Tag Archives: income tax

Tax Reform and Home Equity Loans

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photo by Kalmia

MortgageLoan.com quoted me in Tax Reform Just Made Home Equity Loans A Lot Less Attractive. It reads, in part,

Home equity loans have long been attractive ways for homeowners to borrow money to pay for everything from major home improvements to a child’s college education. But these loans just lost a major benefit: When filing their income taxes, homeowners can no longer deduct the interest they pay on home equity loans each year.

This might make these loans less popular. The loss of the interest deduction might persuade homeowners to look for other ways to tap the money in their homes.

“From what I see, there are very limited times that home equity loans would still come in as a benefit,” said Tristan Ahumada, a real estate agent with Keller Williams Realty in Westlake Village, California.

A rush to pay off home equity loans?

And she’s not alone. Donald Daly, managing partner of REIS Group LLC in New York City and a licensed real estate appraiser, said that since January 1 he has seen a higher level of requests for appraisals from homeowners seeking to refinance their existing mortgage loans. Many of these owners are doing this as a way of paying off their Home Equity Lines of Credit, a form of home equity loan.

The reason? These lines of credit, better known as HELOCs, are not nearly as attractive to homeowners when they don’t come with the bonus of a tax deduction.

“We fully expect this trend to grow over the next weeks and months as more and more homeowners learn of the effect these changes will have on their personal finances,” Daly said.

Goodbye, deduction

In the past, homeowners who took out home equity loans or HELOCs could deduct the interest they paid on up to $100,000 of these loans. If you took out a home equity loan for $50,000, then, you could deduct all the interest you paid during the year on that loan. If you took out a home equity loan for $150,000, you could deduct the interest you paid on the first $100,000 of that loan.

When Congress in December of last year signed the Tax Cuts and Jobs Act into law, this all changed. The big tax reform legislation eliminates the home equity loan deduction starting in 2018. You can still claim your tax deduction when you file your income taxes in April of this year. That’s because you’re paying taxes from 2017.

But you won’t be able to claim the home equity loan deduction when you file on your 2018 taxes and beyond. Most of the tax cuts impacting taxpayers, including the home equity deduction rules, are scheduled to expire after 2025. No one knows, though, whether Congress will vote to continue them past that date once that year rolls around.

Existing loans aren’t grandfathered in, either. If you took out a home equity loan in 2016 and you’re still paying it off this year, you won’t be able to deduct any interest you pay on it in 2018, even if you’ve already deducted interest payments in the past.

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Home equity loans can still work, though

Just because the tax benefits of home equity loans are disappearing, though, doesn’t mean that these loans are no longer a viable option for all homeowners.

The deduction was a benefit, but the biggest advantage of home equity loans is that they are a relatively cheap way to borrow money. The mortgage rates attached to home equity loans tend to be low. That isn’t changing.

So if you do have equity in your home and you want money to help pay, say, for your children’s college tuition, a home equity loan or HELOC might still be a smart move.

“While tax deductions are important, they are not the only reason we take out home equity loans,” said David Reiss, professor law at Brooklyn Law School in Brooklyn, New York.

Reiss said that when considering whether a home equity loan or HELOC is right for them, homeowners need to ask several important questions.

First, why do they want to take out the loan? If it’s for home improvements or to reduce high-interest-rate debt, the loan might still be worthwhile, even with the tax changes.

Next, homeowners need to look at their monthly budgets to determine if they can afford the payments that come with these loans. Finally, homeowners should consider whether they can borrow money cheaper somewhere else, taking the loss of the deduction into consideration.

“If you are comfortable with your answers, there is no reason not to consider a home equity loan as a financing option,” Reiss said.

Manafort Indicted for Real Estate Fraud

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Special Counsel Mueller

Paul Manafort and his protege, Richard Gates III, were indicted on a variety of charges, including conspiracy, failure to file requirement financial reports and the making of false statements. The indictment was signed by Special Counsel Mueller. A number of the allegations involve real estate transactions. Here are the highlights (lowlights?) of the allegations that document how money can be laundered through real estate:

Manafort used his hidden overseas wealth to enjoy a lavish lifestyle in the United States, without paying taxes on that income.  Manafort, without reporting the income to his tax preparer or the United States, spent millions of dollars on luxury goods and services for himself and his extended family through payments wired from offshore nominee accounts to  United States vendors.  Manafort also used these offshore accounts to purchase multi-million dollar properties in the United Sates.  Manafort then borrower millions of dollars in loans using these properties as collateral, thereby obtaining cash in the United States without reporting and paying taxes on the income.  In order to increase the amount of money he could access in the United States, Manafort defrauded the institutions that loaned money on these properties so that they would lend him more money at more favorable rates than he would otherwise be able to obtain. (para 4)

More than $75,000,000 flowed through Manafort and Gate’s 15 offshore accounts. They also had 17 US corporations through which some of these funds flowed as well. In order to avoid paying taxes on this money, Manafort and Gates made millions of dollars in wire transfers to pay “for goods, services and real estate.” (para. 15) Manafort spent more than $12,000,000 on personal items including home improvement services, clothing, cars and housekeeping. He also bought four properties for over $6,000,000.

After Manafort bought these properties, “he took out mortgages on the properties thereby allowing Manafort to have the benefits of liquid income without paying taxes on it. Further, Manafort defrauded the banks that loaned him the money so that he could withdraw more money at a cheaper rate than he otherwise would have been permitted.” (para. 33) He did this by wrongfully claiming on a loan application that an investment property was owner-occupied (banks generally give you a more favorable interest rate if the property is owner-occupied). He was also able to borrow more money by claiming that part of the proceeds of a loan would be used to fund a renovation when in fact he did not intend to use the funds for that purpose.

The allegations in the indictment provide a nice case study of how real estate is used in money laundering.

Foreclosure Body Count

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respres

Case Western’s Matt Rossman has posted Counting Casualties in Communities Hit Hardest by the Foreclosure Crisis (forthcoming in the Utah Law Review) to SSRN. The abstract reads,

Recent statistics suggest that the U.S. housing market has largely recovered from the Foreclosure Crisis. A closer look reveals that the country is composed not of one market, but of thousands of smaller, local housing markets that have experienced dramatically uneven levels of recovery. Repeated waves of home mortgage foreclosures inundated certain communities (the “Hardest Hit Communities”), causing their housing markets to break rather than bend and resulting in what amounts to a permanent transition to a lower value plateau. Homeowners in these predominantly low and middle income and/or minority communities who endured the Foreclosure Crisis lost significant equity in what is typically their principal asset. Public sector responses have largely ignored this collateral damage.

As the ten-year mark since the onset of the Foreclosure Crisis approaches, this Article argues that homeowners in the Hardest Hit Communities should be able to deduct the damage to their home values caused by the Crisis from their federal taxable income. This means overcoming the tax code’s usual normative assumption that a decline in a home’s value represents consumed wealth and, thus, is fully taxable. To do so, this Article likens the rapid, unusual and enduring plunge in home values experienced by homeowners in the Hardest Hit Communities to casualty losses – i.e. damages to personal property caused by a sudden force like a storm or a hurricane – which are deductible. The IRS and most courts have insisted this deduction is limited to physical damage. This Article carefully dissects the law and principles underlying the deduction to reveal that the physical damage requirement is overbroad and inequitable. When viewed in the larger context of other recent tax code interventions that allow those who have experienced personal financial harm due to a crisis to reduce their income tax base accordingly, home value damage in the Hardest Hit Communities actually fits comfortably within the concept of a casualty loss.

Notwithstanding its normative and equitable fit, the casualty loss deduction poses several administrative challenges in its application to the Foreclosure Crisis. This Article addresses each challenge in turn, explaining the extent to which the Treasury Department and the IRS, through administrative action and/or a careful application of case law precedent, can resolve it. The Article also identifies and grapples with the distributional reality that the casualty loss deduction, in its current form, provides a small or no return on lost home equity for a sizable number of low and middle income homeowners, which would make it a problematic method of recovery for homeowners in the Hardest Hit Communities. To make the deduction a better and more equitable fit under the circumstances, this Article identifies two, larger-scale modifications the federal government could adopt: (i) changing the method by which a casualty loss is valued for damage caused by the Foreclosure Crisis and/or (ii) lifting the floors and limits Congress has over time imposed on the deduction, as it has done for those taxpayers most heavily impacted by several recent hurricanes and droughts.

The article offers a creative response to ameliorate an aspect of the foreclosure crisis. Rossman concludes, “Once these homeowners are considered equally worthy of claiming a casualty loss, the question then shifts to how the IRS, the Treasury Department and/or Congress can best adapt and address the administrative and distributional challenges attendant to utilizing the casualty loss deduction in this context. These challenges are not insurmountable barriers, but rather issues to be carefully considered and strategically addressed.” (67)

I can certainly imagine some of those challenges, such as how to reliably identify a “permanent transition to a lower value plateau,” but articles of this type are just what we need as we try to figure out how to address housing crises of this magnitude.  While there was a big gap between the housing crises of the Great Depression and the Great Depression we can be sure that there will be another such event at some point in the 21st century.

5 Signs You Probably Need an Accountant

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Alan Cleaver

WiseBread quoted me in 5 Signs You Probably Need an Accountant. It reads, in part,

Do you dread filing your income taxes each year? Does preparing your taxes take weeks of your time? And once you’ve sent your papers to the IRS, do you have the sneaking suspicion that you might not have taken all the deductions to which you are entitled?

You might need to hire an accountant.

“Hiring an accountant depends on whether your knowledge, time, and money are best spent on bookkeeping, loan application, and tax preparation, or whether you have higher priorities,” says Valrie Chambers, associate professor of taxation and accounting at Stetson University in Celebration, Florida. “A business owner who excels at sales should probably use her time increasing sales rather than learning and doing accounting. That strategy is just more profitable for the business.”

Here are five signs that you need to hire an accountant.

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4. You Own Rental Real Estate

Renting an apartment or two is a great way to earn passive income. But doing so can also complicate your finances. That’s why it makes sense to hire an accountant to make sure that you don’t miss any important tax deductions related to rental income, and that you file all the paperwork necessary when working as a landlord.

“There comes a point when personal tax software is not sophisticated enough to take into account the complexities of real estate investments,” says David Reiss, professor of law and research director for the Center for Urban Business Entrepreneurship at Brooklyn Law School in New York City. “If a taxpayer has multiple properties that have both a personal and investment component, tax software may not be able to accept all of the relevant inputs and generate the correct output.”

Borrowing from Yourself

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MainStreet.com quoted me in Dipping Into Your 401(k) to Finance the Purchase of a Home is a Tricky Decision. It reads, in part,

Dipping into the funds she had amassed in her 401(k) account to make up the remaining difference for her down payment was not a decision that Alyson O’Mahoney embarked on lightly.

After contemplating the benefits and disadvantages of borrowing $40,000 from her retirement account to use for a down payment on her mortgage, the marketing executive for Robin Leedy & Associates in Mount Kisco, N.Y. was certain that she making the right choice.

O’Mahoney was undaunted by the prospect of having another bill each month, even though she opted out of discussing this critical decision with her financial advisor — as she knew he would discourage her.

“It all fit into my debt and income ratio and the bank was fine with it,” she said. “I pay it back automatically with each paycheck and the 5% interest goes to me. It was the easiest process.”

Many financial advisors steer their clients away from borrowing from their retirement, because employers will typically demand that you repay the loan within a short period if you leave your job or get fired. If you can’t pay it back from your savings, then the loan will be treated as a distribution that is subject to federal and state income tax, as well as an early withdrawal penalty of 10% if you’re under the age of 59.5, said Shomari Hearn, a certified financial planner and vice president at Palisades Hudson Financial Group in the Fort Lauderdale, Fla. office.

“If you’re contemplating leaving your company within the next few years or are concerned about job security, I would advise against taking out a loan from your 401(k),” he said.

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If you accept another job offer, refinancing your mortgage may be difficult when you are facing a time crunch, said David Reiss, a law professor at Brooklyn Law School.

“If you leave your job, the loan will come due, and you will have to figure out how to repay it – potentially just at the time it would be hardest to do so,” he said. “Given that it might be hard to refinance the property on such short notice, you might find yourself stuck between a rock and a hard place.”

Tax Expenditure Wars: Wealthy Households v. Poor

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Henry Rose has posted How Federal Tax Expenditures That Support Housing Contribute to Economic Inequality to SSRN. This short article examines “how federal income tax laws benefit more affluent owner households but provide no benefits to economically-strapped renter households.” (1) Housing policy analysts (myself included) constantly bemoan the regressive nature of federal tax policy as it relates to housing, but it is always worth looking at the topic with updated numbers. And this article contains some tables with some interesting numbers.

One table provides an overview of the estimated tax savings (in billions) in FY 2014 for five federal tax expenditures for owners of housing that they occupy:

Mortgage Interest Deduction  (MID)                                                 $66.91

Property Tax Deduction (PTD)                                                        $31.59

Capital Gains Exclusion on Sales                                                   $35.54

Net Imputed Rental Income Exclusion                                            $75.24

Discharge of Mortgage Indebtedness Exclusion                            $3.1

Total                                                                                                 $212.38

The next table provides an estimated distribution of two of these tax expenditures (FY 2014, savings in millions):

Tax-Filer AGI                PTD Tax Savings         MID Tax Savings                

Below $50,000              $693                              $1,443

$50,000-75,000             $2,190                           $4,330

$75,000-100,000           $3,478                           $6,581

$100,000-200,000         $13,648                         $27,421

$200,000+                     $11,798                         $29,340

Total                              $31,806                         $69,115                               

The article concludes by noting that despite

the great disparity in economic positions between owners and renters, federal tax expenditures lavish tax savings on primarily affluent owners and provide none for renters. The federal tax expenditures for owners are so generous that interest can be deducted on mortgage balances up to $1,000,000 and can also be taken on second homes, even yachts, as well as primary residences. It is difficult to conceive of a federal public policy that more directly promotes economic inequality than the federal tax expenditures that support owners of housing but are not available to renters. (9-10, footnote omitted)

I don’t expect this disparity to be addressed any time in the near future, given the current political environment, but it is certainly one that should stay at the top of any list of reforms for those concerned with promoting equitable federal housing policies.