Real Estate Investing

The tax man draweth nigh, and real estate ownership is perhaps the greatest strategy during this dreaded season. There are plenty of ways your home can benefit you tax-wise — as rental property, a home office, or through mortgage interest or home improvements, for starters.

One of the main ways your home can work for you is through interest on your loans. Whether it’s a mortgage loan, equity loan or home improvement loan, the interest is tax-deductible. Interest on home improvement loans are fully deductible if the improvements are “capital improvements,” i.e. things that improve the life of the home or significantly increase its value. Capital improvements could also change the structure’s functionality — for instance, adapt it for a business or handicap accessibility.

Any property taxes paid (and never refunded) are fully tax-deductible. Selling costs are also tax-deductible, including costs related to home improvements completed within 90 days of the sale. These could be minor improvements like painting, but must have the intent of making the home more marketable and must be completed within 90 days of sale.

Job-related moving costs are also tax-deductible to a certain extent, including things like travel expenses and lodging and storage costs, if applicable. According to the Active Rain real estate network:

“To qualify, you must meet certain requirements including, moving within one year of starting your new job, moving 50 miles farther from your old home than your old job was and working full-time at the new job for 39 of 52 weeks following the move.”

There are many other real estate-related tax deductions to be covered in Part II of this series. We will also discuss how your status as landlord can work in your favor at tax time, and things to beware of in doing so.

Home equity debt has become considerably more affordable recently with the many fed rate cuts over the past year, which has a direct effect on mortgage interest rates. Whether a home equity loan or a home equity line of credit, the interest rates on home equity debt can be much lower than many other types of debt – and are typically tax-deductible.

You can lock in the lower interest rates with a home equity loan, which is essentially a second mortgage. This establishes a fixed interest rate on a fixed loan amount as part of a fixed repayment plan over a certain number of years. Interest on a home equity line of credit (HELOC), on the other hand, is typically prime rate or prime plus 1%. HELOCs function much like a credit card. For instance, the average HELOC is $58,800, but consumers do not have to max out their credit line.

One common use – and the originally intended use – for home equity debt is to fund a home remodeling project. This makes sense because the home remodeling project drives up your home’s value, which can ultimately help pay off the loan upon resale. For a one-time remodeling project, a home equity loan may be most appropriate. However, a home equity line of credit may be better suited for an ongoing remodeling project stretched out over several years.

Other uses for home equity debt include a vacation home or debt consolidation. This makes sense if the interest on the home equity debt is less than the credit card debt and if the consumer can exercise financial discipline in paying off the home equity debt. Some use home equity debt to fund a lifestyle that is beyond their normal, day-to-day financial means. This is a recipe for disaster.

Home equity debt is not inherently evil, but there is high potential for disaster. You do not want to mismanage this debt. It’s not fun, it’s not easy, but full attention must be paid to this debt because your house is at stake. The following points should be considered before taking out a home equity loan or line of credit.

-Analyze your financial management patterns. What is your debt-to-income ratio? Are you actively trying to pay off debt or paying off your credit card balance each month? Or are you taking out more and more loans, making minimum payments on all and even running late on some?

-Decide what your total monthly payments will be and whether that is affordable. It should ideally be around one-fourth of your monthly net income (after taxes).

-Decide whether you would rather pay more money per month over a shorter period of time or less money per month over a longer period of time with more total interest payments.

-The total amount of your current mortgage combined with the “second mortgage,” or home equity debt, should not exceed the value of your home.

-Along the same lines, never take out a no-equity home loan where the amount of the loan itself is more than your home is worth. These typically have much higher interest charges and are probably not tax deductible. Ultimately, there is little more stressful than being upside down in your home. It’s a good way to lose money fast.

Here are three great real estate-related gift ideas that also happen to be tax write-offs. These are kind of different, and may not be for everyone, but they’re worth a look at least.

Make It Right donation: This campaign, spearheaded by Brad Pitt, aims to build eco-friendly homes in New Orleans’ Lower 9th Ward, the area hardest hit by Hurricane Katrina. You could “adopt” an entire house, or only a piece of a house, as a gift to someone who needs nothing and who values such initiatives. And it’s a donation, so it is a tax write-off!

Give Your House Away: OK, so when you give your house away to a charitable organization like House Angel or Real Estate With Causes, you might not actually get to see the recipient’s response. But you’ll feel better having done some good. You’ll also get a tax deduction equal to the home’s current market value, not what its value was when originally purchased.

Buy a house for your college student: This is the ultimate gift for a college student. You can sign them up as co-owner and help build their credit as well, an added bonus. There are, however, pros and cons to this scenario. Consider it carefully before deciding one way or the other. But of course, it is well known that real estate ownership has tremendous tax benefits.