Pay Cash & Refinance Later? BAD Advice

How often have you been involved in a real estate transaction and decided to put down a large down payment just to "get the deal done"?  After all, you're a good risk and expect to get a loan whenever you want it.  You'll just refinance the loan later and "pull cash out"

It would be easy for me to shake my head and suggest that you are getting poor financial advice...that would be easy.  You might be violating the tax code if you deducted that interest from the larger loan if you took it out after 90 days from the close of escrow.   AND...you probably got away with it...up until next year.

A few things you should know about the deductibility of mortgage interest:

1- It is limited to $1.1 million.
2- You must itemize (Schedule A) to receive that deduction.
3- A fully-amortizing loan reduces your Acquisition Indebtedness each month.
4- An interest-only loan does not reduce your Acquisition Indebtedness; it remains level.
5- You are entitled to a $100,000 over the Acquisition Indebtedness as a home equity exclusion for tax deductibility.

Now, here's the catch.  The IRS monitors your interest paid on mortgages through a Form 1098.  The IRS has no formal system to monitor the segregation of debt (how much was the Acquisition Indebtedness, how much is covered under the home equity exclusion, and how much is not deductible)...UNTIL NOW.

In 2007, lenders are required to report cash-out refinance transactions.  That includes any and all refinanced loans that exceed the original Acquisition Indebtedness.  This means that if you bought a home in 2000 with a $250,000 loan against it and have subsequently increased that debt to $400,000, your qualifying debt for interest will be capped at $350,000, more if you paid down the loan through an amortized loan.  In California, that applies to MANY refinance transactions for homes owned more than three years.

Why is the IRS doing this?  Well, follow the money.  The IRS has overlooked this common ignorance of the tax code because it really didn't affect the average Joe...until NOW.  The real estate boom gave homeowners a chance to use their home like an ATM and withdraw cash.  Now, the IRS wants it's pound of flesh.  If you've refinanced and pulled out cash over and above $100,00 above your Acquisition Indebtedness, you had better start paying attention to your deductibility of mortgage interest ...because Uncle Sam is...next year.

Mortgage planning encompasses this information and works with your tax professional to ensure that you get the largest tax-deduction available.  You can always opt against that advice and put down a larger down payment.  Wouldn't you like to make an educated choice?

Ask the mortgage salesman your Realtor recommended why she didn't tell you about this when you bought your home; she could cost you a lot of money next year.

*Article written by guest author Brian Brady and is solely his opinion and information.

Comments

[Jeff Belonger]

Brian....This is more than an excellent post, but it should open the eyes of those that give this kind of advice. As I just told a client yesterday, I am not a lawyer and that is a question for a lawyer. Just as this is for an accountant. Great job.

[William J Archambault Jr]

Brian,

The prolmem with bloging is that this piece gets the same type size and placement as the most frivolous piece of fluff!

This should be mandatory reading.

Well done.

Bill

William J Archambault Jr
The Real Estate Investment Institute
http://www.reii.org

PS: I disagree with Jeff. He’s right about referring them to the attorney and/or account, but we should supply the questions and know when the answers are wrong.

[laurie manny]

I sell real estate, I do not offer financial advice. That is the job of the attorneys, accountants, financial advisors and lenders.

[Sparky]

Okay, so where did you put the 'switch?' This REALLY pisses me off! You bait the hook really well, attracting my interests, luring me away from the comforts of AR, and there's NO stinkin' SWITCH!!

[Robert D. Ashby, CMPS]

Excellent advice. The only thing I would add is there may be some confusion in the $1.1 Million dollar limitation. That limitation is combined between Acquisition Indebtedness ($1.0MM limit) and Home Equity Indebtedness ($100,000 limit).

I also believe thta as trusted advisors, we mortgage professionals should know the tax codes as it applies to mortgages and not rely solely on the disclaimers. Most likely, borrowers will not take the time to seek tax advice, so we could potentially save them from the hangman's noose.

[Brian Brady]

Robert:

You are correct. How did I know a CMPS would catch that? The limit for Acquisition Indebtedness is $1 MM and the Home equity Indebtedness is $100K.

I agree that mortgage planners need to know enough about the tax code to save the borrower from the hangman's noose.

[David A Podgursky MBA]

Great post... this is a common issue that needs to be addressed in mandatory Realtor Continuing Education.

[Vicki Lloyd]

Isn't the aquisition debt increased when additional financing is used for capital improvements?

[Brian Brady]

Vicky,
That's a great question. the answer is yes if it is within a specified period of time from the closed refinance transaction. I believe it's 90 days.

[Kaye Thomas]

Can I steal this post and make you my guest blogger?

[Brian Brady]

Do it, Kaye !

[William J Archambault Jr]

Brian,

The more comments you collect on this post the more upset I’m getting!

I’m not a lawyer, not a CPA, not even an MBA. just a banker. turned REALTOR®, turned mortgager broker, turned consultant. I don’t know all the answers, but I’ve made it my business to learn most of the questions. How can other wise good to great real estate professionals take the position that “It’s not my job”? Mortgage people know more about the client financially than anyone. The REALTOR®, good ones anyway come in a close second. When was the last time an attorney or CPA ask to see a clients credit report and/or 1003? A good one may ask for the O & A. We’re the only one who regularly sees everything. Just what is our job? The on-line order takers can get most people some kind of loan, the para-legal can fill in an O & A ($50 at the coroner legal forms store), what do we do for the big money? I’ve been under the impression that we got paid well for our experience and advice.

We have to walk a thin line. We have to stay within the parameters of our E & O insurance, but there is no regulation against referring clients to attorneys and CPA and providing the questions!

I once was called in to help with a huge short sale, I completed the transaction and saved the client $3,000,000.00 in taxes on the $8,000,000.00 short sale. Their attorney and CPA told the client they didn’t think of “that” didn’t think of over $3,000,000.00 in immediate taxes. Ya, right. Big deals are rare, but little ones come up all the time. I’ve always believe real estate was so much more that asking “don’t you just love the family room?”

It’s no wonder we have such a public relations problem with the sub-prime problem, Obviously it was no one’s job to tell the clients that adjustable rate loans that start at the lowest point in history age going to go up! God forbid anyone helping the client. At least don’t say anything that can get in the way of a quick closing.

On the other hand, it’s comforting that so many are concerned!

Bill

[Brian Brady]

Bill,

I'm going to agree with you concluding comment. I have been spending a lot of time on education these past few months. In fact, I'm studying for my Certified Financial Planner designation at SDSU, now.

Why? I really want the edge. We are often the first contact the average Joe has with financial services and are de facto financial planners whether we like it or not.

The advise we're giving is often "safe" but, as Robert Ashby points out, I think we owe it to our clients to keep them from the "hangman's noose".

I want us to do better. I want us to know more. I want us to force the consumers to think good and hard about these ideas. Ten years ago, the words "1031 exchange" didn't exist in the average Realtor or originator's vocabulary. Today, the butcher has completed two exchanges.

Let's take solace in your concluding comment and be the catalyst for positive change in our industry.

[Mitchell Hall]

Great informative post Brian and just when I thought we had a "kinder gentler" IRS

[Robert D. Ashby, CMPS]

OK, I am not a tax professional and any advice I give should be be researched with one who is to ensure it applies to you specifically.

Still, I read tax code (yes, as crappy as it is written, I actually read it). Why? To be a better advisor for my clients.

Regarding increasing acquisition indebtedness. Yes, home improvements can be used to increase it, subject to documentation and can be as long as 24 months prior. Divorce settlements can also be used to increase it. Again documents are needed.

Heck, you can even exceed the $1.1MM limitation, but it has to be done correctly and documented. Make to much money to qualify for mortgage interest deduction, no problem, you may still be able to deduct it through documentation.

In case you are not getting the picture, you need to seek an advisor who can help your specific situation. I know people who have even been told by CPAs and others that just go ahead and deduct all interest as the IRS won't go after you anyways. I HAVE WARNED PEOPLE ABOUT THIS TOPIC FOR YEARS, now the IRS is going to start enforcing it and guess what, millions of Americans are going to lose a lot of money because they didn't follow the law.

[Keith Jeppson]

Brian, as an ex-CPA, I enjoy providing this kind of information to my real estate clients.

Can I also include you on www.saltlakespeaks.com as a guest blogger with this post?

Do It, Keith! This is an important message. Just be sure to add this weblog tyo your blogroll

[Cal]

Could you expand on point 4 more?

If someone has a 100k IO loan at 5% and they take their deduction off the 5,000 they paid the first year. You are saying the next year if they claim $5,000 again it would be a violation of the tax code?

And aren't all IO loans fully amortizing at some point, if you were on a 30 year fixed with a 10 year IO how would it work after the first 10 years when you go fully amortizing? It sounds like the maximum deduction (assuming no equity withdrawl) is however much you can take if the loan was fully amortized over 30 years. Does this sound right?

[Brian Brady]

Good questions, Cal.

Acquisition indebtedness is reduced when you have an amortizing loan. Interest paid would reduce, also in year two, for an amortizing loan so your deduction would be less.

Your second comment is a good one. After ten years, your I/O period is up and the loan starts to amortize. Most people would not have the same loan after ten years (they would have sold or refinanced).

[Chuck]

Here's a CPA's point of view. Too often the client doesn't know what questions to ask nor who to ask them of. The best thing us professionals can do is work together in the client's best interest. When the loan officer/broker sees a tax issue and can phrase a question for the client to take to his CPA, that allows the CPA to respond. I hate to be in a position to tell a client what he/she could have done if only we had talked before the transaction was completed.

I agree with Bill, the more the loan officer/broker and real estate agent know about taxes the better they can waive the flag and tell the client to seek advise. Be the hero and warn your client or suggest some tax planning when there is an issue.

We have simular issues in our industry. We CPA's know the tax law but most of us have limited knowledge of real estate and mortgages.

The best situation I have been in is when my client put me in contact with the loan broker so that we could talk through the particular issues of the transaction. Its amaizing what we have discovered. My real estate agent clients regularly refer their buyers to me to review the tax issues of their contemplated transaction.

Chuck

[Brian Brady]

...and that, folks, may be the best CPA in Arizona.

I have his number if you need expert tax advice.

[Marc Brinitzer]

Great thread Brian. The average homeowner is totally unaware of this issue and needs to get a handle on it now.

Knowing the IRS had no enforcement policy in place allowed us to postpone the inevitable. But, you're right, there is too much money on the table to ignore. Now,if we can get them to fix AMT with the extra revenue. That might be a good tradeoff.

[unsecured loans]

Unsecured loans are the loans where you are not required to pledge any collateral and collateral free loans are meant to be burden free loans.You can have the unsecured loans for debt consolidation, home improvement, to run smoothly your business, to buy a car of your choice or to go for an exotic holiday.There are unsecured loans for the bad credit holders too.With unsecured loans, there is no fear factor and there is the talk of benefits only.

[Shamun Mahmud]

How about paying off your mortgage more quickly WITHOUT refinancing???

Have a great day & if you have a little extra time, please watch this 4 minute video to find out how you can pay off your mortgage in as little as 1/3 to 1/2 the time with no change to your current cash flow & without refinancing your existing mortgage! Give me a call if you'd like to get more information once you take a look.
http://u1stfinancial.net/betterloansNOW
Click on "Money Merge Account Flash Video" link below "Welcome To U1st Financial!

[Payday Loan Advocate]

Loan Companies today are very prominent because of its easy and fast transactions. If you need cash in an urgent, you can easily borrow cash from payday loan shops. Payday loans are very useful to the consumers because it has a quick transaction no more paper works at all. All you need to do is to fill in the given application online and after the approval you can now get your desired cash loan. That is why loan companies help the consumers a lot although some of the government officials are against to this kind of transaction.http://personalmoneystore.com/moneyblog/