Your home shelters you from the elements, but it is also a valuable tax shelter.
Your home provides many tax benefits -- from the time you buy it right on through when you decide to sell. Here's a summary of the tax benefits of home ownership; you can get details by visiting the IRS website at www.irs.gov. |
| 1. Mortgage Interest |
Joint tax filers can deduct all the interest on a maximum of $1 million in mortgage debt secured by a first and second home. The maximums are halved for married taxpayers filing separately.
You can't use the $1 million deduction if you pay cash for your home and later use it as collateral for an equity loan.
Learn more from IRS Publication 936, Home Mortgage Interest Deduction, available at www.irs.gov. |
| 2. Points |
Your mortgage lender will charge you a variety of fees, notably what are called "points." A point equals 1% of the loan principal. One to three points are common on home loans, which can easily add up to thousands of dollars. You can fully deduct points associated with a home purchase mortgage. You cannot deduct a mortgage broker's commission.
Refinanced mortgage points are also deductible, provided they are amortized over the life of the loan. Homeowners who refinance can immediately write off the balance of the old points and begin to amortize the new. |
| 3. Equity Loan Interest |
You may be able to deduct some of the interest you pay on a home equity loan or
line of credit. However, the IRS places a limit on the amount of debt you can treat
as home equity debt for this deduction. Your total home equity debt is limited to the smaller of:
$100,000 (or $50,000 for each member of a married couple if they file separately),
or
the total of your home's fair market value -- that is, what you would get for your house on the open market -- less certain other outstanding debts against it.
The IRS rules about the home equity loan interest deduction are complicated. IRS Publication 936, Home Mortgage Interest Deduction, available at www.irs.gov, explains the details. |
| 4. Home Improvement Loan Interest |
If you take out a loan to make substantial home improvements, you can deduct the interest on this loan. There is no dollar limit on this deduction. However, the work must be a "capital improvement" rather than ordinary repairs.
Qualifying capital improvements are those that increase your home's value, prolong its life, or adapt it to new uses. For example, qualifying improvements might include adding a fence, driveway, new room, swimming pool, garage, porch or deck, new built-in appliances, insulation, new heating/cooling systems, a new roof, landscaping, and the like. (Do keep in mind that capital improvements that increase the square footage of your home could trigger a reassessment and higher property taxes.)
Work that doesn't qualify you for an interest deduction includes such repairs as repainting, plastering, wallpapering, replacing broken or cracked tiles, patching your roof, repairing broken windows, and fixing minor leaks. Wait until you are about to sell your home to gain tax benefits from repair work. (See Selling Costs and Capital Improvements, below.) However, you can use a home equity loan, up to the limits discussed above, to make repairs and deduct the interest. |
| 5. Property Taxes |
Often referred to as "real estate taxes," property taxes are fully deductible from your income. You can't deduct escrow money held for property taxes until the money is actually used to pay your property taxes.
A city or state property tax refund reduces your federal deduction by a like amount. |
| 6. Home Office Deduction |
| If you use a portion of your home exclusively for business purposes, you may be able to deduct home costs related to that portion, such as a percentage of your insurance and repair costs, and depreciation. |
| 7. Selling Costs and Capital Improvements |
If you decide to sell your home, you'll be able to reduce your taxable capital gain by the amount of your selling costs.
Real estate broker's commissions, title insurance, legal fees, advertising costs, administrative costs, and inspection fees are all considered selling costs. In addition, the IRS recognizes that costs ordinarily attributed to decorating or repairs -- painting, wallpapering, planting flowers, maintenance, and the like -- are also selling costs if you complete them within 90 days of your sale and with the intention of making the home more saleable.
All selling costs are deducted from your gain. Your gain is your home's selling price, minus deductible closing costs, minus selling costs, minus your tax basis in the property. Your basis is the original purchase price, plus the cost of capital improvements, minus any depreciation. |
| 8. Capital Gains Exclusion |
| This is a true tax shelter for those who are treating home buying as an investment. Thanks to the Taxpayer Relief Act of 1997, many home sellers no longer suffer a taxable gain. Married taxpayers who file jointly now get to keep, tax free, up to $500,000 in profit on the sale of a home used as a principal residence for two of the prior five years. Single folks and married taxpayers who file separately get to keep up to $250,000 apiece tax free -- including single people who own a home jointly. (For more information, see Tax Breaks for Selling Your Home.) |
| 9
. Moving Costs |
If you move because you got a new job, you may be able to deduct some of your moving costs. To qualify for these deductions you must meet all of the following requirements, which get more and more complicated as you read on:
You must move within one year of starting your new job.
Your new job must be at least 50 miles farther from your old home than your old job was.
The distance between your new home and new job can't be greater than between your new home and new job -- in other words, you can't have created a situation where your commute is longer than if you'd stayed put. (An exception, however, is made if your new commute will, in practice, save you time or money, or if your employer insisted on the move as a condition of your employment.)
You must work full-time at the new workplace for 39 of the 52 weeks following the move. If you are self-employed, you must work full-time for at least 39 weeks during the first 12 months and a total of 78 weeks during the first 24 months after arriving at the new job location.
Deductions include travel or transportation costs and expenses for lodging and storing your household goods. |
| 10. Mortgage Tax Credit |
A home-buying program called mortgage credit certificate (MCC) allows low-income first time homebuyers to benefit from a mortgage interest tax credit of up to 20% of the mortgage interest payments made on a home (the amount of the credit varies by jurisdiction). This credit is available each year you keep the loan and live in the house purchased with the certificate.
The credit is subtracted, dollar for dollar, from the income tax owed. For example, if you paid $10,000 in interest, your tax credit would be $2,000. If you make, say $20,000 per year and owe $2,000 in income taxes without the credit, you would end up owing nothing to the IRS after the credit was applied. You would take the remaining 80% of the interest -- $8,000 -- as a mortgage interest deduction. |
A 1031 tax-deferred exchange offers strong benefits that translate into investment savings.
A 1031 exchange, also known as a Starker exchange or a tax-deferred exchange, allows you to sell investment property and to defer capital gains and depreciation recapture taxes. This assumes reinvestment of 100% of the equity into "like-kind" property of equal or greater value. Any property held for investment purposes or for productive use in a trade or business generally qualifies as "like kind" property for 1031 exchange purposes.
1031 exchange rules require an investor to identify up to three potential "replacement" investment properties within 45 days of the close of escrow on their relinquished property. The acquisition of the replacement investment property (or properties) must be successfully completed within 180 days of close of the relinquished property.
In their 1031 exchange, many investors benefit from buying investment property as Tenants In Common (TIC) because it completes their exchange and can be closed in a timely manner due to pre-arranged financing.
A 1031 tax-deferred exchange offers strong benefits that translate into investment savings. |
Defer Taxes
A 1031 exchange enables you to defer capital gains and depreciation recapture taxes. You can also harvest dormant equity at predictable time intervals with a 1031 exchange to maximize the inherent benefits of your real estate investments. |
Potentially Increase Cash Flow
The tax dollars saved may be maximized to increase cash flow and overall net worth. The compounding effects of leveraging the equity in investment property over several holding periods can potentially produce higher actual dollar returns, new depreciation schedules to tax shelter cash flow, and accelerate equity accumulation. |
Eliminate Day-to-day Property Management
1031 exchanges structured as Tenants In Common interest ownership provide real estate investors a range of opportunities to meet personal investment objectives. This includes property type and geographic diversification, and, most importantly, the elimination of day-to-day property management obligations. |
When Would I Consider a Reverse Exchange?
If you find a property you would like to acquire before you sell your current property, a Reverse 1031 Exchange can save you thousands of dollars in capital gains tax. |
What is the IRS's Position on Reverse Real Estate Exchanges?
The IRS issued Revenue Procedure 2000-37 (Rev Proc) in September 2000 that gives taxpayers guidance on Reverse 1031 Exchanges. A “Safe Harbor” Reverse introduces a new entity into the reverse process-an Exchange Accommodation Titleholder (EAT). An EAT is a single member limited liability company (LLC) established by a Qualified Intermediary (QI) for use specifically in a reverse exchange. The EAT takes title to, or parks, a property for the taxpayer and holds it until the taxpayer is able to sell the old property. Rev Proc places a time restraint on the taxpayer-the EAT must convey the title on or before 180 days from the date of the EAT’s purchase. When the EAT parks the new property, Rev Proc requires the taxpayer to identify their old property on or before 45 days from the EAT’s purchase. Our reverse exchange specialists will guide you through this process.
Rev Proc also refers to the fact that some reverse exchanges will fall outside of the “Safe Harbor.” A “Non-Safe Harbor” Reverse will follow the guidelines outlined in Rev Proc, with the exception of the 180 day requirement. Typically, construction exchanges fall into this category because they require more time to complete the exchange.
Before the reverse process begins, we will review with the two types of reverse exchanges so you have the information necessary to select the reverse exchange that is best suited to your needs. |
| REVERSE EXCHANGE TIMELINE |
Purchase | Contract Stage
Negotiate your purchase contract for the new property. The Buyer on the contract should be you "and/or assigns."
Include language in the contract to establish your intent to do a tax-deferred exchange.
With the guidance of your realtor, select a title or escrow company and/or closing agent to handle the closing of the transaction. Notify them that you are participating in a Reverse 1031 Exchange. |
Purchase | Financing Stage
Negotiate a loan with your lender on behalf of the EAT. The loan is usually secured by the new property.
The EAT signs the Note and the Deed of Trust. Your lender may require you to guarantee the loan. Sometimes the lender also takes a security interest in your old property. Be sure that there is an assumption clause in the Deed of Trust allowing you to assume the loan made to the EAT.
Negotiate with your lender for a clause that allows re-amortization of the loan if there is a single substantial pay down on the loan in excess of a stated percentage. |
Purchase | Closing Stage
When you have a signed purchase contract, the information needed includes:
1. A copy of the contract
2. The phone number, name and reference number for the closing agent or title company
3. Your mailing address, phone and fax numbers
4. Sale price of the property being purchased
Then, the Qualified Exchange Accommodation Agreement (QEAA) is prepared between you as the Exchanger, and the newly-formed EAT as the accommodation titleholder, as required by Rev Proc 2000-37. Ensure that your lender will forward the funds needed to close on the purchase. The QEAA and other documents will be forwarded to you or to the closing agent, depending on timing and the location of the closing.
The purchase closes, and the title to the property is recorded in the name of the EAT. |
Identify the Relinquished Property
You have exactly 45 days (including Sundays and holidays) from the closing of the new property to identify the property you are going to sell. You have 180 days from the date of closing to close on your sale in order to be within the "Safe Harbor" provided by Rev Proc.
You will be sent a notice with the closing date of the new property, the expiration date of the 45-day identification period, the expiration date of the 180-day closing date, and a form to notify of the location of the relinquished (old) property to be sold. |
Transfer the Replacement Property
The sale will be coordinated with the title company or closing attorney to prepare the closing and transfer documents. |
Private annuity trusts provide a powerful alternative capital gains tax reduction strategy to the section 1031 exchange to defer capital gains tax, eliminate estate/inheritance taxes, and to transfer appreciated real-estate property to one's heirs with deferred capital gains and depreciation recapture taxes.
A private annuity trust (PAT) provides owners of highly appreciated assets such as businesses, real estate, and stocks/equities the following benefits:
• Capital Gains Tax Deferment
• Lifetime Income Stream
• Investment Flexibility
• Deferred Depreciation Recapture Taxes
• Disciplined Retirement Savings
• Family Controlled
• Program Eligibility
• Tax Free Estate/Inheritance Transfer to one's Heirs
As illustrated below, the Private Annuity Trust has the ability to generate substantially more money over the long run than a direct and taxed sale.
In many respects, a PAT is superior to a charitable remainder trust (CRT), installment sales. And unlike a section 1031 like-kind real estate tax exchange, a PAT can be created from the
sale of a variety of appreciated assets and not just sale of real estate property.
This trust is especially useful for deferring taxes on appreciated assets such as real estate and other equities - for property that does not qualify for 1031 tax treatment as well as 1031 qualified property. |
| Private Annuity Trust versus Taxed Sale |
|
| |
Taxed Sale |
Annuity Deferral |
| Selling Price |
$2,500,000 |
$2,500,000 |
| Basis |
-500,000 |
-500,000 |
| Profit |
2,000,000 |
2,000,000 |
|
| Capital Gain Tax |
500,000 |
Deferred |
|
| NET INVESTMENT CASH |
$2,000,000 |
$2,500,000 |
|
| Deferral Period |
20 Years (7.4% Growth) |
20 Years (7.4% Growth) |
|
| Annuitant Present Age |
45 |
45 |
|
| Annual Payout |
$950,250 |
$1,187,820 |
|
| EST. LIFE PAYOUT |
$19,005,000 |
$24,756,400 |
|
| PAT ADVANTAGE |
|
$4,751,400 |
|
| ANNUITANT |
| Tax Free Build up to Annuitant |
| No Capital Gains Taxes Owed by Annuitant from Sale to Trust |
Annuity Payment Amount Remains the Same for Both Spouses
(payment continues until the second death - "Last to Die") |
| |
| ANNUITY PROPERTY |
| No Estate Taxes, Ever |
| No Gift Taxes, Ever |
| No Probate, Ever |
| No Medicaid Claims |
| |
| TRUST OWNERS |
| The Heirs - Your Family - are Beneficiaries |
DEFERRING CAPITAL GAINS TAXES WITH PRIVATE ANNUITY TRUST
Taxation for Annuitant
The tax ramification to the annuitant is that the exchange is not immediately taxable. Under IRS rules the annuitant is taxed only on payments actually received, as they are received, and not all up-front on the entire amount. This is similar to making an installment sale, then paying taxes only on the installment payments as they are received. If the annuitant chooses to defer his annuity, that is wait for some period of time before payments begin, there will be no taxes during the deferral period because no money is received. Once payments begin, whether immediately or at some deferred period, there will be a proportionate amount of taxes owed on each year’s payment. |
Taxation When A Trust Liquidates Property
The tax ramification to the trust’s liquidation of the property is: Zero taxes. That is due to the fact that, in this example, the trust sold the asset for $1,000,000 to the outside buyer, and the trust paid $1,000,000 to the annuitant, by means of the private annuity contract. That leaves zero gain to the trust, and zero taxes. |
| CHARITABLE REMAINDER ANNUITY TRUST (CRAT) |
| A charitable remainder annuity trust (CRAT) is a popular type of life-income plan. Cash, securities, real property, or other assets are transferred into a trust. The trustee manages the trust assets and pays you or others you choose a fixed income for life or for a term of years. When the trust terminates, the remaining assets in the trust are transferred to the Marriott School. |
The typical donor:
• Needs income for life or a specified term of years.
• Desires a fixed income based on the original value of assets transferred.
• Does not plan to make additional gifts to the trust in the future.
• Is between the ages of 55 and 80.
• Gifts features and benefits: |
Income for life (fixed payments)
• Possibility of multiple beneficiaries
• Assets transferred to the trust can be reinvested
• Ability to choose the trustee (may be the donor)
• Investment of assets is designed to balance income needs with |
| |
preservation of principal |
How Do I Make a Gift Using a Charitable Remainder Annuity Trust?
A trust document tailored to your needs is drafted. Your assets are transferred to the trustee you choose. The assets are usually sold by the trustee and reinvested to match your income objectives. You receive fixed income for your life or a specified period of years. At your death or the end of the period, the remaining assets are transferred to the charity of your choice. |
| Before you begin, you need to make sure your financial and legal advisors are part of your gift strategy team. A charitable remainder annuity trust can have an impact on other parts of your financial and estate plan. |
Other Facts You Should Know about a Charitable Remainder Annuity Trust
The income tax deduction you receive from a charitable remainder annuity trust is based on an Internal Revenue Service (IRS) formula that considers the ages of the donors and income beneficiaries, the payout of the trust, and an IRS index rate known as the Applicable Federal Rate (AFR). The older you are, the larger your income tax deduction. Generally, if the trust is for a term of years rather than for life, the income tax deduction will be larger. If the present value of the remainder interest equals at least 10 percent of the value of assets transferred into the trust, the trust will qualify as a charitable remainder annuity trust. Also, a federally imposed 5 percent probability test determines the viability of the trust assets supporting the annuity payments. To qualify, the trust provision must meet this test. |
The trust provisions you have control of when drafting your charitable remainder annuity trust include:
• Choosing a trustee.
• Designating the income beneficiaries.
• Naming the charitable remainder beneficiaries.
• Deciding on a payout rate for the trust.
• Determining the frequency of the payments.
• Selecting the term of the trust.
With a charitable remainder annuity trust, certain activities associated known as "self-dealing" are prohibited. Self-dealing rules prevent a donor who has transferred property to a trust, or a donor's family, from dealing with the trust. Actions considered to be "dealing" include buying from, selling to, and renting from the trust, and continuing to do business with the trust. The donor, the trustee, members of their families, and entities such as corporations in which they have substantial interests are "disqualified persons" and are prohibited from dealing with a trust that has been a recipient of the donor's property.
Charitable remainder annuity trusts use a tier system in determining the taxation of trust income to income beneficiaries. Whether or not all income produced by the trust is distributed to the income beneficiary, the trust pays no income taxes on its earnings as long as it has no unrelated business taxable income (UBTI). An example of UBTI would be debt-financed income. The income to the income beneficiary from the trust is taxed based on the historical pattern of how income in the trust was earned. Income distributions are taxed in the following order:
• Ordinary income
• Capital gain income
• Tax-free income
• Return of principal (corpus)
For example, suppose you transferred a piece of real estate to the trust then sold the real estate and reinvested in blue-chip stock that provided both dividend income and capital growth. As income is paid from the trust to you, you would report all income as ordinary income (tier 1) to the extent of all dividend income received into the trust. Only after recognizing all ordinary income would you then report capital gain income (tier 2) from the sale of the real estate. As a general rule, you should assume for planning purposes that trust income will be taxed as ordinary income. |
| UNDERSTANDING FORECLOSURES |
| Many experts agree that an increase in real estate foreclosure rates is just around the corner. One could say foreclosures are a double edged sword, depending on what your situation is. On the one hand you have real estate owners who are trying to keep their property out of foreclosure. On the other hand, there are people looking to buy a foreclosed property as a primary residence or as an investment. |
| Foreclosure Defined: |
| When most people purchase real property, they do not have enough money to simply purchase the property outright. In order to make the purchase, they are required to borrow money from a lender. In exchange for lending the money, the lender will hold a lien against the property. If the borrower does not make the required payments, then the loan goes into default and the lender can exercise the lien against the property, in order to take legal possession of the property for the purpose of selling the property to pay off the borrower's loan. This process is called mortgage foreclosure. |
| Foreclosure Options: |
Foreclosures depend on whether the borrower wants to keep the property or not. If he or she does not wish to do so, the property owner can sell the property himself or herself before the mortgage forecloses. The advantage to this is that he or she will not have a foreclosure judgment on his or her credit record. This can help make it easier to secure financing in the future. This option will more likely be available for borrowers who have equity in the property. By selling the property on his or her own, the borrower can then pay off the mortgage, and pocket the difference if there is equity remaining.
Another available option is for the borrower to file bankruptcy. There are two
primary types of personal bankruptcies available in the United States. A Chapter 13 bankruptcy is used when the individual wishes to "reorganize" his or her debts and continue paying what is owed. Filing a Chapter 13 bankruptcy can allow a borrower to keep his or her real property. This is not the case with a Chapter 7 bankruptcy, which completely discharges any debt the borrower had accumulated under the mortgage. Of course, there are serious repercussions to filing bankruptcy, including severe damage to one's credit rating. If you are considering this option, it is very important that you speak with an experienced professional to determine if this option is best for you.
A final option is to voluntarily deed the property to your lender using what is called a "deed in lieu of foreclosure" or "deed in lieu of forfeiture". This transaction will appear on your credit rating, and may be difficult to negotiate with some lenders. If you wish to pursue this option, it is usually best to have a lawyer or experienced credit counselors assist you on your behalf. |
| Trying to Keep the Property: |
If the borrower wishes to keep the property, there are a number of options available before the property goes into foreclosure. The first and best option is to deal directly with the situation. Oftentimes individuals faced with a difficult situation such as a potential foreclosure will simply ignore it and hope it will go away. It is much better to be straightforward and explain any problems to the lender as soon as possible. By doing this, the lender may be able to accommodate the situation, and work with the borrower to resolve the situation in a way that is agreeable to both parties. Typically the borrower will deal with the lender's Loss Mitigation Department in cases like this.
There are a number of different options that the lender may offer depending on the situation. To determine these options, it will usually be necessary for the borrower to provide detailed information about his or her economic situation. There are certain commonly available options, including forbearance, refinancing, mortgage modification, deferral of principal, and a temporary indulgence. |
| Temporary Indulgence: |
| A temporary indulgence occurs when the lender agrees to suspend payments for a certain period of time, with the agreement that the suspended payments will be brought up to date when the temporary indulgence period is over. Typically, the borrower will need to demonstrate that there is a temporary problem making it difficult to pay the mortgage, and that this problem will be resolved in the near future. Two examples of this would be if the borrower had sold another property and was waiting to receive the proceeds from the sale, or if the borrower was waiting to receive an insurance settlement. |
| Forbearance: |
| Another option is forbearance, where the lender agrees to allow the borrower to make reduced payments or no payments for a certain period of time. Such an agreement can be difficult to negotiate unless the borrower has an excellent track record with the lender. If the borrower does not abide by the terms of the forbearance, a foreclosure proceeding will likely be initiated. A similar option is deferral of principal. This means that the borrower agrees to pay the interest only for a certain period of time, and then making the normal monthly payments. |
| Mortgage Modification and Refinancing: |
| Mortgage modification and refinancing are two other options available to a lender who finds himself or herself in a financial bind. Mortgage modification means that the borrower renegotiates the terms of the mortgage with the current lender. This can include changing the interest rate, adding any arrearage to the principal, and extending the length of the mortgage. Refinancing means that the borrower obtains a new mortgage with a different lender. It is usually best to avoid this option, because most of the alternatives available to a borrower in distress will only make the situation worse. |
| Reinstatement or Redemption: |
Sometimes, the borrower may also have the option of reinstatement. This means that the borrower brings the foreclosed mortgage current, including all overdue amounts, as well as fees and costs. In states where redemption is available, the borrower is usually limited in how often he or she can take advantage of this option. Again, redemption is only available in some states, and the law varies among those states that offer redemption. It is important to consult an experience professional if you are unsure about this option.
A final option for a borrower in foreclosure who wishes to keep the property is for him or her to redeem the mortgage. This means that the borrower pays off the entire principal balance of the mortgage, along with the accumulated interest, fees and costs. Obviously, it will be very difficult for many borrowers to take advantage of this option. |
| Buying Foreclosure Property: |
| It is important to be aware that buying property in foreclosure is a risky venture. Most foreclosed properties are sold "as is" and there can be problems not only with the structure, but there may also be liens on the property, unpaid taxes, and other problems to deal with. If you are not experienced in real estate, you should be very cautious before getting involved with purchasing foreclosed properties. That being said, buying foreclosure properties can be very rewarding and profitable if you are careful and thorough. |
| Finding Foreclosures: |
The first step will be to familiarize yourself with the applicable laws and the
process
in your area. Once you understand this, you will next want to start
identifying geographical areas in which you would like to purchase a property.
Once you determine the areas you are interested in, you will want to begin locating properties that are in the foreclosure process. There are a number of different ways to do this, including checking the classified ads in your local newspaper. Foreclosure properties may be listed several different ways, such as under "Foreclosure Sales",
or "Sheriff's Sales". You can also learn about properties if the lender is giving notice
to the borrower of the lender's intention to initiate foreclosure proceedings.
Other ways of learning about foreclosure properties include commercial databases, the number of which has greatly expanded in recent years. If you are using a commercial database of foreclosure properties, it is best to make sure that there are many pre-foreclosure properties listed, as these will typically be the best bargains. Interested parties may also check with the County Recorder's Office, and it may be possible to get information from the applicable court in some areas. Another way to obtain information is through the banks or other lending institutions that hold the mortgages, or through government agencies such as the Federal Housing Administration, the Department of Housing and Urban Development (HUD), or
the Veterans Administration. |
| Inspecting Foreclosure Properties |
After you learn about the properties in foreclosure in your area, the next step is to inspect the properties you are interested in, if possible. Sometimes you will not be able to inspect the property ahead of time. You will then want to determine the value of comparable properties in the same area. This information can be obtained from Martin Szumanski at Sotheby’s International Realty. If you are still interested in the property at this point, the next step will be to find out who owns the property, and what liens encumber the property. Find out the balance in default to the lender, and the balance remaining on the loan that has resulted in the foreclosure proceeding.
You will want to find out if back taxes are owed on the real estate. To determine this information you will want to conduct a full title search. Finally, you should make sure you are familiar with any land zoning, easement or toxic waste issues that could impact your use of the property. Also make sure there are no pest problems, other structural problems, and determine if any illegal alterations have been made to the property without the necessary permits. Once you know exactly what you are facing, how you will proceed will depend on what type of sale is taking place. |
| Pre-Foreclosure Sales: |
There are three different types of foreclosure sales: pre-foreclosure sales, foreclosure auctions, and real estate owned sales. A pre-foreclosure sale takes place when the property owner sells the property privately after the foreclosure process has begun, but before the property has actually gone into foreclosure. This is where most beginners will have the best experience getting involved with foreclosure sales. Typically, the owner will be willing to sell the property below its appraised value, because he or she is under duress and wants to pay off the mortgage, avoid the foreclosure process, and prevent damage to his or her credit rating. Experts suggest that buyers not pay more than 70% of the appraised property value in a pre-foreclosure sale, although in the current tight real estate market, one may have to pay more than this amount.
One advantage of pre-foreclosure sales is that the prospective buyer will have the opportunity to inspect the property prior to the purchase. The difficult part of these sales will be the negotiation with the seller and the fact that there will often be time pressures to complete the transaction before the foreclosure sale takes place. You may want to have an attorney or other experienced professional help you negotiate the sales contract. The best way to improve your negotiating position is to have pre-approved financing in place when you enter into negotiations. Another possible advantage to having pre-approved financing in place is that this may allow the buyer to simply take over the seller's existing mortgage and pay whatever is necessary to bring the loan up to date.
Finally, it is important to establish a good relationship with the seller. This can be difficult, because often the seller is very disturbed because of the process and the time constraints. This may make the seller difficult to deal with. Being patient and understanding the situation can help smooth this process. Also, making the seller feel that he or she is also getting a good deal can be helpful.
The key to success in these types of transactions is to know exactly what deal you are entering into and what you can expect to have to spend. If you are getting a below-market deal and you believe that the additional hassles of this type of transaction do not outweigh the cost savings, then this is likely a good deal. |
| Foreclosure Auctions: |
Foreclosure auctions are the next type of foreclosure sales. These are the riskiest type of foreclosure sales for novices to get involved with, as many of the participants at the auctions are savvy professional investors who make their living through purchasing property at auctions. Attempting to compete with these individuals can be very difficult for someone who is not properly prepared. Often the lender will also participate in the auction as well, in order to prevent the property from selling for a low price that would cause the lender to lose money. Approximately eighty percent of auctions end with the lender retaining the property.
Another problem is that you may not be able to inspect the property before the auction, and you will typically be required to pay the full auction price within a short period of time. You may also have to evict any tenants that remain in the property after the auction. This can be a messy process. You will also be required to pay for the property with a certified check or cash.
If you do wish to get involved with foreclosure auctions, you should be well-prepared in advance. It would be a good idea to make certain that you fully understand how the process works, and you should also sit in on one or more similar auctions beforehand to help you become comfortable with the process. At the time of the auction, you should make sure that you have any necessary financing in place, and then determine your maximum bid, and do not go over that amount. It is probably best for inexperienced individuals to avoid these types of sales, unless one is very well prepared by taking the steps explained above. It is also important to know that about half of all properties at foreclosure auctions are never actually sold at the auction, as the original owner works out some way to keep the property. This can be very frustrating if one has spent a great deal of time and effort preparing to buy a certain property. |
| Real Estate Owned Sales: |
The final type of foreclosure sales are real estate owned sales. These are the easiest and least risky types of transactions, but they also offer the least potential reward. These are properties that have already completed the foreclosure process and are now owned by the bank or other lending institution. These properties will usually be sold free and clear of any encumbrances, as the bank will pay these to sell the property with a clear title. These properties will sometimes have necessary repairs made before they are sold, although this is not always the case. Because these properties are usually sold "as is", it is important to know if there are any repairs necessary.
In essence, this type of transaction is very similar to the typical real estate transaction one would expect for any real estate that is not in the foreclosure process. The advantage of this is that the buyer has more time to secure financing and inspect the property. The disadvantage is that this type of transaction does not offer a significant savings as compared to a traditional real estate transaction. |
| Conclusion: |
| In conclusion, buying a foreclosure property can be an excellent way to save money on the purchase of a home or property, but it is not without risks. The key to success is to be very well prepared and be sure that you completely understand the process and applicable laws in your area. For most first-time foreclosure buyers, buying a pre-foreclosure property will offer the best opportunities of saving a significant amount of money without undue risk. Purchasing property at a foreclosure auction is far more risky, and is best left to professionals who are well-acquainted with how the process works. Buying a real estate owned property is very similar to purchasing property through a conventional real estate sale, and usually offers little savings over a conventional sale. |
Martin Szumanski does not assure the accuracy or reliability of this information. Confer with a tax specialist
or attorney for tax or law related advice. |
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| Martin Szumanski |
| 310.481.7129 |
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