Financial Information

When Should You Refinance?

How do you know when to refinance from both a financial and timing standpoint? Here are some of the questions you should ask yourself:

Q: Why does it pay to refinance?
A: First you must analyze your own mortgage and fully understand its terms and conditions. What is the interest rate? Do you pay private mortgage insurance on top of that interest rate? Is there a prepayment penalty? If your loan is an adjustable rate mortgage, what are the index and the margin? How often does it adjust and when? You need to be able to answer these questions before you can consider refinancing.

Q: How much lower than my current rate should interest rates be compared to make refinancing available?
A: This is not as simple as it sounds. Many articles have been written suggesting that if the rate is not 2 percent or lower than your present rate; you shouldn’t bother refinancing. You should consider both the costs of refinancing and how long you plan on staying in your present home. Combine these two factors with the anticipated monthly savings on your payments and you can determine exactly how long it will take to break even. After that break-even point, the savings are all yours.

Q: When do I know that rates are at their lowest point?
A: No one can predict how low rates will go. The real question is, are rates low enough to make it worthwhile to refinance now? Talk to a professional mortgage lender who can analyze your situation with today’s rates. Ask them to be specific and put the facts in writing. If it makes sense at 7%, then consider refinancing now. No one can forecast the bottom of the cycle, and when it happens, it will be over before you can react.

Q: Are there other reasons to refinance than lower rates or payments?
A: Yes. Many homeowners are combining a lower rate with a shorter maturity, such as a 15-year loan, in order to save on total interest costs. Others are consolidating consumer debt because of the law changes eliminating deductibility of interest on those debts. Others simply are remodeling or sending their children to college.

Whatever the reasons, see a mortgage professional so your present mortgage can be analyzed and today’s alternatives fully explained. For referrals on local lenders on the coast, call Kennedy & Associates, (707) 884-9000 or e-mail us at property@kennedyrealestate.com.

Reduce Your Tax Burden Through Home Ownership

Here’s a nice surprise…good news involving the word “taxes".
Recent changes in the tax laws have made real estate a more attractive investment than ever before. As a homeowner you are eligible to take advantage of these tax changes and deductions to keep more money in your pocket this year. These laws apply to your single-family residence that you claim as your primary residence on your tax return. For tax information on investment property, go to 1031-EXCHANGES.

Profits from the sale of your home
Congress did homeowners a huge favor by passing the Taxpayer Relief Act of 1997. Today, you can exclude up to $250,000 in profits (or $500,000 if you are married and filing a joint return) from the sale of your primary residence from your taxable income. Previously, this type of deduction only applied to those who were age 55 or older. For more details please call Kennedy & Associates at (707) 884-9000.

To be eligible for this exclusion, your home must have been owned by you and used as your main home for a period of at least two out of the five years prior to its sale. You also must not have excluded gain on another home sold during the two years before the current sale. If you and your spouse file a joint return for the year of the sale, you can exclude the gain if either of you qualify for the exclusion. But both of you would have to meet the use test to claim the $500,000 maximum amount.

Let’s say a married couple purchased a home for $300,000 five years ago and sold it for $450,000 in 1998. They get to keep the $150,000 profit tax-free, provided they have lived in the home for at least two years. The IRS allows people of any age to claim the exemption each time they sell their home, but no more frequently than once every two years.

To exclude gain, a taxpayer must both own and use the home as a principal residence for two of the five years before the sale. The two years may consist of 24 full months or 730 days. Short absences, such as for a summer vacation, count as periods of use. Longer breaks, such as a one-year sabbatical, do not count.

Homeowners looking to downsize will benefit the most from the tax change. You no longer have to reinvest the profits in a home that is similar in price to avoid paying capital gains tax, and you free up cash for additional investments like rental property, mutual funds, education, and more.

If you do not meet the ownership and use tests, you may be allowed to exclude a portion of the gain realized on the sale of your home if you sold your home due to a change in health or place of employment.

Mortgage interest, real estate taxes and points
In most cases, the interest you pay on your primary mortgage and your real estate taxes are fully deductible on your tax return. Your lender will send you Form 1098, outlining the amount you paid in interest and real estate taxes over the course of the year.

Mortgage points are also deductible. If you bought a home last year, you can deduct the full amount of the points you paid as home mortgage interest. Meanwhile, if you sold a home in 1998 and paid points, you cannot deduct them as interest but you can claim them as a selling expense if your profit is subject to a taxable gain.

One last point about points. If you were one of the many homeowners who took advantage of low interest rates and refinanced your mortgage last year, the points you paid on the refinanced mortgage are not fully deductible on your return. You can, however, deduct refinancing points as mortgage interest over the life of the loan. And, if you are refinancing for the second or third time, don’t forget to deduct the remaining balance of your previous refinance (those points not yet deducted). This extra deduction can be claimed in the same year you do your new refinance.

Please contact Kennedy & Associates for more information on reducing your tax burden through home ownership.  Call us at (707) 884-9000 or email at property@kennedyrealestate.com.

1031 Exchange

Often investors do not realize that taxation on a personal residence is far different than taxation on an income or investment property. Under Internal Revenue Code ¤121, homeowners are allowed to exclude up to $250,000 of capital gains if single, $500,000 if married, upon the sale of a principle residence provided they have owned and occupied it two of the previous five years.

If an investor sells property they pay tax. Taxes are paid on capital gain, not equity or profit. However, property that qualifies for preferential treatment under Internal Revenue Code ¤1031 is treated quite differently.

No gain or loss shall be recognized if property held for productive use in a trade or business or for investment purposes is exchanged solely for property of a like kind. The benefits of exchanging include using leverage to maximize your investment dollars to property diversification to allow you the widest range of investment freedom. 1031 Tax Deferral can range anywhere from a simple swap of two properties to a complex, multi-leg, multi-property transaction involving a delayed, reverse or construction exchange. The investment strategy and the nature of the transaction will decide which exchange best suits your needs.

Imagine selling rental property, your vacation rental or land, acquiring new real estate of any type and not paying one dime in capital gain taxes. Thousands of investors are profiting every day simply by using the tax deferred sale IRC 1031!

Like-Kind Property

Investors often mistakenly believe they must acquire property like their relinquished property. They are surprised to learn a wide variety of properties can be considered "like-kind." "Like-kind" does not refer to the nature, character or type of property. Instead, it addresses the intended use of the property. Provided the property is initially acquired and held for either business or investment purposes, it can qualify as a suitable replacement property under IRC Section 1031.

For example, any of the following can be considered "like-kind" property exchanges: a duplex for a fourplex, bare land for improved property, a rental house for a retail center , an apartment building for an office building or a vacation home for another investment property. Investors do not have to exchange for exactly the same type of property as relinquished.

The tax code also lists items that are not considered "like-kind". These include:

• Stock in trade or other property held primarily for sale;

• Stocks, bonds, or notes;

• Other securities or evidences or indebtedness

• Interests in a partnership;

• Certificates of trusts or beneficial interest.

Benefits of Exchanging

Prior to 1979, trading properties was at best complicated. Completing a tax deferred exchange meant properties had to be "swapped" simultaneously. Unfortunately, this made exchanging cumbersome and risky, if not impossible. The 1979 Starker decision in the U.S. Court of Appeals enabled the non-simultaneous or "delayed" exchange to qualify for tax deferral. This gave investors the time necessary to find desirable replacement property by using an Intermediary.

Treasury Regulations effective June 10, 1991 validated the delayed exchange and simplified the exchange process. By providing specific guidelines, these Regulations were welcomed by real estate investors who were previously uncertain of the viability of 1031 transactions.

Many investors have held property for years because a sale translated into paying taxes of up to 40% of their capital gain. Typically, as an investor's needs change over the years, the type of investment property they want changes. Relocation, estate building, retirement, desire to increase cash flow, to reduce management responsibilities, all affect the type of property investors want to own. Under IRC Section 1031, investors now have the alternative of moving their investments (and equities) into more desirable or profitable properties. The true power of exchanging is the ability to meet investment objectives without losing equity to taxation.

Frequently Asked Questions

What is the difference between a sale and an exchange?
A sale is an exchange of real property for cash. Because cash does meet the requirements for "like-kind" property, the capital gains tax is not deferred. An exchange where property is traded for property is a "non-taxable" sale.

What provisions are required in a Purchase and Sale Agreement to enter into an Exchange?
Exchanges begin with a Purchase and Sales Agreement. When a Purchase and Sale Agreement is used to begin a transaction, it should contain language which establishes the exchanger's intent and notifies the buyer of the exchange.

Examples of such contractual provisions are:

When Selling:
"It is the intent of the Seller to perform an IRC Section 1031 tax deferred exchange ."
"Buyer agrees to cooperate with seller at no additional cost or liability to Buyer."

When Buying:
"It is the intent of the Buyer to perform an IRC Section 1031 tax deferred exchange Seller agrees to cooperate with buyer at no additional cost or liability to Seller."

Can an investor trade from several small properties into one large one?
Yes. An investor can also trade out of one large property into several smaller ones. When selecting more than one property, investors must adhere to the guidelines regarding property identification.

How much time do I have to complete the transaction?
In the delayed exchange, "like-kind" properties must be designated within 45 days of the sale closing. The replacement property must close escrow by the 180th day.

What do I need to do first?

Notify your Realtor of your desire to execute a 1031 exchange at the time the property is listed for sale. The proper language for the buyer to cooperate with you in the exchange needs to be part of the purchase contract. You should discuss the transaction with your CPA or accountant to confirm that the transaction will qualify. A "qualified intermediary" needs to be involved as a principle in the transaction. The exchange intermediary will execute the exchange documents and forward them to the to the appropriate parties in the transaction.

Funds from your sale will be transferred to either the intermediary, in the case of the deferred exchange or to the escrow company in the case of a simultaneous exchange.

If you are thinking of selling your vacation or investment property, contact Kennedy & Associates at (707) 884-9000 or e-mail at property@kennedyrealestate.com.

Be sure to consult our accountant or CPA for specifics about your exchange property or tax ramifications.