Taxes and Real Estate

Before I begin this column, please know that I am not an accountant.

When I was a boy, my father shared a bit of wisdom with me regarding taxes.  He said, "Give Uncle Sam every dime he is due... and not a penny more."  My father is both wise and a great citizen and his advice has served me well.

Consider this when it comes to taxation - suppose you have a penny and you double it every day for 30 days.  You would end up with almost $5.4 million dollars!  And you could get taxed on it at that point.  Now let's suppose you take the same penny and do the same thing, but tax it at 25% every day.  You would end up with about $1,200 dollars.  If that tax were 35%, you would end up with only $20 after 30 days.  Would you rather be taxed as you go, or at the end of the investment life?

In the real estate arena, taxes can be a daunting issue and, unfortunately, many people not only run the risk of running afoul of the law, they often do not take full advantage of the rules the government has set up.  I would suggest to anyone considering the purchase or transfer of real estate that they consult with an Estate Planning Attorney, an Accountant, and a Financial Planner.

One of the greatest tax gifts given home owners is the interest deduction.  This benefit allows tax-paying home owners with a mortgage loan to lower their marginal taxable income.  The government also sets up rules concerning limitations to tax deductions, as well as interest deductions under certain circumstances and it is vital that one be knowledgeable of these limitations as well.

One tax concept addresses what is known as Acquisition Indebtedness.  Without going deeply into this, it generally it states that when you buy your home, the debt that is placed against it at that time is the highest debt for which you can take an interest deduction.  You may be allowed to take an additional $100,000 in debt in the future and but with only few exceptions, no more.  As the debt is paid down, the acquisition indebtedness benefit is permanently reduced for interest deductions.

In a previous column, I used a scenario where a home buyer had the option of putting a small or large down payment on the home.  Taking into account the tax law, a larger down payment results in a smaller basis for tax deductions - permanently.  Since tax deductions are a good thing, it stands to reason that one would want to keep that option available for as long as possible and for as high a deduction as possible.

Considering transfer of real estate to heirs is another tax issue.  Should a property be gifted?  Should it be transferred as part of an estate?  This gets into what is known as Carry-over Basis versus Step-up Basis.  Carry-over (gift based) basically would say that the property was worth $X when purchased, the value at time of receipt by the heir is $Y, and so the heir must pay tax on the difference between present value and original value.  Step up (inheritance based) allows the heir to receive the property at its present value and will only have to pay taxes on the future increase in value. 

1031 Exchanges take this to an even higher level, theoretically delaying taxation in perpetuity.  1031s are for investment real estate only and one-on-one consultation with a knowledgeable professional is highly advisable when seeking to delay taxation, or for developing strategies for transferring real estate to heirs.

Taxation and real estate can be quite complex.  This column has not even touched on basic issues such as capital gains, investment real estate and depreciation, acquisition points, divorce buyouts, home improvements, cashing out equity for investment purposes, and many other applicable topics relevant to taxes and real estate.

When considering buying, selling or refinancing real estate, one should fully consider making use of the expertise and knowledge of professionals.  The cost associated with hiring for services will quite likely be highly offset by the savings you and your heirs could realize.

Greg Polashock is a Real Estate Home Mortgage Loan Consultant and Certified Mortgage Planning Specialist with Cherry Creek Mortgage and resides in Castle Rock, Colorado.  He can be reached via email at Greg@GregIsFinancingSolutions.com, by phone at 303-887-0672 or on the web at http://www.gregisfinancingsolutions.com/.