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Taxes

The Fed Raised Rates: What Should Property Owners Do Now?

Borrowers beware...The Federal Reserve’s interest rate setting committee last month raised short-term interest rates, a move that will eventually impact all borrowers: from credit card users to car buyers to those looking to purchase or refinance a home or investment property.Don’t panic just yet, however. The Fed’s rate hike was small () and overall rates remain near historic lows. The Federal Funds rate—a very short-term rate that banks charge each other for overnight loans—is still under .75%More to Come.Still, the Fed’s move is not “one and done.”Fed Chair Janet Yellen and her colleagues at the central bank clearly signaled that they think the economy is healthy enough—with small but sure signs of inflation and wage growth—to withstand a very gradual path back toward a normal interest rate level. Fed watchers predict perhaps three more rate hikes in 2017, which, according to giant mutual fund company Vanguard, could take the Federal Funds rate to 1.5% a year from now.Of course the Fed does not set mortgage rates—they are determined in bond markets. But the rate the Fed does control can eventually influence mortgage rates, as can the Fed’s general outlook for the economy, which is closely linked to its rate setting.Mortgage rates are still near historically low levels, hovering just around 4.2% for a 30-year fixed loan nationally. Rates in the San Francisco area are a bit lower, right around 3.9%, on average. Multifamily, or apartment, loan rates are closer to 5% or a bit higher, though the rate you get depends on the terms, from the size of the loan to the money put down and the loan-to-value ratio.

So how fast will mortgage rates rise?

Not very fast, at least that’s the current outlook. The Fed is expected to proceed with its rate hikes very carefully. Mortgage giant Fannie Mae sees rates rising very gradually through 2017.But that doesn’t mean property investors can ignore the Fed and the economic outlook. So, here is a list of things Bay Area landlords should think about as the Fed pushes rates higher:

  1. If you’ve been thinking about refinancing a mortgage loan, do it sooner rather than later. Mortgage rates are headed gradually higher, and just a half of a point rate difference on a $200,000 loan can save you $20,000 over the course of a 30-year loan.
  2. Watch those prices if you’re even dreaming about buying another property. Here’s why: how home buyers react to the Fed may be more important than actual rates right now. And the prospect of higher mortgage rates may already have motivated Bay Area home buyers to accelerate purchases, according to Selma Hepp, chief economist at Pacific Union International.
  3. Time to sell stocks? Often when the Fed begins to raise rates, it weighs on the stock market, pushing stock prices down. With a very strong local job market and a lack of housing supply, Bay Area housing may be a better investment, believe it or not, than stocks. As the Oracle of Omaha, Warren Buffett, says, “Be fearful when others are greedy and greedy when others are fearful.”
  4. And absolutely watch closely for signs of inflation. Not only in official data put out by the Bureau of Labor Statistics, but also in everyday prices from milk to underwear. President Elect Donald Trump is contemplating several policies—including trade sanctions and an economic stimulus package—that many economists think could cause inflation to accelerate. If that happens Janet Yellen and Co. will react quickly with higher short-term rates, and all borrowing rates could climb very quickly. Of course, real estate has historically been a hedge against inflation, since it tends to rise in value faster than inflation.

Executive SummaryIt all adds up to an uncertain future—we don’t know what 2017 will really bring and no one else does either. But we do know this much: careful and opportunistic property owners/investors can make the best of it.They always do.

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Eliminating the Estate Tax, AMT and Most Personal Deductions - How Trump's Tax Reform Plan Will Affect Real Estate Investors (Part II)

Real estate industry experts have expressed mixed emotions about President Trump’s proposed changes to the tax code. The changes will certainly affect homeowners differently than they affect real estate investors.In Part II of this three-part series, we break down the key components of the tax reform plan released last week by the Trump administration. This post looks specifically at how we think eliminating the estate tax, the alternative minimum tax, and most personal deductions will affect real estate investors.

Eliminates the estate tax.

The estate tax, otherwise known as the “death tax,” seems like a positive thing for real estate investors, who can now pass their real estate portfolio on to heirs without worrying about the portfolio’s value being whittled away by taxes.

Eliminates the alternative minimum tax ().

This is another change that should benefit real estate investors. The was originally enacted in the 1960s to prevent wealthy people from using deductions to reduce their tax liability to nearly zero. For instance, Trump’s own tax return from 2005 revealed huge losses from real estate investments, which he deducted. Were it not for the , Trump would have paid next to nothing in taxes. But because the ignores most deductions, Trump wound up paying taxes at the 24% rate – still far below the top rate, but much higher than without the . Eliminating the would allow people in a similar situation to write off losses to reduce their tax liability once again.

Eliminates most personal deductions, including deductions for state and local income taxes, but preserves deductions for mortgage interest payments () and charitable contributions.

At one point in time there was speculation that President Trump might try to eliminate the deduction. Thankfully President Trump, himself an avid real estate investor, came to his senses and preserved this deduction in the plan released on Wednesday.Any change to the deduction would have been terrible for the real estate industry. Really terrible. It would have been awful for landlords, investors and homeowners alike. Real estate is perhaps the most tax-advantaged industry, and the ability to write off mortgage interest payments saves owners thousands of dollars each year. Real estate investors have built their pro formas around the assumption that this tax advantage would hold. Changing the policy could dramatically impact a person’s return on investment.*****In Part I of this series, we shared why real estate investors should be cautiously optimistic about Trump’s proposal to consolidate tax brackets into just three and to reduce taxes for corporate and pass-through businesses.Stay tuned for Part III of this series in which we’ll analyze how we believe doubling the standard deduction and eliminating the investment income surcharge will impact real estate investors.

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Fewer Tax Brackets and Lower Corporate Taxes - How Trump's Tax Reform Plan Will Affect Real Estate Investors (Part I)

He made a promise on the campaign trail to cut taxes for individuals and businesses alike—and last week, the Trump administration unveiled a tax reform plan that would do just that. Treasury Secretary Steven Mnunchin and National Economic Director Gary Cohn briefed reporters on the plan at the White House earlier this week. Although details about the plan remain sparse, real estate investors should be cautiously optimistic about what's known about the plan so far.In this 3-part guide, we provide a rundown of the proposed changes, as well as a recap of how we believe the changes may affect real estate investors.

Consolidates tax brackets from seven to just three ().

Generally speaking, this seems like a good thing. It will certainly simplify things for everyone who files. But in terms of impact on real estate investors, we do not believe this change will have a major impact one way or another.

Reduces corporate taxes from 35% to 15%.

The U.S. corporate tax rate is currently the highest in the industrialized world, which some say has caused a massive exodus of U.S. companies to lower-tax nations. Reducing the corporate tax rate to 15% would make it one of the lowest in the world. The goal is to incentivize companies to come back home.Again, we don’t see this change as having a major impact on real estate investors specifically. But on the whole, it seems like good policy to incentivize businesses to stay in the U.S. where they can grow jobs and strengthen the national economy. A strong economy usually translates into a healthy housing market.

Applies a 15% tax rate to “pass-through” businesses.

President Trump wants to be sure small businesses and professional organizations receive the same tax treatment as corporations—and that means lowering taxes for “pass-through” businesses, as well.This would really benefit real estate investors. Pass-through businesses include everything from barber shops to hedge funds, as well as LLCs created to invest in real estate. Some say that President Trump is pushing for this change for his own benefit; he has more than 500 pass-through entities that contain his real estate holdings. In any event, reducing the pass-through tax rate () will certainly benefit landlords, real estate investors and other real estate-related professional service companies.*****On the whole, we see these proposed changes as being relatively beneficial to real estate investors. Stay tuned for Part II and Part III of this series, in which we look at other tax reform provisions and how those might impact the future of real estate.

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10 Tax Deductions Often Overlooked by Landlords

Owning rental property isn’t always easy, but there are some serious tax advantages that come along with being a landlord. Yet surprisingly, most landlords don’t take full advantage of these tax benefits. Most write off standard tax deductions like mortgage interest, insurance and ordinary maintenance and repairs – and understandably, as these are the heavy hitters.But there are a number of other tax deductions that rental property owners either miss or don’t know about.

Here are 10 tax deductions that are often overlooked by landlords:

  1. Business startup costs.If you’re just starting your rental property business, you might be able to deduct a portion of your startup costs. Common startup costs include accounting fees, the study of potential markets, training for new employees, office equipment and furniture, and salaries. Although most startup costs are considered capital expenditures, you may be able to deduct up to $5,000 of those costs if your total startup costs exceed $50,000. The remaining costs must be amortized over a period of time.
  2. Costs incurred while looking for new property.The costs of your hotel, airfare, rental car, meals and other travel expenses incurred while looking for a new rental property are fully tax deductible if they are ordinary and necessary. To qualify, at least half of the time you spent away on travel must have been spent on doing business, and the primary reason for travel must be for business. Technically, this means you could write off a long weekend in Florida as long as you spend the majority of time engaging in business-related activities.
  3. Ordinary and necessary advertising expenses.Landlords can write off any costs incurred while advertising their business () and/or a rental unit (). Common expenses include classified ads, signs and postage for mailers. You can even deduct the costs of building a new website.
  4. Utilities paid by the landlord.It’s common for landlords to pay for common area lighting and security systems. But did you know that landlords can also write off expenses like heating, water, sewer, gas, trash collection, cable and internet? The costs of utilities used by tenants are fully deductible, even if the tenants reimburse you later—just be sure to claim those reimbursements as income.
  5. Pay your kids to help with property maintenance.This is one of the oldest tricks in the book. If it looks like you’re going to have a large tax liability at the end of the year, put those children of yours to work! “Hire” your kids to help with property maintenance. Have them mow lawns, shovel snow, and clean vacant units. Keep a written receipt detailing how much you paid them, for what activities, and when (). Not only will this help reduce your tax liability, but it will introduce your children to the world of real estate and property management.
  6. Property management fees.No kids to put to work? No problem. You can still reduce your tax liability by deducting property management fees. Property management fees are considered administrative expenses and can be written off in full. If you self-manage your rental properties, don’t forget to write off the costs of ordinary maintenance, screening prospective tenants (), and advertising ().
  7. Interest paid on loans or credit cards.Most landlords won’t overlook writing off their mortgage interest, but they’ll often forget to write off interest paid on other loans or credit cards. If the loan or credit card was used to buy, maintain or repair something at your rental property, you can deduct the interest paid. Be careful not to co-mingle business expenses on a card with personal expenses, as interest paid on credit cards for personal items does not qualify.
  8. Home office or workshop.Claiming a home office or workshop is a bit of a grey area, and for that reason, many landlords opt to steer clear of this tax deduction. But this deduction can be highly valuable, so it’s worth looking into. Office furniture, tools, and a portion of other expenses – like utilities and home maintenance – might also qualify as write-offs. Before claiming this deduction, we suggest talking with your accountant to be sure you understand the minimum requirements that make these spaces eligible for write off.
  9. Selling the property to your own S-Corp.In rare circumstances, it might make sense to sell your rental property back to yourself through the creation of an S-Corporation. For instance, selling a property to your own S-Corp may allow you to shield the appreciate value through capital gains protection. Here’s an example: You purchased a property in 2005 and made significant improvements to the property before moving out in 2009. You’ve rented ever since. If you go to sell the home now, the appreciated value is subject to capital gains tax because you haven’t lived in the property as a primary residence for two of the last five years (). Instead, if you had sold the property to your own S-Corp sometime between 2009 and 2012, you could have excluded capital gains () because the requirements for the two-year rule would have been met. Selling to an S-Corp can be complicated and shouldn’t be used by everyone. Consult with a tax advisor before deciding to go this route.
  10. Depreciate more than the standard 1/27.5 years.When you purchase rental property, you’re really buying multiple assets: land the building sits on, improvements to the land such as landscaping, the building itself, and any property included with the sale (). Most landlords depreciate all of these items together over the standard 27.5-year recovery period. But each asset can be depreciated separately (). This depreciation method, known as “cost segregation,” is more complicated, but it allows landlords to accelerate depreciation because land improvements and personal property have shorter depreciation periods than real property, usually between five and seven years. Your total depreciation won’t be different, but cost segregation gives you a larger depreciable deduction during the first several years you own the property. Every rental property owner should consider having a validated accounting firm perform a cost segregation study to determine whether this approach can save you money.

If you own rental property, you should always be looking for ways to maximize the return on your investment. Increasing cash flow is one strategy. Reducing expenses is another. Taking these valuable tax deductions is a great way to shield income earned as a landlord.Time’s a tickin’! The IRS filing deadline is just a month away (). Schedule a meeting with your accountant or tax attorney ASAP to be sure you’re taking full advantage of all possible deductions.

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