If you sell, you pay Uncle Sam! Or do you??

The following article is not by any means tax advice, instead it should be taken as an encouragement to potential buyers (move up buyers) and sellers to consult with a qualified tax advisor BEFORE entering into a selling / buying transaction.

Prior to 1997, typical move up buyers (you sell your home to buy another home) could “roll over” accumulated capital gains from the sale onto the newly purchased home. Simply put if a person first bought a house for $50,000 and later sold it for $60,000 and then purchased a new home for $100,000. The capital gains tax on the $10,000 profit from the sale was rolled over into the new house. But in 1997, the rules changed. The “roll over” rule changed and was essentially replaced by exemptions from capital gains tax for the first $250,000 gain for single people and $500,000 for married couples.

Under present rules if a single buyer first purchased a home for $5000,000 and later sold it for $800,000 and purchased a new home for $900,000, the seller would have to pay capital gains tax liability on the amount of gain in excess of $250,000. In our example the seller would pay taxes on $50,000.

A similar exemption applies to married couples but the amount exempt from capital gains tax increases to $500,000.

There are certain rules that determine qualification for the $250,000 or the $500,000 exemption from capital gains tax. For example the property must be a principal residence and the owner/seller must have lived in the property for at least 2 of the last 5 years. Keep in mind that my description of the capital gains tax rules in this article are very simplistic.

Consult with a tax expert to determine your specific situation.

If you are thinking about selling your present home and purchasing another using the net proceeds from the sale as a down payment, be aware that the sale could create a capital gains tax liability. If in fact you do have a liability and have to pay capital gains tax, make sure you know how much and when you must pay it.

If you fail to consider this liability, you could end up receiving some unpleasant surprise, which could cut short your down payment amount.

Given the fast increase in prices, not necessarily this year but the past few years, many homeowners have gained a lot in equity. Therefore, they could potentially obtain a large profit from the sale and a possible tax liability on this profit as well. And this liability could be owed not only to the IRS but also to the Franchise Tax Board.

In conclusion, the net sales proceeds may not be all yours at the end, so you don’t want to over-commit on your next purchase. Do your homework and your math too so you can be prepared for any tax liability you may owe. Like the saying goes “Better safe than sorry”

For more information visit www.irs.gov and look for IRS Pub 523

July 10th, 2006 · Filed Under Real Estate Information

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How Meaningful is the APR??

The Annual percentage rate also known as the APR was implemented to inform borrowers of the “real” cost of borrowing. HOWEVER, this value is ONLY accurate for fixed rate loans.

The APR for ARM loans is virtually MEANINGLESS. Not only it is meaningless, it’s inaccurate and can be misleading.

Here is an example of what I’m talking about. Lets say you borrow $650,000 and you compare a 30 year fixed rate loan at 6.875% and a 5/1 ARM at 6.275%, assuming the costs for this loan total $4,500 with no points.

To calculate the APR for the 30 year fixed you do the following. First determine the monthly payment required to amortize $650,000 over 30 years. The monthly payment is $4,270

Next deduct the cost of $4,500 for getting the loan and 15 days of advance interest of $1836 from the original amount of $650,000. So we have 650000 – (4500 + 1836) = $643,664.

Now, if you are using an HP12C or a TI BAII plus calculator, use the same payment of $4,270 against the $643,664 and solve for the interest. For those without these calculators or something similar will have to trust me this calculation is correct. We have an APR 6.972%

To calculate the APR for an ARM loan is quite more complicated. You start with the same steps above but you calculate the first five year’s payments on the given start rate of 6.275% which gives us a payment of $4,012 and the remaining 25 years are calculated on the fully indexed rate payment.

To calculate the fully indexed rate, add the 2.60% margin to TODAY’s 5.67% index and you get 8.27%. Note on this example we are using today’s index rate and it does change so it wont be the same. We use this fully indexed rate to helps us calculate the monthly payment required to amortize the loan balance at the end of the 5th year ($606,872) over the remaining twenty-five years. The monthly payment on this example is $4,793

The total payments for the first five years are added to the total payments for the remaining 25-years, then divided by 360 to get the average monthly payment for 30 years. Then again using the calculator solve for the interest. The APR should be 7.86%.

So, according to these calculations, the APR for a 5/1 ARM seems more costly than a 30-year fixed. But the problem in these calculation lie on using today’s index to get to the fully indexed rate and assuming that rate will remain flat (very much unlikely) for the final twenty-five years of the loan.

Given that the Fed raised short-term rates this past June 29th and it is expected that it will do it once again in August, it is quite likely that the index in five years could be closer to 7.78% than 5.67%.

If you add the 2.60% margin to 7.78%, we get an interest rate of 10.38% with a monthly payment of $5,678 for the final 25 years of the loan. And when calculating the APR, it would be 9.47%

By all means this is much less advantageous to borrowers that the 6.972% APR on a fixed rate loan.

To conclude, the APR calculated on an ARM loan is very inaccurate because its calculation is based largely on today’s index. It cannot be guaranteed this index will remain flat. In fact as I mentioned above, today’s indexes are almost certain to rise into the future. So you cannot rely on getting an accurate APR with an ARM loan.

It should also be noted that this article talks about the accuracy of the APR not about good or bad ARM loans. That is a personal decision that will be resolved with your mortgage consultant because there are NO bad loans available. ONLY bad loan officers that want to make a quick buck and put their clients into loans that don’t fit their financial needs with no way out but to refinance again.

July 5th, 2006 · Filed Under Mortgage - Loan Information