Friday, August 27, 2004

Capital Gains Exceptions Finalized

The Internal Revenue Service issued final rules recently that could reduce capital gains taxes for some homeowners. Current rules allow taxpayers to exclude $250,000 in gains for single sellers and $500,000 for married sellers if they have met certain criteria.

Ann vom Eigen, Legislative and Regulatory Counsel for the American Land and Title Association (, reports on her group’s web site, “The IRS has finalized rules for the treatment of taxpayers who do not qualify for the maximum exclusion of capital gains on home sales because they have not owned and used their property as their principal residence for two of the past five years, or have taken an exclusion within the preceding two years. The rules significantly expand the situations under which capital gains exclusions may be taken.”

In essence, if a homeowner found it necessary to move before the two year period, then he or she would owe capital gains taxes on gain under the two floor amounts ($250,000/$500,000).

There have always been exemptions under the code to allow for at least some exemption from taxation if the homeowner had extenuating circumstances, such as a change in place of employment, health or unforeseen circumstances. Under the final rules, “safe harbors” are established for taxpayers to qualify for these exclusions of capital gains taxes.

Unforeseen circumstances have been the most confusing section of the rules, though they point out that the IRS is not heartless when it comes to taxes and hard times. What determined unforeseen circumstances seemed to be considered on a case-by-case basis in the past. Now, the IRS has named an unforeseen circumstance as "an event that the taxpayer could not reasonably have anticipated." In addition, the unforeseen circumstance could affect someone in the household other than the taxpayer, such as the taxpayer’s spouse or other dependent who lives in the house.

Safe harbors under the unforeseen section include, but are not limited to:

A natural or man-made disaster or act of war or terrorism resulting in a casualty to the residence.
The cessation of employment as a result of which the individual is eligible for unemployment compensation.
A change in employment or self-employment status that results in the taxpayer’s inability to pay housing costs and reasonable basic living expenses for the taxpayer’s household.
Divorce or legal separation under a decree of divorce or separate maintenance; and
Multiple births resulting from the same pregnancy.

If you find yourself in an “unforeseen circumstance” situation, then you may be in luck, as it were, for your hardship. It means you may be able to pay less taxes or be exempt from taxes altogether. The tax would be calculated based on how long you had lived in the property, among other criteria. Check with your accountant to be sure and you can use the online capital gains calculators below to get started.

Members of the military also receive some final rules on the length of stay test. ATLA also reported that under the military exception, “A taxpayer serving, (or whose spouse is serving) on qualified official extended duty as a member of the uniformed services or Foreign Service may elect to suspend the running of the 5 year period for up to 10 years. The exception for members of the Foreign Service and the military is retroactive to May 7, 1997.”


For the full text of the final revisions, visit the Federal Register online at, and search for “page 50302”.

Capital Gains Calculators:
Certified Residential Specialists ( ( (

Sunday, August 22, 2004

Selling Note Creates Instant Cash for Seller, Profit for Buyer

There are many reasons why you may find yourself as the owner of a real estate note. A note is a financial instrument by which the owner of real estate borrows money against the property. Most times, the note is referred to as a mortgage. A homeowner can have several mortgages on one property – totaling more than the value of the property with some programs. However, in most circumstances the note is only a portion of the value of the property. For instance, the property may be worth $200,000, but the mortgage is for $180,000.

The first mortgage is usually held by a large lender – such as a bank or investment firm. Second trusts can be held by large companies, but it’s not unusual for individuals to hold a second trust on a property. In some instances, the seller of a property will offer to hold a second trust to enable a purchaser to buy the property. Sellers often make such an offer for several reasons. Most times it’s because the buyer may only qualify for a smaller mortgage, so the owner/seller takes on a second to enable them to qualify to purchase the house.

For instance, the buyer may put down 5 percent in cash, take on a mortgage for 75 percent of the value of a house, and then the owner creates a note for the remaining 20 percent to make the deal work.

The owner can hold on to this note and receive payments over time or the note holder could sell it, get cash upfront, but at a discount. It’s like either taking $120 over the next year at $10 per month or taking $60 now. Many note holders would rather take the lower amount of cash than hold out for the larger amount over time. This impatience can work in the best interest of a bargain-hunting note buyer.

It works like this. Let’s say a home sells for $200,000. The buyer puts down 5 percent ($10,000) and the owner provides a 20 percent second trust at $40,000 and the bank loans the buyer the rest ($150,000).

If the second trust was to be paid back over 15 years at 9 percent, the monthly payment would be $405.71. The total amount paid to the note holder would actually be $73,027.80 – quite a bit of money. However, if the note holder got into financial distress in year 5, he has the option to selling the note for some quick cash. At this point the note is only worth $31,861 (after 60 payments) and to make it worth the note buyer’s while, the note owner would most likely sell it at a discount. By discounting the note, the actual return on the buyer’s money is more than the original 9 percent on the face of the note.

For instance, if the buyer purchases the note for $25,000 and continues to receive the payment of $405.71 over the remaining 10 years of the note, he’ll receive a return of 15.15 percent per year on the note. If the seller is really desperate and sells the note for $20,000, the return balloons up to 21.43 percent. But it hasn’t been so bad for the seller by letting the note go for just $20,000. Remember, he’s received 60 payments of $405.71 ($24,342.60) and then a final purchase price of $20,000, totaling $44,342.60. The drawback is that over 10 years, he’s only received a cumulative 10 percent return on the money.

Now – the new owner will receive a total of $48,685.20 in payments on his $20,000 investment over the next decade. Not a bad return. What’s more – it’s a guaranteed return on the money – not a hopeful return like most investors face with stocks. In addition, the investment is secured by real estate, not paper or the last quarter’s performance.

So how do you purchase or sell these notes? There are plenty of places online to find those who want to buy notes, but the best place to look is to your local mortgage industry, settlement companies or real estate investment club.

Your first contact would be with either a mortgage broker/banker who is looking for people with a bit of cash who are looking to buy seconds at the table when the property is being settled. Another contact would be with a Realtor who works with investors to help buyers get into properties who need creative financing.

There are plenty of ways to invest in real estate – buying paper can be one of the cleanest alternatives out there.

Friday, August 13, 2004

Promissory Note An Instrument of Investment

There are plenty of ways to invest in real estate and one of the cleanest ways is to loan money to homeowners/buyers who need cash to purchase a property. For most individual investors, this loan would be based on a promissory note – an instrument by which you loan someone money and they promise to pay it back in certain terms and at a certain interest rate.

It sounds easy – and the process actually is pretty simple. There are plenty of sample notes on the Web and even Microsoft has some templates for this type of document at its documents site – I’ve used it several times. The tough part comes in the risk factor. After all, you’re handing over thousands of dollars to someone and hoping, praying they’ll pay it back. If they do – great – you’re making more than market interest on your money. However, if they don’t, you may have to foreclose on the property, which can get pretty messy.

If the person signing the note (the borrower) is a trustworthy person – then there’s no fear. That’s why you want to complete a financial background check on anyone to whom you would consider issuing a promissory note. Assuming you’ve completed this process, then your next task is looking at the terms of the note.

This will include these basic points:
Start date and finish date
Loan amount
Length of loan
Interest rate
Payment plan
Recourse for non-payment
Location payments are to be sent
Name of who will receive payment
Name, address of borrower…just to name a few.

There are several ways to figure repayment. If this note is a family member and you’re just loaning them the money, but don’t really care when it’s paid back, then you can be a bit more flexible on the payback requirements. Let me mention something here – it you are receiving a loan from a family member, you definitely want to use a promissory note. It removes any question as to the intentions of both the borrower (son/daughter/nephew/niece/grandchild) and the lender (mom/dad/uncle/aunt/grandparent).

I’ve seen plenty of bad blood boil over because “My grandson never paid back that $15,000 I loaned them to buy a house.” If the borrower gets into further financial stress, it gets more uncomfortable and distressing at between the family members and can ruin what should be a nurturing relationship. However, a promissory note takes away the flexibility of “just pay it back when you can.”

The payback can occur several ways:

Amortized – This is how most loans are paid off. A payment that includes interest and principal over the term of the loan. For a $10,000 loan over 5 years at 7 percent, the amortized payment would be $198.01 per month and the payments would be spread over 60 months.

Balloon Payment - Let’s say you can only afford $100 per month, but you still want to pay off the mortgage in 5 years. Then you would be looking at a monthly payment of $100, but then a final large payment at month 60 of $7,016.96.

Interest Only – There’s a lot of talk about interest only loans these days. On a simple plan, the above loan would cost the borrower $58.33 per month for 59 months (7 percent per year divided by 12 monthly payments) and then a balloon payment of $10,058.33 on month 60.

Single Payment – This is how many promissory notes are structured – “Here, Johnny, take this $10,000 and pay me back with interest in five years.” Johnny, then would pay back the $10,000, plus accrued interest totaling $3,500 (7 percent per year). It could even be compounded interested, which is a great deal for the borrower – because Johnny is paying interest on interest and principal and the loan amount grows each year.

There’s a lot of information out there about promissory notes. Before you either issue one or take one, read up on the risks and benefits. Next week, I’ll talk about how to get cash for a note you may already be holding.

Friday, August 06, 2004

Home Sale Values: The Truth Is Out There

I heard of a news story the other day on a local radio station that blew me away. Apparently, a local real estate agent has a condo listing that has lingered on the market for a while and called a reporter from this station to complain about it. The reporter quoted him and determined that the real estate market in Montgomery County, MD was, indeed, slowing down.

What’s so ludicrous about this is that the president of the Greater Capital Area Association of Realtors, James Kneussl Jr., had also been interviewed for the story, he says, and he shared with the reporter how all numbers were heading upward – except for one – the days on market. It was taking a shorter period of time for houses to sell in his county – namely, 18 on average. When he heard the story air, he expected to hear his quotes coming out to balance the nay-saying agent – but it didn’t happen. The reporter quoted the agent’s negative observation, instead of sticking to the local statistics which were shared with her and which were readily available online and through other sources.

This is a prime example of not believing everything you hear in the media and read in the newspapers (except here, of course).

Well, there’s a way to get to the bottom of any real estate market very quickly by looking up your local or state Realtor association and clicking on the link that leads to market statistics. Not all local associations carry statistics and in those cases the states do. Furthermore, in some localities, the statistical data may be hosted by the local multiple listing service, which may be owned by a separate entity.

In the Washington, DC suburban area, that web site is – the official web site for the Metropolitan Regional Information Systems, Inc. Here, you’ll find two monthly pull-down reports for MLS information for 56 counties and cities in the company’s coverage area from Pennsylvania to Virginia.

It’s a great tool to use to see where home price trends are headed. It’s not such a great tool to price your individual house, because it’s too broad to determine an individual home’s current value.

Nevertheless, if you want to know how your market is moving -- up or down -- finding the local jurisdiction’s web site is a very good start. To locate any local set of stats, simply click by, scroll down the page and click State & Local Associations, under “About the National Association of Realtors.” Then, just drill down to your local Realtor association from the state level.

You may find your local association, then determine that they don’t carry their local stats – click back to the state list and click the state’s web site, which usually carries all the numbers for the state, county by county.

Your best source of finding out the value of your home’s value is still by using your neighborhood real estate specialist or appraiser. The numbers you’ll find reported on an association’s site is a look at your community on a county or city level. To find out your home value, you need an analysis of homes that have sold in your neighborhood like your house and the local sales force or appraisal group’s are best equipped to determine that value.

Regardless of the fact if your market is hot or cold, if your home is lingering on the market, it doesn’t mean the whole market is falling – it may mean you simply have priced it too high or the condition of your property does not reflect your asking price. If that’s the case, review your pricing with your listing agent and discuss a price drop. Keep in mind, the “market” doesn’t care how much you put into the remodeling or how much money YOU think you can get out of it. The market reflects what the buyer is willing to pay and what sellers are willing to accept, period.