A reverse mortgage is a loan program in which the homeowner receives payments from the lender rather than making payments on a loan.
To qualify, you must be at least 62 years old and own your home free and clear, or have a very small loan balance relative to the value of your home. A formula is used to calculate the amount of money that can be loaned against your home based on your life expectancy and the amount of equity in your home.
The older you are and the more equity you have, the larger the loan amount. The idea of the reverse mortgage program is to give senior citizens money to live on without being forced to sell their home when their equity runs out.
Homeowners can receive money from the reverse mortgage in monthly payments, or, if they prefer, they can get a lump sum of cash.
The monthly cash payments (or lump sum) that you receive from a reverse mortgage are not taxable income because you (or your heirs) have to pay the money back when the home is sold. It is just like any other kind of loan. Borrowed money is not "income" because it is a debt obligation that has to be repaid.
Now, let's look at how a reverse mortgage affects your interest deduction. We all know that the interest paid on your home mortgage is tax deductible each year. It is the last great tax shelter available to the average American.
But what happens when you don't pay your mortgage interest each year, as is the case with a reverse mortgage?
You don't lose the interest deduction, you merely have to wait until the interest is actually paid before you can claim it.
For example, if a homeowner had accumulated $60,000 worth of unpaid interest on his reverse mortgage and decided to sell his house, he could claim a $60,000 mortgage interest deduction for the tax year in which the home sale closed.
Some homeowners use this feature of reverse mortgages as an estate planning tool. Financial planners sometimes use reverse mortgages to reduce the estate tax burden on their clients.
Even though no payments are required on a reverse mortgage, financial planners sometimes have their clients pay down some or all of the accumulated interest in tax years when it is advantageous for them to do so.
In some cases, an estate planner will have his clients take out a reverse mortgage and use the proceeds to buy a single payment "last-to-die" insurance policy that would pay off the reverse mortgage. The money left over would then be given to the heirs.
When the estate is settled, the tax-free insurance proceeds would pay off the reverse mortgage principal, and the accrued mortgage interest will be used to offset estate taxes. So, in essence, the estate planner has moved money from the taxable pile to the nontaxable pile by acquiring a reverse mortgage at no cost to his client and providing some cash up front for a gift to the children or other heirs.
As you can see, the tax consequences of a reverse mortgage can get a little complicated if you are using sophisticated estate planning strategies, so please consult a professional tax adviser before making any final decisions.
If you are just using a reverse mortgage to generate cash to live on until you pass on, however, you won't have to worry about the income tax consequences. The unpaid interest will be deducted from the sale or refinance of your home by your heirs.
Showing posts with label real estate. Show all posts
Showing posts with label real estate. Show all posts
Sunday, May 15, 2011
Sunday, January 16, 2011
Real Estate ownership and taxes
Property values are at an all time low and many investors are taking advantage of this opportunity to purchase rental properties. Probably for the first time in history, investors can enjoy positive cash flow as well as anticipate a future increase in equity. If this is the year you become a landlord, you will want to pay attention to the tax rules governing this investment.
Your rental income and expenses are listed on your individual tax return on Schedule E, available for your perusal at www.irs.gov. The profit or loss from the activity is included in income and taxed at your ordinary income tax rate. It sounds pretty straightforward, but it can get tricky fast.
First of all, what is rental income? If a prospective tenant pays first and last month’s rent and a security deposit when moving into the property, not all of that is included in current year taxable income. Or is it? Here’s how it breaks down:
1. First and last month’s rent are included in the current year income even if the last month’s rent will be applied in a future year.
2. Advance rent is all included in income for the current year, regardless of what year the payments are for.
3. Non-refundable deposits are included in current year rent, even if a fee, for example, a non-refundable cleaning fee, won’t be used until the tenant moves out in a future year.
4. Security deposits need not be claimed as income if you intend to return the deposit to the tenant at the end of the lease term.
5. Barter is income. If, for example, as part of the rent, your tenant agrees to maintain the gardens and pool, you must show the value of these services as rental income. By the same token, you may also deduct the same amount as a rental expense. I know it’s a push, but the IRS loves to see us sharpening our pencils and doing extra paperwork.
6. Expenses paid by your tenant. See barter income above. Say you’re jet setting through Europe and the pipes in the rental spring a leak; your tenant pays the plumber then deducts it from his rent. You must include the full rent in income and write off the plumbing expense against it. Yes, again, it’s a push.
7. Lease cancellation. If your tenant pays you to cancel the lease, include the payment as rental income.
8. Option payments. If your tenant signs a lease with an option to buy, the option payments are generally rental income. But once the tenant exercises the right to buy the property, all payments received after the sale are considered part of the selling price.
9. Here’s a little tax break for you: If you rent out part of your personal residence for fewer than 15 days, you need not include the rent you receive in your income.
10. If you are renting space in your personal residence (including a vacation home) for more than 15 days, you must declare the income. But you should consult with your tax pro to determine how to properly allocate your rental expenses against the income you receive.
Make sure you keep all lease/rental agreements and tenant applications. When under audit, the IRS likes to look at these documents as part of the verification that this is indeed a rental property. Also keep all cancelled checks and credit card receipts for all rental expenses deducted on your tax return.
http://terrencericecpa.weebly.com/7. Lease cancellation. If your tenant pays you to cancel the lease, include the payment as rental income.
8. Option payments. If your tenant signs a lease with an option to buy, the option payments are generally rental income. But once the tenant exercises the right to buy the property, all payments received after the sale are considered part of the selling price.
9. Here’s a little tax break for you: If you rent out part of your personal residence for fewer than 15 days, you need not include the rent you receive in your income.
10. If you are renting space in your personal residence (including a vacation home) for more than 15 days, you must declare the income. But you should consult with your tax pro to determine how to properly allocate your rental expenses against the income you receive.
Make sure you keep all lease/rental agreements and tenant applications. When under audit, the IRS likes to look at these documents as part of the verification that this is indeed a rental property. Also keep all cancelled checks and credit card receipts for all rental expenses deducted on your tax return.
Your rental income and expenses are listed on your individual tax return on Schedule E, available for your perusal at www.irs.gov. The profit or loss from the activity is included in income and taxed at your ordinary income tax rate. It sounds pretty straightforward, but it can get tricky fast.
First of all, what is rental income? If a prospective tenant pays first and last month’s rent and a security deposit when moving into the property, not all of that is included in current year taxable income. Or is it? Here’s how it breaks down:
1. First and last month’s rent are included in the current year income even if the last month’s rent will be applied in a future year.
2. Advance rent is all included in income for the current year, regardless of what year the payments are for.
3. Non-refundable deposits are included in current year rent, even if a fee, for example, a non-refundable cleaning fee, won’t be used until the tenant moves out in a future year.
4. Security deposits need not be claimed as income if you intend to return the deposit to the tenant at the end of the lease term.
5. Barter is income. If, for example, as part of the rent, your tenant agrees to maintain the gardens and pool, you must show the value of these services as rental income. By the same token, you may also deduct the same amount as a rental expense. I know it’s a push, but the IRS loves to see us sharpening our pencils and doing extra paperwork.
6. Expenses paid by your tenant. See barter income above. Say you’re jet setting through Europe and the pipes in the rental spring a leak; your tenant pays the plumber then deducts it from his rent. You must include the full rent in income and write off the plumbing expense against it. Yes, again, it’s a push.
7. Lease cancellation. If your tenant pays you to cancel the lease, include the payment as rental income.
8. Option payments. If your tenant signs a lease with an option to buy, the option payments are generally rental income. But once the tenant exercises the right to buy the property, all payments received after the sale are considered part of the selling price.
9. Here’s a little tax break for you: If you rent out part of your personal residence for fewer than 15 days, you need not include the rent you receive in your income.
10. If you are renting space in your personal residence (including a vacation home) for more than 15 days, you must declare the income. But you should consult with your tax pro to determine how to properly allocate your rental expenses against the income you receive.
Make sure you keep all lease/rental agreements and tenant applications. When under audit, the IRS likes to look at these documents as part of the verification that this is indeed a rental property. Also keep all cancelled checks and credit card receipts for all rental expenses deducted on your tax return.
http://terrencericecpa.weebly.com/7. Lease cancellation. If your tenant pays you to cancel the lease, include the payment as rental income.
8. Option payments. If your tenant signs a lease with an option to buy, the option payments are generally rental income. But once the tenant exercises the right to buy the property, all payments received after the sale are considered part of the selling price.
9. Here’s a little tax break for you: If you rent out part of your personal residence for fewer than 15 days, you need not include the rent you receive in your income.
10. If you are renting space in your personal residence (including a vacation home) for more than 15 days, you must declare the income. But you should consult with your tax pro to determine how to properly allocate your rental expenses against the income you receive.
Make sure you keep all lease/rental agreements and tenant applications. When under audit, the IRS likes to look at these documents as part of the verification that this is indeed a rental property. Also keep all cancelled checks and credit card receipts for all rental expenses deducted on your tax return.
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