SECOND HOME
When analyzing the possible purchase of a second home, a number of factors must be considered: location, investment potential, and overhead, management and possible pitfalls. Carefully evaluate each proposition for good location, history of sound resale, property management and a lifestyle that is not trendy but stable.
Well-located and developed real estate can offer potential long-term appreciation. From an accounting standpoint, there are some depreciation advantages although initial cash flow will not usually be positive.
REVERSE MORTGAGES:
Reverse mortgages are federally insured by Home Equity Conversion Mortgage and require no repayment as long as the borrower lives in the home, or up to 12 months of living elsewhere. They can either get:
1) An immediate cash advance at closing,
2) A credit line account that lets them take advances whenever they choose, or
3) Monthly cash advance for as long as they live in the home.
The HECM loan credit line or cash advance is a growing line of credit, increasing by the mortgage rate each year. This interest rate is the same as for their borrowing. The loan ends when the last surviving borrower dies, sells the home or permanently moves away.
The amount borrowed, plus interest, is deducted from the sales price to repay the HECM, while heirs receive the balance. The home’s title cannot be transferred until the loan is repaid.
Upfront costs are similar to those incurred for purchasing a home, although most of these can be financed with the loan. The application fee and appraisal fee must be paid in cash.
Interest rates on the HECM loans are governed by the Federal Trust-in-lending law and require the disclosure of Total Annual Loan Cost (TALC). This includes any upfront expenses and averages the interest rates over the life of the loan. Interest rates are tied to 2% above the 10-year treasury, so they are quite low.
The optimum loan is for:
1) An older couple (70s or older) (the minimum age is 62).
2) An expensive home ($250,000), and
3) A low-interest rate environment.
If they end up living in the home well past their life expectancies or the home doesn’t appreciate very much, they will get a bargain with the loan. However, if they die, sell or move within just a few years or the home appreciates a lot, the true cost could be higher.
RENTAL PROPERTY
When property is converted from the taxpayer’s primary residence to rental property, any gain realized upon the subsequent sale of the property will be taxable at capital gains rates. The special non-recognition of gain rules, relating to the sale of a personal residence is not applicable. Loss realized upon subsequent sale will be deductible capital loss.
It is possible to lease your principal residence on a temporary basis, before it is sold, without jeopardizing the non-recognition of gain provisions. This can be done for a period of up to 24 months.
Deduction:
In addition to some deductions for taxes and interests, deductions may be claimed for utilities, insurance, management fees, maintenance and repairs, depreciation, and any other expenses incurred in connection with the rental property – i.e., travel, long distance phone calls, etc.
Basis for Depreciation:
The basis for depreciation of a rental property is the lesser of (1) its fair market value at date of conversion or (2) its “adjusted basis” at date of conversion – i.e., its original cost plus the cost of permanent improvements.
Basis for Gain upon Subsequent Sale
The basis for gain of a rental property is its original cost, plus the cost of permanent improvements, less depreciation claimed during the rental period.
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