Qualified Charitable Contribution

If you're at an age where you need to be taking Required Minimum Distributions (age 70.5) from your IRA, a qualified charitable contribution and some planning may allow you to lower your overall tax liability.

Let's say that a couple's 2019 itemized deductions include $8,000 in property taxes, $4,400 in interest and $20,000 in charitable contributions.  That would total $32,400 which exceeds the 2019 $25,300 standard deduction for married couples, 65 years of age or older, filing jointly. 

Their required minimum distribution from their IRA is $40,000 which will be taxed at ordinary income.  If this couple is in the 24% tax bracket, the tax liability would be $9,600.

Alternatively, if they made the $20,000 in charitable contributions from their IRA as a Qualified Charitable Contribution, it would not be taxable in the withdrawal.  The balance of the RMD of $20,000 would be taxable at 24% which would have a tax liability of $4,800.

Their $32,400 worth of itemized deductions would be reduced by the $20,000 because it was paid from the IRA which makes their itemized deductions $12,400.  The $25,300 standard deduction would benefit them more by an amount of $12,900 increased deductions.  At 24%, this would reduce their liability by $3,096.

In the first instance, they would owe $9,600 in taxes due to the $40,000 RMD from their IRA.  In the second example, because of the increased amount by taking the standard deduction, the net tax liability would be $1,704 ($9,600 - $4,800 - $3,096 = $1,704).

This example shows how shifting contributions to a Qualified Charitable Contribution will get the same amount to the charity but lower the Required Minimum Distribution that must be recognized as ordinary income.  The shifting also gives the taxpayers the advantage of a higher amount of the standard deduction than the itemized deduction.

As always, before taking action, you should get advice from your tax professional on how this strategy may impact you.  There is information available on www.IRS.com for IRS Required Minimum Distribution FAQs and Qualified Charitable Distributions.

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To-Do List for Better Homeowners

Checklists work because they contain the important things that need to be done.  They provide a reminder about things we know and realize but may have slipped our minds as well as inform us about things we didn't consider.  Periodic attention to these areas can protect the investment in your home.

1. Change HVAC filters regularly.  Consider purchasing a supply of the correct sizes needed online and they'll even remind you when it's time to order them again.
2. Change batteries in smoke and carbon monoxide detectors annually.
3. Create and regularly update a Home Inventory to keep track of personal belongings in case of burglary or casualty loss.
4. Keep track of capital improvements, with a Homeowners Tax Guide, made to your home throughout the year that increases your basis and lowers gain.
5. Order free credit reports from all three bureaus once a year at www.AnnualCreditReport.com.
6. Challenge your property tax assessment when you receive that year's assessment when you feel that the value is too high.  We can supply the comparable sales and you can handle the rest.
7. Establish a family emergency plan identifying the best escape routes and where family members should meet after leaving the home.
8. If you have a mortgage, verify the unpaid balance and if additional principal payments were applied properly.  Use a Equity Accelerator to estimate how long it will take to retire your mortgage.
9. Keep trees pruned and shrubs trimmed away from house to enhance visual appeal, increase security and prevent damage.
10. Have heating and cooling professionally serviced annually.
11. Check toilets periodically to see if they're leaking water and repair if necessary.
12. Clean gutters twice a year to control rainwater away from your home to protect roof, siding and foundation.
13. To identify indications of foundation issues, periodically, check around perimeter of home for cracks in walls or concrete.  Do doors and windows open properly? 
14. Peeling or chipping paint can lead to wood and interior damage.  Small areas can be touched-up but multiple areas may indicate that the whole exterior needs painting.
15. If there is a chimney and fires are burned in the fireplace, it will need to be inspected and possibly cleaned.
16. If the home has a sprinkler system, manually turn the sprinklers on, one station at a time to determine if they are working and aimed properly.  Evaluate if the timers are set properly.  Look for pooling water that could indicate a leak underground.
17. Have your home inspected for termites.

Instead of remembering when you need to do these different things, use your calendar to create a system.  As an example, make a new appointment with "change the HVAC filters" in the subject line.  Select the recurring event button and decide the pattern.  For instance, set this one for monthly, every two months with no end date.  You can schedule a time or just an all-day event will show at the top of your calendar that day.

By scheduling as many of these items as you can, you won't forget that they need to be done.  If you don't delete them from the calendar, you'll continue to be "nagged" until you finally do them.

If you have questions or need a recommendation of a service provider, give us a call at (256) 705-0733.  We deal with issues like this regularly and have experience with workers who are reputable and reasonable.

Eliminate FHA Mortgage Insurance

Mortgage insurance premium can add almost $200 to the payment on a $265,000 FHA mortgage.  The decision to get an FHA loan may have been the lower down payment requirement or the lower credit score levels, but now that you have the loan, is it possible to eliminate it?

Mortgage Insurance Premium protects lenders in case of a borrower's default and is required on FHA loans.  The Up-Front MIP is currently 1.75% of the base loan amount and paid at the time of closing.  Annual MIP for loans with greater than 95% loan-to-value is .85% per year. 

For loans with FHA case numbers assigned before June 3, 2013, when the loan is paid down to 78% of the original loan amount, the MIP can be cancelled.  The borrower may need to contact the current servicer.

However, for loans greater than 90% with FHA case numbers assigned on or after that date, the MIP is required for the term of the loan.

Most homeowners with FHA mortgages are not eligible to cancel the MIP because they either originated their loan after June 3, 2013, put less than 10% down payment and/or got a 30-year loan.  If they have at least 20% equity in the home, they can refinance the home with an 80% conventional loan which in most cases, does not require mortgage insurance.

With normal amortization on a 30-year loan, it takes approximately 11-years to reduce the original loan to the 78-80% requirement based on normal amortization.  There is another dynamic involved which is the appreciation on the home.  As the home goes up in value and the unpaid balance goes down, the equity increases.

If the homeowners believe that they have enough equity that would eliminate the need for mortgage insurance, they can investigate refinancing with a conventional loan.  Borrowers refinancing will incur expenses in starting a new mortgage and the interest rate may be higher than the existing rate.  Analysis will determine how long it will take to recapture the cost of refinancing.

Call me as (256) 705-0733 for a recommendation of a trusted mortgage professional.

Year End Tax Newsletter

One of the first steps in a good outcome is knowing a little bit about what you're about to undertake.  By being aware of some of the areas regarding homes that may not come up every year in a tax return, you'll be able to point them out to your tax professional or seek more information from IRS.gov.
Look through this list of items for things that could affect your tax return.  Even if you have relied on the same tax professional for years to look out for your best interests, they need to be aware that there could be something different in this year's return.
If you bought a home for a principal residence last year, check your closing statement and identify any points or pre-paid interest that you or the seller paid based on the mortgage you received.  These can be deducted on your Schedule A as qualified home interest if you itemize your deductions.  See Home Mortgage Interest Deduction | IRS Publication 936 (2018 version not released as of this newsletter).
Keep track of all money you spend on your home that might be considered a capital improvement.  Get in the habit of putting receipts for money spent on your home that is not the house payment or utility bills.  Repairs are not tax deductible but improvements, even small ones, can be added to the basis of your home which can lower the gain when the home is sold.  Years from now, your tax preparer can sift through them and determine whether they're capital improvements or maintenance. See Increases to Basis | IRS Publication 523 Selling Your Home (2018 version not released as of this newsletter).
By making additional principal contributions with your mortgage payment, you'll save interest, build equity and shorten the term of a fixed-rate mortgage.  See Equity Accelerator.
If you sold a home last year, the payoff on your old mortgage included interest from the last payment you made to the date of the payoff.  That interest is tax deductible.  You may need a breakdown of the payoff to the mortgage company; you should be able to get that from your closing officer.
If you refinanced your home, unlike a home purchase, points paid to refinance are not deductible as interest in the year paid; they must spread ratably over the life of the mortgage.  See Home Mortgage Interest Deduction | IRS Publication 936 (2018 version not released as of this newsletter).
For homeowners who have lost a spouse, there is an exception regarding the exclusion on the sale of a principal residence.  If the surviving spouse concludes a sale of the home within two years of the death of their spouse, they may exclude up to $500,000, instead of $250,000 for single taxpayers, of gain provided ownership and use tests are met prior to death.
The two-year period begins on the date of death and ends two years after that date.  See Sale of Main Home by Surviving Spouse | IRS Publication 523 Selling Your Home (2018 version not released as of this newsletter).
There could be significant tax consequences to a person selling a home that was received as a gift as compared to receiving the home through inheritance.  With a gift, the basis of the donor becomes the basis of the donee.  With inheritance, the heir usually gets a stepped-up basis and avoids potential unrecognized gain.  See Home Received as Inheritance | IRS Publication 523 Selling Your Home (2018 version not released as of this newsletter).
Click here to download a Homeowners Tax Guide.  This is meant for information purposes only and advice from a qualified tax professional should be sought to find out about your individual situation.

Getting the "Right" Home

Finding the right home is still the biggest challenge buyers are faced with in today's market as is shown in the latest Confidence Index Survey.  Assuming the buyers find the "right" home with determination, perseverance and the help of a real estate professional, 88% of all transactions last year required financing to get the buyer's address on the home.  93% of first-time buyers needed financing.

Pre-approval is an essential step that needs to be handled before buyers begin searching for a home.  The benefits to the buyer fall into the category of confidence.

PRE-APPROVAL GIVES YOU CONFIDENCE

• Knowing the amount you can borrow  
  the mortgage amount decreases as interest rates rise
• Looking at the right priced homes
  price, size, amenities, location
• Comparing and identifying the best loan
  rate, term, type
• Uncover issues early that could affect the most favorable loan terms
  time to cure possible problems
• Bargaining power to negotiate with the seller and possibly, competing buyers
  price, terms, & timing
• Settlement can occur sooner after contact is acceptedverifications have already been made

Items Needed for Pre-Approval

• Photo ID
• Two months current pay stubs
• Last two year's W2s
• Complete copies of checking and savings statements for last three months
• Copies of statements for IRAs, 401k, savings, CDs, money market funds, etc.
• Employment history for last two years with addresses and contacts
• Proof of commissioned or bonus income
• Residency history for last two years with addresses and contacts
• Assets for down payment, closing costs, and reserves; must provide paper trail
• If self-employed, last two years tax returns, current profit and loss statement and balance sheet; copy of partnership/corporate tax returns for last two years if owning more than 25% of company
• FHA requires driver's license and social security card
• VA requires original certificate of eligibility and DD214
• Other things may be required such as previous bankruptcy, divorce decree

Contact us at (256) 705-0733 or Bob@BobGifford.com if you'd like a recommendation of a trusted mortgage professional.

Start Early and Live Happily Ever-after

As storybooks go, the character is introduced, they meet their love interest, a villain thwarts their intentions, true love overcomes, they marry and live happily ever-after.  It's a very familiar formula.

Similarly, there is a formula that couples follow in real life.  They go to college, get a good job, rent a home, fall in love, get married and buy a starter home.  They start a family, move into a larger home, save for their children's education, start planning for their retirement and if they live within their means, they invest their surplus funds.

An alternative to this might be to start investing in rental homes early in their adult life before their standard of living becomes so expensive that they don't feel like they have the money to purchase rentals.  There are infinite possibilities but let's say a single person, after getting a good job, buys a small three or four-bedroom home with an owner-occupied, minimum down payment.  They move into the home and possibly, rent out the bedrooms to other singles who need a place to live.

At some point, they decide to buy another home to live in with a minimum down payment and either rent out their bedroom in the first home or rent the whole home to a tenant.  And they repeat the process again with the second home.

This could continue until they acquired several homes.  Let's say, that in the meantime, they have met their love interest, decide to get married and together, they buy a starter home for them to live in.

This concept advances the investment in rental homes from the latter part of their lives to the early part of their life.  The early investment gives them more time for appreciation and wealth accumulation.  A simple principle of investing is that sooner is better than later.  By delaying gratification to own your "dream home" early, a person may be able to accumulate more net worth in the same period of time.

Buying a property initially as owner-occupied permits a lower down payment of 3.5% compared to a typical down payment for non-owner-occupied properties is 20%.  By using more borrowed funds, leverage can increase the yield on the investment.

It may be too late for some people reading this article to adopt this strategy but if they have kids in college, it may be something for them to consider.

It's Not Just the Tax Benefits

When the standard deduction for married couples filing jointly was increased from $12,700 to $24,000 for 2018, there was some speculation that the bloom was off the rose of homeownership.  The thought was that if the tax benefits from being able to deduct the property taxes and interest was less than the standard deduction, that maybe, the buyer would be better off continuing to rent.

With mortgage rates as low as they have been for the past eight years, payments have been lower and so has the amount interest that was paid.  This and the fact that sales and local taxes, which include property taxes, are limited to $10,000 a year on the Itemized Deduction form have made it harder to reach the increased standard deduction.

The reality of the situation is tax benefits are only one of the components that make a home an excellent investment and it probably contributes the least of the top three benefits.  Principal reduction and appreciation build an owner's equity in an automatic way that is like a forced savings account.

In today's market, it is common for the total house payment to be lower than the rent a first-time home buyer is currently paying.  As a homeowner, the buyer would have additional expenses like maintenance and possibly, a HOA. 

To illustrate the net effect, let's look at a purchase price of $275,000 with 3.5% down payment on a 4.75% 30-year FHA loan.  We'll assume the home appreciates at 3% annually and the buyer is currently paying $2,000 a month rent.

The total payment is $2,115 including principal, interest, property taxes, property and mortgage insurance. However, when you consider the monthly principal reduction, appreciation, maintenance and HOA, the net cost of housing is $1,181. It costs $819 more a month to rent than to own. In a year's time, it would cost $9,831 more to rent than to own which is more than the down payment required to buy the home.

In seven-years, the $9,625 down payment would grow to over $58,000 in equity.  The equity build-up far exceeds the tax benefits which some people would have as an additional incentive. Use this Rent vs. Own to see what the net cost of housing would be using a home in your price range or call me at (256) 705-0733 and I'll do it for you.