The government plan considers using funds from the bailout to lower interest rates for troubled homeowners.
The government is considering a plan that would help around 3 million homeowners avoid foreclosure, sources briefed on the matter said.
A final deal had not been reached as of Wednesday afternoon and negotiations could still fall apart, but government agencies were contemplating using around $50 billion from the recently passed bailout of the financial industry to guarantee about $500 billion in mortgages.
The plan could include loan modifications that would lower interest rates for a five-year period, according to two people briefed on the plan, who asked not to be identified because details were still being worked out and the plan was not yet public.
The plan would be the most aggressive effort yet to limit damages from the U.S. housing recession, which has shaken global credit markets.
More than 4 million American homeowners with a mortgage were at least one payment behind on their loans at the end of June, and 500,000 had started the foreclosure process, according to the most recent data from the Mortgage Bankers Association.
The government's program would be run by the Federal Deposit Insurance Corp. The agency's chairman, Sheila Bair, said last week she was working "closely and creatively" with the Treasury Department on such a plan, but revealed few details.
Andrew Gray, an FDIC spokesman, said it would be "premature to speculate about any final framework or parameters of a potential program."
Treasury Department spokeswoman Jennifer Zuccarelli called details of the loan modification plan "simply inaccurate." She said the Bush administration "is looking at ways to reduce foreclosures, and that process is ongoing," but has not decided on a final approach.
Criticism growing
Borrower frustration is growing over the government's existing assistance programs, which critics say have been too slow and small in scope to have much impact on soaring foreclosures.
On Wednesday, about 100 demonstrators marched in front of the headquarters of Fannie Mae, and forced a mid-afternoon meeting with the company's chief executive, Herbert Allison.
Some held signs that read "Restructure our loans now," "Fannie Mae destroys lives" and "Foreclose on Fannie Mae."
Bruce Marks, chief executive of the Boston-based Neighborhood Assistance Corp. of America, called on Fannie Mae to adopt a program similar to the one the FDIC put in place at failed IndyMac Bank of Pasadena, Calif. Borrowers there are getting interest rates of about 3 percent for five years.
After the meeting, which included Allison and other top managers, company spokeswoman Amy Bonitatibus said "we agreed to continue to meet with them and work together on foreclosure prevention." Allison and other top executives
Over the past 10 weeks, Fannie Mae says it has received more than 40,000 defaulting loans and stopped 80 percent of them from going into foreclosure.
After meeting with Allison, Marks said the chief executive "understands the issue of making these mortgages affordable over the long term."
Last month, the government seized control Fannie Mae and Freddie Mac the two biggest U.S. mortgage finance companies, with a rescue plan that could require the Treasury Department to inject as much as $100 billion into each to keep them afloat.
It was unclear Wednesday what role Fannie and Freddie would play in the government's sweeping plan to help millions of American homeowners. But lawmakers on Capitol Hill want the companies to take a more aggressive approach.
Sen. Christopher Dodd, D-Conn., the chairman of the Senate Banking Committee said in a statement that "federal agencies and financial institutions must do more to modify the mortgages they hold in order to stop foreclosures and help families keep their homes."
By guaranteeing millions of mortgages, the government could help restore confidence in the market for securities backed by mortgage loans. That was where the global credit crisis started, leading to this month's dramatic stock market plunge.
As a surprising number of homeowners began defaulting on their loans, investors could no longer put a value on the securities which were backed by pools of mortgages. So trading of these securities froze, sending shock waves through the financial industry.
Quote of the Day
October 30, 2008
Three Things You Must Know to Attract Success
Thursday, October 30, 2008
Saturday, October 25, 2008
Despite the credit crunch, there's still plenty of mortgage money
Credit squeeze, credit freeze, credit system seizures: Everybody knows how severe and painful the global financial breakdown has been -- with banks unwilling to lend even to other banks.But what about mortgages? Can you still get a home loan with less than a 20% or 30% down payment? Or with a credit score below 720?
Absolutely. It would be a big stretch to label housing the sunny side of the market at the moment, but there's more light there than in other financial sectors. Consider these facts:* There is no shortage of money available for home mortgages, no freezing of credit to purchase or refinance a house. Why? Because the American mortgage market effectively has been federalized -- at least for the time being. More than 90% of new loans now are being made through the Federal Housing Administration insurance program, plus Fannie Mae and Freddie Mac. FHA is owned by the federal government, and Fannie and Freddie are operating under federal conservatorship. All three have unfettered access to global capital markets at rock-bottom costs because their borrowings are fully guaranteed by the Treasury. Ginnie Mae, which is FHA's pipeline to the bond market, recorded an all-time high of $29 billion in new mortgage-backed securities issued in August.
* Loan terms and credit underwriting standards have been toughened up, but you can still put down 3% (3.5% after Jan. 1) on an FHA-insured mortgage and 5% on certain Fannie Mae and Freddie Mac loan programs with private mortgage insurance. FHA's credit standards are generous and forgiving -- the agency exists to help people with less-than-spotless credit histories. Fannie and Freddie have raised their credit-score requirements over the last year, but buyers and refinancers with scores in the upper 600s can still qualify for loans carrying reasonable rates and fees.* Despite the global financial system's quakes, mortgage rates not only remain low by historical standards but have actually declined recently. For the week that ended Oct. 8, according to the Mortgage Bankers Assn., 30-year fixed rates fell to an average 5.99%, and 15-year mortgages averaged 5.71%. Freddie Mac said 30-year rates dropped to an average 5.94%.* Maximum loan amounts through FHA, Fannie and Freddie in high-cost local markets on the West and East coasts continue to be $729,750 through December. In January, the maximum is projected to drop to about $625,000.* Home prices -- pushed by foreclosures and short sales -- have rolled back to 2003 and 2004 levels or lower in many former boom markets. As a result, growing numbers of buyers are coming off the sidelines. The pending home sales index jumped by 7.4% based on purchase contracts signed in August, according to the National Assn. of Realtors. The heaviest increases -- pointing to higher closed sales in the coming two to three months -- were in California, Florida, Nevada and the Washington, D.C., area.Housing and mortgage leaders say consumer worries about the stock market have obscured positive developments underway in real estate, where pricing pain and downsizing have been facts of the life for the last 2 1/2 years.David G. Kittle, president and chief executive of Principle Wholesale Lending Inc. and incoming chairman of the Mortgage Bankers Assn., says "the mortgage market has never shut down" despite the global financial crisis. Money is "clearly available as long as you can qualify for it."Bottom line: Scary as the news has been about stocks and banks, this is not the case for mortgages. Besides shopping at large national lenders, home buyers should check with local banks and credit unions, which may be originating loans for their own portfolios -- not for Fannie, Freddie or FHA. Many of them are healthy and have plenty of cash to lend.
Absolutely. It would be a big stretch to label housing the sunny side of the market at the moment, but there's more light there than in other financial sectors. Consider these facts:* There is no shortage of money available for home mortgages, no freezing of credit to purchase or refinance a house. Why? Because the American mortgage market effectively has been federalized -- at least for the time being. More than 90% of new loans now are being made through the Federal Housing Administration insurance program, plus Fannie Mae and Freddie Mac. FHA is owned by the federal government, and Fannie and Freddie are operating under federal conservatorship. All three have unfettered access to global capital markets at rock-bottom costs because their borrowings are fully guaranteed by the Treasury. Ginnie Mae, which is FHA's pipeline to the bond market, recorded an all-time high of $29 billion in new mortgage-backed securities issued in August.
* Loan terms and credit underwriting standards have been toughened up, but you can still put down 3% (3.5% after Jan. 1) on an FHA-insured mortgage and 5% on certain Fannie Mae and Freddie Mac loan programs with private mortgage insurance. FHA's credit standards are generous and forgiving -- the agency exists to help people with less-than-spotless credit histories. Fannie and Freddie have raised their credit-score requirements over the last year, but buyers and refinancers with scores in the upper 600s can still qualify for loans carrying reasonable rates and fees.* Despite the global financial system's quakes, mortgage rates not only remain low by historical standards but have actually declined recently. For the week that ended Oct. 8, according to the Mortgage Bankers Assn., 30-year fixed rates fell to an average 5.99%, and 15-year mortgages averaged 5.71%. Freddie Mac said 30-year rates dropped to an average 5.94%.* Maximum loan amounts through FHA, Fannie and Freddie in high-cost local markets on the West and East coasts continue to be $729,750 through December. In January, the maximum is projected to drop to about $625,000.* Home prices -- pushed by foreclosures and short sales -- have rolled back to 2003 and 2004 levels or lower in many former boom markets. As a result, growing numbers of buyers are coming off the sidelines. The pending home sales index jumped by 7.4% based on purchase contracts signed in August, according to the National Assn. of Realtors. The heaviest increases -- pointing to higher closed sales in the coming two to three months -- were in California, Florida, Nevada and the Washington, D.C., area.Housing and mortgage leaders say consumer worries about the stock market have obscured positive developments underway in real estate, where pricing pain and downsizing have been facts of the life for the last 2 1/2 years.David G. Kittle, president and chief executive of Principle Wholesale Lending Inc. and incoming chairman of the Mortgage Bankers Assn., says "the mortgage market has never shut down" despite the global financial crisis. Money is "clearly available as long as you can qualify for it."Bottom line: Scary as the news has been about stocks and banks, this is not the case for mortgages. Besides shopping at large national lenders, home buyers should check with local banks and credit unions, which may be originating loans for their own portfolios -- not for Fannie, Freddie or FHA. Many of them are healthy and have plenty of cash to lend.
Friday, October 17, 2008
Where did all that "lost" money go?
And why are mortgage rates so high when the Fed keeps cutting rates?
The financial market collapse of the past few weeks has destroyed trillions of dollars in wealth. So where, exactly, did all that money go?
Where did the "lost" money go? I'm sure dollar bills weren't burned up in a fire or flushed down the toilet. … Common sense says "If party A loses a buck, party B makes that buck. So who is party B?
There have definitely been winners in the ongoing collapse of the financial system. And there will be many more as it gets back on its feet.
In the case of stock market gains and losses, the math is pretty simple. If you sold me 100 shares of IBM at the market peak (about $131 a share), you locked in a gain on stock that is now “worth” just $87 a share, according to Friday’s closing price. To me, it looks like the money evaporated. But, depending on when you bought it, you can take a nice vacation trip at my expense.
One the other hand, if you bought IBM stock on Friday, the seller almost certainly lost money if they bought within the last two years – the last time IBM traded for less than $87 a share.
But IBM is the same company it was a few months ago before the market sold off. It’s very likely the price is going to rebound – based on the value of all of IBM’s assets, its business prospects and its highly skilled workforce. The same is true for hundreds of other companies whose stock have gotten hammered. So today’s buyers are likely going to capture some of the “lost” value of stocks. It may take awhile to recover, but the value is almost certainly still there.
The losses related to the housing market are a little more difficult to trace. But despite the continued rise in mortgage defaults and foreclosures, one of the biggest winners of the collapse of the housing market was the American homeowner. Or at least those who sold or refinanced a house before the bubble burst.
As we’re now seeing, the rapid rise in the prices of homes — probably the biggest single asset for most homeowners — was not rooted in a real increase in value. Home prices were rising by double digits in the late stages of the bubble — even though wages were flat.
With their true purchasing power limited by wages, the only way home buyers could keep bidding up prices was by taking advantage of the flood of money from lenders — who began handing out mortgages to anyone who wanted one. Appraisers — hired by the mortgage brokers writing these loans — went along with the rapid run-up in prices.
These lenders didn’t have to worry that some borrowers couldn’t pay the money back — because they sold the loans off to Wall Street, which wrapped them up in a package with a big bow that said “Triple-A Rated.” As long as house prices kept rising, no one bothered to look under the hood to see how risky these loans really were.
But when prices were rising, sellers during that period made real profits. Of course, many had to buy another house at similarly inflated prices. But the gains on those sales were very real — and represent the flip side of the losses we are seeing now.
Some people locked in those gains by refinancing their mortgage — more than once — as home prices rose. Others took out loans against the rising equity in their homes; though that equity has evaporated, they still get to keep the money. They still have to pay back the loan, and that money is going to come out of consumer spending — which is a big reason the economy is at risk. Something like one in six homeowners are “underwater” — they owe more than their house is worth. As everyone tightens their belt at the same time, the contraction in spending would be a huge drag on the economy.
The banks and investors holding all those mortgage backed investments are also big losers, now that millions of homeowners are defaulting on their loans. The winners there are all the folks who profited from the lending boom. The mortgage brokers collected their fees and commissions on those mortgages, lenders took a slice when they sold them to Wall Street, which collected fees for packaging all them and selling them to investors. When the music stopped, there weren’t enough chairs. So if you're holding this mortgage backed paper, you’re going to have a tough time finding a chair to sit on.
Why are mortgage rates going up since the Fed's lowered the rate yesterday? Will they ever reflect the current rate decreases?
Despite what you see in those Web ad pitches with annoying wacko dancers, the Fed has little direct control over long-term rates like 30 year mortgages.
Even under normal circumstances, the Fed’s impact on all interest rates is limited. And these are anything but normal circumstances.
The money market ultimately sets the true “cost” of money — just like the stock market sets the value of shares. Banks and investors with money to spare sell it in the credit markets; interest rates rise and fall as borrowers offer more or less interest to “buy” money. Just as supply and demand set price in any market, if there’s lots of money sloshing around the system, rates go lower. If money is “tight,” rates go up.
When the Federal Reserve's policy makers “set” a short-term interest rates, they’re really just setting a target they’d like to hit. They then try to steer shorter-term rates by buying and selling of Treasury bonds on the open market. (Rates are set by the Fed's Open Market Committee.) Selling those bonds takes cash out of the system (buyers of the bonds have to pay cash) and buying bonds pumps more money into the system.
But the Fed only targets very short term rates; the “fed funds” rate you read about is for loans banks make to each other overnight to make sure they maintain the level of reserves set by regulators. A bank with a little extra money lends it to one that needs a few dollars — and pockets some change on the overnight interest. (When you’re a large money center bank moving billions through the system, that overnight interest adds up.)
Long-term rates like mortgages are also set by the money market, based on the supply of money and the level of risk associated with lending it out for 30 years. That’s why interest rates on long-term loans like mortgages are typically higher than very short term rates like those set by the Fed.
At the moment, the conventional rules are out the window. The credit markets are not behaving normally, and the price of money is based on full-blown panic. Banks have stopped lending to each other because they’re afraid the bank they lend to may be the next one to blow up. Mortgage lending is in slightly better shape — as long as you’re willing to put down a large sum of money to cover the risk that the price of the house you want to buy will fall further.
It remains to be seen how long banks remain locked in panic mode. The Fed and the Treasury are flooding the system with cash, but that doesn’t seem to be enough. It may take a complete government-backed guarantee of all loans between banks before these folks settle down and start lending again.
Quote of the Day
October 16, 2008
Life is the art of drawing without an eraser. -John W. Gardner
The financial market collapse of the past few weeks has destroyed trillions of dollars in wealth. So where, exactly, did all that money go?
Where did the "lost" money go? I'm sure dollar bills weren't burned up in a fire or flushed down the toilet. … Common sense says "If party A loses a buck, party B makes that buck. So who is party B?
There have definitely been winners in the ongoing collapse of the financial system. And there will be many more as it gets back on its feet.
In the case of stock market gains and losses, the math is pretty simple. If you sold me 100 shares of IBM at the market peak (about $131 a share), you locked in a gain on stock that is now “worth” just $87 a share, according to Friday’s closing price. To me, it looks like the money evaporated. But, depending on when you bought it, you can take a nice vacation trip at my expense.
One the other hand, if you bought IBM stock on Friday, the seller almost certainly lost money if they bought within the last two years – the last time IBM traded for less than $87 a share.
But IBM is the same company it was a few months ago before the market sold off. It’s very likely the price is going to rebound – based on the value of all of IBM’s assets, its business prospects and its highly skilled workforce. The same is true for hundreds of other companies whose stock have gotten hammered. So today’s buyers are likely going to capture some of the “lost” value of stocks. It may take awhile to recover, but the value is almost certainly still there.
The losses related to the housing market are a little more difficult to trace. But despite the continued rise in mortgage defaults and foreclosures, one of the biggest winners of the collapse of the housing market was the American homeowner. Or at least those who sold or refinanced a house before the bubble burst.
As we’re now seeing, the rapid rise in the prices of homes — probably the biggest single asset for most homeowners — was not rooted in a real increase in value. Home prices were rising by double digits in the late stages of the bubble — even though wages were flat.
With their true purchasing power limited by wages, the only way home buyers could keep bidding up prices was by taking advantage of the flood of money from lenders — who began handing out mortgages to anyone who wanted one. Appraisers — hired by the mortgage brokers writing these loans — went along with the rapid run-up in prices.
These lenders didn’t have to worry that some borrowers couldn’t pay the money back — because they sold the loans off to Wall Street, which wrapped them up in a package with a big bow that said “Triple-A Rated.” As long as house prices kept rising, no one bothered to look under the hood to see how risky these loans really were.
But when prices were rising, sellers during that period made real profits. Of course, many had to buy another house at similarly inflated prices. But the gains on those sales were very real — and represent the flip side of the losses we are seeing now.
Some people locked in those gains by refinancing their mortgage — more than once — as home prices rose. Others took out loans against the rising equity in their homes; though that equity has evaporated, they still get to keep the money. They still have to pay back the loan, and that money is going to come out of consumer spending — which is a big reason the economy is at risk. Something like one in six homeowners are “underwater” — they owe more than their house is worth. As everyone tightens their belt at the same time, the contraction in spending would be a huge drag on the economy.
The banks and investors holding all those mortgage backed investments are also big losers, now that millions of homeowners are defaulting on their loans. The winners there are all the folks who profited from the lending boom. The mortgage brokers collected their fees and commissions on those mortgages, lenders took a slice when they sold them to Wall Street, which collected fees for packaging all them and selling them to investors. When the music stopped, there weren’t enough chairs. So if you're holding this mortgage backed paper, you’re going to have a tough time finding a chair to sit on.
Why are mortgage rates going up since the Fed's lowered the rate yesterday? Will they ever reflect the current rate decreases?
Despite what you see in those Web ad pitches with annoying wacko dancers, the Fed has little direct control over long-term rates like 30 year mortgages.
Even under normal circumstances, the Fed’s impact on all interest rates is limited. And these are anything but normal circumstances.
The money market ultimately sets the true “cost” of money — just like the stock market sets the value of shares. Banks and investors with money to spare sell it in the credit markets; interest rates rise and fall as borrowers offer more or less interest to “buy” money. Just as supply and demand set price in any market, if there’s lots of money sloshing around the system, rates go lower. If money is “tight,” rates go up.
When the Federal Reserve's policy makers “set” a short-term interest rates, they’re really just setting a target they’d like to hit. They then try to steer shorter-term rates by buying and selling of Treasury bonds on the open market. (Rates are set by the Fed's Open Market Committee.) Selling those bonds takes cash out of the system (buyers of the bonds have to pay cash) and buying bonds pumps more money into the system.
But the Fed only targets very short term rates; the “fed funds” rate you read about is for loans banks make to each other overnight to make sure they maintain the level of reserves set by regulators. A bank with a little extra money lends it to one that needs a few dollars — and pockets some change on the overnight interest. (When you’re a large money center bank moving billions through the system, that overnight interest adds up.)
Long-term rates like mortgages are also set by the money market, based on the supply of money and the level of risk associated with lending it out for 30 years. That’s why interest rates on long-term loans like mortgages are typically higher than very short term rates like those set by the Fed.
At the moment, the conventional rules are out the window. The credit markets are not behaving normally, and the price of money is based on full-blown panic. Banks have stopped lending to each other because they’re afraid the bank they lend to may be the next one to blow up. Mortgage lending is in slightly better shape — as long as you’re willing to put down a large sum of money to cover the risk that the price of the house you want to buy will fall further.
It remains to be seen how long banks remain locked in panic mode. The Fed and the Treasury are flooding the system with cash, but that doesn’t seem to be enough. It may take a complete government-backed guarantee of all loans between banks before these folks settle down and start lending again.
Quote of the Day
October 16, 2008
Life is the art of drawing without an eraser. -John W. Gardner
Wednesday, October 15, 2008
New Listing - Laguna Woods
Model Perfect 1BR 1BA home in Laguna Woods priced at only $125,000. This home is perfect for a single person or couple as a primary or secondary home. Furniture is negotiable.
Call KRISTIN NOW for a private showing.
_________________________
Kristin Devlin
949.350.3771
Thursday, October 9, 2008
Housing Assistance Act Will Impact Many Investors
Housing Assistance Act Will Impact Many Investor Capital Gain Calculations
It has been said that the only time Americans are safe is when Congress is not in session. A possible corollary of this maxim might be that any time a widely-supported bi-partisan bill is hailed as a "rescue”, someone is liable to get hurt. Certainly, if your situation is dealt with in the portion of the bill titled Revenue, you'd better watch out.
Thus we turn to section 3092 of HR 3221 (The Housing Assistance Tax Act of 2008). There, in just a few short lines, much is taken away from what had once been given. Under current law, if you sell a property that has been your personal residence for at least two of the past five years, you may exclude from your taxable income up to $250,000 of the capital gains ($500,000 for a married couple). This is true even if the property has also been used as a rental -- as long as you meet the time period required.
Investors who have acquired the property through a 1031 tax-deferred exchange may use this provision also, although they are required to have owned the property for at least five years before they can take advantage of the exclusion. For example -- and this is a fairly common scenario -- an investor might exchange into a nice rental property which he rents out for three years. Then he moves into it as his principal residence, and sells it after two more years. In that case, the full capital gains exclusion is available.
Under the new rules, the amount of gain available for exclusion will depend on a ratio between the amount of "qualified” and "nonqualified” use of the property. Qualified use is defined as any use of the property as a primary residence. Nonqualified use is defined as any use of the property other than as a primary residence, including use as a second home, a vacation property, a rental or investment property or use in a trade or business. The ratio period is based on the length of ownership of the property. Only the qualified use portion is available for exclusion from taxable gain.
The rules don't take effect until January 1, 2009, and only unqualified use after that date will be taken into account. In short, if you're selling this year, don't worry about the new rules. Moreover, in most cases, sales during the next couple of years will not have an issue.
To see how these rules work, let us consider a couple of examples. (Depreciation issues and sale costs will not be considered in the examples.) Current rules: You acquired a rental property in 2003. Your basis in it is $200,000. You rent it out for three years and then occupy it as your personal residence. In 2008, five years after acquiring it, you sell for $400,000, with a gain of $200,000. (Good for you.) The total gain falls within your individual $250,000 exclusion limit and is excluded from taxable income.
New rules: You acquire a property in 2009. Your basis in it is $200,000. You rent it out for three years and then occupy it as your personal residence. In 2014, five years after acquiring it, you sell for $400,000, with a gain of $200,000. Three of the years, 60% of the ownership period, were of nonqualified use. Thus 60% ($120,000) of the gain will be taxable. Just 40% of the gain ($80,000) represents the qualified use of the property and may be excluded from taxable (capital gain) income.
These new rules will appear as amendments to section 121 of the Internal Revenue Code. There are way, way too many scenarios, variations, and fine-print exceptions to cover in the space available here. Suffice it to say that anyone who is making plans to sell a property that has or will have both qualified and nonqualified uses needs to consult with a competent real estate tax accountant and/or attorney.
Some might be thinking, "Why all the concern about such an esoteric issue? There can't be that many who will be affected by it.” Well, prior to the vote on HR 3221, the Senate Finance Committee estimated that these new rules would raise $1.394 billion over 10 years! I don't know where they get their numbers, but there must be more than a couple of people who are going to be affected by it.
Quote of the Day
October 9, 2008
We should be taught not to wait for inspiration to start a thing. Action always generates inspiration. Inspiration seldom generates action.
~Frank Tibolt
It has been said that the only time Americans are safe is when Congress is not in session. A possible corollary of this maxim might be that any time a widely-supported bi-partisan bill is hailed as a "rescue”, someone is liable to get hurt. Certainly, if your situation is dealt with in the portion of the bill titled Revenue, you'd better watch out.
Thus we turn to section 3092 of HR 3221 (The Housing Assistance Tax Act of 2008). There, in just a few short lines, much is taken away from what had once been given. Under current law, if you sell a property that has been your personal residence for at least two of the past five years, you may exclude from your taxable income up to $250,000 of the capital gains ($500,000 for a married couple). This is true even if the property has also been used as a rental -- as long as you meet the time period required.
Investors who have acquired the property through a 1031 tax-deferred exchange may use this provision also, although they are required to have owned the property for at least five years before they can take advantage of the exclusion. For example -- and this is a fairly common scenario -- an investor might exchange into a nice rental property which he rents out for three years. Then he moves into it as his principal residence, and sells it after two more years. In that case, the full capital gains exclusion is available.
Under the new rules, the amount of gain available for exclusion will depend on a ratio between the amount of "qualified” and "nonqualified” use of the property. Qualified use is defined as any use of the property as a primary residence. Nonqualified use is defined as any use of the property other than as a primary residence, including use as a second home, a vacation property, a rental or investment property or use in a trade or business. The ratio period is based on the length of ownership of the property. Only the qualified use portion is available for exclusion from taxable gain.
The rules don't take effect until January 1, 2009, and only unqualified use after that date will be taken into account. In short, if you're selling this year, don't worry about the new rules. Moreover, in most cases, sales during the next couple of years will not have an issue.
To see how these rules work, let us consider a couple of examples. (Depreciation issues and sale costs will not be considered in the examples.) Current rules: You acquired a rental property in 2003. Your basis in it is $200,000. You rent it out for three years and then occupy it as your personal residence. In 2008, five years after acquiring it, you sell for $400,000, with a gain of $200,000. (Good for you.) The total gain falls within your individual $250,000 exclusion limit and is excluded from taxable income.
New rules: You acquire a property in 2009. Your basis in it is $200,000. You rent it out for three years and then occupy it as your personal residence. In 2014, five years after acquiring it, you sell for $400,000, with a gain of $200,000. Three of the years, 60% of the ownership period, were of nonqualified use. Thus 60% ($120,000) of the gain will be taxable. Just 40% of the gain ($80,000) represents the qualified use of the property and may be excluded from taxable (capital gain) income.
These new rules will appear as amendments to section 121 of the Internal Revenue Code. There are way, way too many scenarios, variations, and fine-print exceptions to cover in the space available here. Suffice it to say that anyone who is making plans to sell a property that has or will have both qualified and nonqualified uses needs to consult with a competent real estate tax accountant and/or attorney.
Some might be thinking, "Why all the concern about such an esoteric issue? There can't be that many who will be affected by it.” Well, prior to the vote on HR 3221, the Senate Finance Committee estimated that these new rules would raise $1.394 billion over 10 years! I don't know where they get their numbers, but there must be more than a couple of people who are going to be affected by it.
Quote of the Day
October 9, 2008
We should be taught not to wait for inspiration to start a thing. Action always generates inspiration. Inspiration seldom generates action.
~Frank Tibolt
Monday, October 6, 2008
Open House Sunday 32 Cedarlake, Irvine
Open house 1-5PM at 32 Cedarlake at lovely 3BR 2.5 Bath, 2 story home with wraparound English garden yard complete with fountain and privacy. Woodbridge a block from the beach and tennis courts at Southlake. A must see!
_____________
Kristin Devlin
949.350.3771
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