number. In Washington, if you are managing another person’s property, that is not a family member, you must be licensed to receive compensation.

Anyhow, an agent asked me if I had a firm I could recommend in Wichita since she had read the less than flattering review of another company that I used previously. I sent her an Excel spreadsheet that I had my assistant put together for me with a list of questions that I gave her to use to pre-qualify the companies she found online.  Here is the list of questions I used; perhaps you will find them useful too.  These are by no means a comprehensive or exhaustive list of everything you should ask, but it’s a start and can lead to additional information you may want regarding the company you’re considering hiring. These questions are reasonable for both in-town and out-of-town landlords to ask a management firm.

1. What are your management fees on a monthly basis?  Are the fees charged before or after expenses are paid for the month?

2. What are your “lease up” fees for getting a new tenant?

3. Is the cost of advertising wrapped into the lease up fee or is the owner charged separately for these costs?

4. What advertising methods do you use?  Do you do a combination of print and online advertising?  Is advertising on-going or only as vacancies arise?  Do you pool fees from multiple clients to do annual on-going advertising?

5. What are your reporting methods for financial data?  Will I get an annual statement at the end of the year besides monthly statements?

6. Do you offer annual maintenance agreements or other methods to check-up on the properties under your management?

7. How is maintenance handled on an ad-hoc basis?  Do you have your own maintenance staff or do you hire out?

8. How do you handle the move-in/move-out checklist for tenants? Are digital photos taken during the move-in/move-out periods to help augment checklists to secure deposits and to handle charging for damages above normal wear and tear on a unit? 

9. Do you require the use of your own leases or do you allow other leases to be used on properties your company manages? And, if you use your own lease, will you provide a copy for me to review prior to signing up with your firm? Has your lease been reviewed by an attorney?

10. If an out of state owner wants or needs work done can your firm help to manage the work, and what is the cost to manage it?  If I have a preferred company to use for a certain type of work (eg. plumber, electrician) will you work with them as well?

11. Does your firm also sell property?  If so, will you require me to use your services to sell my property when I am ready to sell, or is that negotiable if I already have my own agent that I prefer to use? Will the decision to use another agent raise the cost of the fees you will charge me?

12. Will you provide a list of references including other out-of-state owners that I may contact?

13. If I have a large number of units or buildings to manage, is there a discount applied or available to negotiate if I turn them over to you for management?

14.  What is your coverage area for property?  Do you limit your business geographically or to certain types or sizes of property?

15. How do you handle doing background and credit checks on rental applicants?  Do you do full criminal background checks and, if so, how far do you search (eg. local, state, national).  Does your background check include registered sex offenders?  If not currently, will you consider doing it for my business?

16. Do you track local market information regarding rent levels, vacancies, etc and do you share that information with your clients?

17. How do you handle notices and evictions with tenants? Have you ever had to appear in court on tenant related issues? What was the outcome of any such court action?

18. Do you belong to any professional organizations for property management? Does your staff have on-going training or educational opportunities related to your field of expertise?

19. Are you licensed? Do you have a copy of local landlord/tenant laws in your office for reference? How do you handle or deliver necessary disclosure forms for tenants?

20. How do you handle Fair Housing requirements in your area? Do you use the same process for each applicant?  Have you ever had a Fair Housing complaint made against you or any of your clients? How do you handle section 8 tenants and the yearly reviews that are required?

These questions aren’t listed in any particular order but you may find them useful.  Even if you’re looking to manage your own property you might consider asking yourself these questions to determine how you’ll handle these things on your own.

For those readers/landlords in the Seattle and surrounding area I would suggest getting to know the Rental Housing Association of Puget Sound too.  They are a great resource for information, forms, education and more. Check them out at http://www.rha-ps.org

I’m involved in all kinds of online networking sites, the longest time spent as a member on LinkedIn partly due to my time spent in the technology sector prior to becoming an agent 5 years ago.  Occasionally there is a question posted that I just have to reply to because it is a question I am asked frequently and I feel very strongly about the answer.

Damodhar Mata of the United Arab Emirates asked this question about 18 days ago: “When you are looking to secure a mortgage, based on waht parameters would you select a particular lender?”

Here was my reply - and I was thrilled to see that it got voted “best answer” on LinkedIn: 

“First of all, someone you trust and like. You’re about to turn over your most personal asset and credit information to this person. Also, I would suggest that it be a person not representing you as the agent in a transaction as this has the potential of becoming a conflict of interest issue. If it’s for a refinance this isn’t a problem. Some marketplaces make it very common that one person handles both sides but I am personally a skeptic of it as it puts more economic hardship on the salesperson if your transaction doesn’t go through and there is motivation to push it forward, perhaps when it shouldn’t be done. I rarely suggest clients go with the first person they talk to because it’s worth it to ask at least 3 firms for a GFE (good faith estimate).

Second, be sure to use a reputable firm. This can include direct lenders or mortgage brokers. Friends, colleagues and your agent can help you get referrals and references. Be sure to check if your state requires any kind of licensing for mortgage brokers and ask if the loan officer is licensed and have them show you the information - and check it. Washington State just recently implemented such a requirement and there are some folks out there that haven’t yet passed the licensing but they are still writing loans. This is a big no-no.

Loan programs available to you will vary depending on your credit score so know what this is BEFORE you go shopping for a loan. This will help with the process of getting quotes or Good Faith Estimates (GFE) without having to have a lender pull your credit on their own - this will save you potentially if you end up shopping to a few companies since loan officers typically must charge for a credit check AND you could start lowering your score if you don’t know or understand the rules around these requests for credit.

Knowing the terms of a loan outside of just the rate is important and is likely one of the biggest mistakes people have made in the past several years. Rate is one thing, but pre-payment penalties are another. Perhaps the loan you’re being offered requires points be paid to get the lower rate? Is there a teaser rate (oddly low) and then a spike in the rate later on, or it another form of adjustable rate mortgage (ARM)? When does this occur and what is the maximum that it can go up to, not only yearly but for the life of the loan?

Really, you need to know what your holding period is before choosing a loan anyway. Think you’ll be in an area for only 5 years? Well, maybe an ARM (if still available) at 5 or 7 years make sense. Think you might be around longer? Then perhaps a 10 year ARM, a 30-year fixed, or a 15-year would work better.

Figure out what you can comfortably pay and then find options that fit. Fixed rates are low enough still that these make sense for a lot of people. But they aren’t for everyone if there is a big disparity and your life or job situation isn’t right for it.

How much down payment you have will also affect your rate and what loan options you have to choose from. Many banks are requiring higher down payments than in the past several years so ask what you’ll need to have available and DO NOT assume it will stay the same - not in today’s financing market. It might go up, and we’ve seen it happening and we’re getting feedback from lenders that they’re seeing it too.

I hope this helps!

Links:

• http://www.bankrate.com

Rebecca Haas also suggests these experts on this topic:

• Jerry Rutherford
• Eric Aasness
• Danny Tseng

Clarification added 18 days ago:

Because you work for a lending organization I assume you are polling the LinkedIn user base to see if you can get marketing data. I am responding from the viewpoint of how we counsel clients when they come to us to buy a home or investment property.”

When asking Damodhar about whether he was doing market research or otherwise he did report back to me that he is trying to understand how people make their considerations.  When I looked a little further into it and paid attention to where he is doing business, the UAE, it struck a chord.  This is one of the most expensive and lavish places on the planet right now.  Oddly enough, I was just watching a show on Dubai last night on CNBC and it was fascinating.  I get spam from all over the world with regard to real estate but watching this show has me rethinking next time how quickly, or if, I’ll hit the delete button on my laptop.

Anyhow, if you’re out shopping for a loan at this time either in the Seattle area or anywhere else around the USA, keep some of these things in mind that I mention above as you do your review of lenders.  Happy Monday!