Tax
ALTERNATIVE SELLER FINANCING FOR SAN DIEGO HOMES
An alternative kind of seller financing for San Diego homes, and another very easy way for you to sell a house, is on a lease with option to purchase. The most attractive feature is that buyers can move into the house for almost no down payment, without any closing costs or points to a bank. The lease generally expires in 3 to 5 years. At that time the buyer would have to obtain financing and cash you out. If in this case the buyer does not purchase the house, you, of course, get it back. Generally, it is worth more by the time this happens than it was 3 to 5 years earlier. And you still keep the money paid to you during the period the buyer lived in the house. In the unlikely event that the buyer has not kept the house in good condition, the maximum amount most owners end up paying for repairs and painting is about $3,500. An additional point: sometimes a buyer knows that at a definite point down the road he or she will get an infusion of money from a bonus, from the settlement of an estate or from some other source. In such cases – and only these cases – you, as a seller, would enter into an agreement for the buyer to pay you what is known as a balloon payment at that future time, commonly in 3 to 5 years.
Charles Gregg, a widower, landed in that situation. Having lost his wife, he no longer wanted to stay in the condo he had shared with her. He had bought the condo for $50,000. He owed a $25,000 mortgage on it, at 7 percent. A young couple, both of whom were medical students, offered to buy it. The condo had a market value of $100,000. The buyers did not have enough income yet to qualify for a mortgage, because they were still in school. However, they made an arrangement to receive a lump sum of money from their families and other sources upon graduation in 3 years. They arranged this future income in order to pay Charles the full amount in cash by giving a bank $20,000 (20 percent of the purchase price) and getting a loan for the remaining 80 percent. At the time they wanted to buy the condo, they could not finance it. But they had saved $5,000, in addition to having the guarantee of that stipend coming later. Charles, once he heard the details of the couple’s situation, was happy to accept the $5,000 as a good-faith payment. The couple agreed to pay 10 percent interest on a “wraparound mortgage” for $95,000. (A wraparound mortgage is a mortgage carried by the seller. It is an alternative to an agreement for deed for $95,000. Some attorneys prefer to use mortgages and notes rather than agreements for deed. The end results are the same).
What do I need to know about taxation of San Diego, California real estate?
Taxes are an important aspect of all real estate transactions. Property owners are taxed annually on the property they own. In addition, there are other state and federal taxes that must be paid in order to buy, sell or give away real property. The amount of tax and who must pay the tax are often major factors to consider in the transfer of real estate.
Property taxes
A city or county receives most of its operating revenue from the assessment and collection of real property taxes. REAL PROPERTY TAXES are taxes determined according to the value of the real property, and are paid annually or semi-annually. These taxes are called ad valorem taxes. An AD VALOREM TAX is a tax that is charged in proportion to the value of the property. Property taxes are based on the concept that taxes should be assessed in accordance with a person’s ability to pay. In the case of real estate, the higher the value of the property, the higher the property taxes.
Ad valorem means taxed according to value. San Diego, California real estate is reassessed each time it is transferred (sold). Annual property taxes are about 1% of selling price.
Taxes for income producing San Diego, California real estate
Investors of income producing San Diego, California real estate can annually deduct these items from their income taxes:
- Mortgage Interest on Loans (no maximum)
- Property Taxes
- Prepayment Penalties
In addition they can deduct:
- Operating Expenses
- Depreciation of Improvements
In addition to deducting mortgage interest (no maximum), property taxes and prepayment penalties, income property owners can deduct operating expenses and depreciation. Owners cannot deduct losses due to vacancies.Depreciation of income property (federal & state)
DEPRECIATION FOR TAX PURPOSES is a yearly tax deduction for wear, tear and obsolescence on investment property that is deducted from the taxpayer’s income on his or her income tax form. This deduction applies only to investment real estate or property used in a business, not on a taxpayer’s personal residence. Apartment buildings, commercial buildings and any building improvements to investment property can be depreciated. The land itself cannot be depreciated.
One can only depreciate property that is improved. Since land cannot be depreciated, only the improvements can be depreciated. Currently, the straight-line method is the accepted way to depreciate buildings and other improvements.
Residential (homes & apartments) property depreciation schedule: Minimum 27.5 years (Straight-line).
Commercial improvements depreciation schedule: Minimum 39 years (Straight-line).
The amount of depreciation must be spread uniformly over the useful life of the property, with the same amount deducted each year (straight-line depreciation). Since most buildings in these inflationary times actually increase in value, depreciation is usually just a technique for postponing income taxes until the property is sold.
Example: If you own a cabin in the desert that you rent to vacationers and the cabin cost $100,000 and the land value is $17,500, this leaves improvements of $82,500. Divide this $82,500 by 27 1/2 years giving you a depreciation of $3,000 for each year of the 27 1/2 years.
Remember: A property owner can deduct depreciation on income, trade or business real property, not on a residence.
Taxes on personal residence of San Diego, Ca homes
Taxes on personal residence
Owners of San Diego, Ca homes can annually deduct these three items from their income taxes based on their personal residence:
- Mortgage Interest on Loan (Trust Deeds)
- Property Taxes
- Prepayment Penalties
By the way, you cannot deduct the cost of personal residence repairs from your federal taxes, except for uninsured casual losses. For example, if your roof blows off and you have no insurance to cover it, the replacement cost can be deducted from your federal income taxes.Deduction of interest
Deduction of interest on your home loan from your income taxes is one of the major tax advantages of owning real estate. Buying a first and second home provides the average family with the biggest buffer against income taxes that it is likely to enjoy.
Despite recent income tax reforms, the federal tax laws still provide incentives to those who purchase a first and even a second home. When buying these homes you may finance up to $1 million ($1,000,000) with all the interest paid out during the year fully tax deductible. An additional deduction is available on the interest from home equity loans, taken for any purpose, even buying a second home, of up to $100,000 in principal. The $1,000,000 and $100,000 debit limit is a total applied against both first and second homes together or one owner-occupied home taken separately.
Deduction of property taxes
Property taxes on your 1st and 2nd San Diego homes are deductible from your income taxes. This makes us feel better about paying local property taxes.
Deduction of prepayment penalties
Prepayment penalties are also deductible from your income taxes. If you pay off or drastically reduce your home loan balance, there may be a prepayment penalty.
Interest, property taxes and prepayment penalties paid on your personal residence can be deducted from your income taxes.
PROFITING FROM “PRIME-TIME” SHARING OF SAN DIEGO HOMES
I do not advocate buying time-shares as a resale or investment unit, with two exceptions. Perhaps you have bought a “prime-time” sharing unit. This is a high-season week, in the most desirable time of year, which varies from region to region. The developer is either 90 percent sold out or wants to close out the balance of the units. Investigate buying one of the remaining shares, because the place is a winner. You can resell one of your purchases for a profit, usually within five years. Or perhaps you meet a private individual who for some reason – divorce, death, health or financial problems – wishes to unload a time- share unit for less than it is worth. The value of a time share in, say, an oceanfront resort is easily determined. What is the individual seller’s asking price? What is the going rate of comparable San Diego homes on the open market? Compare the two. If there is a 40 to 50 percent difference in the private person’s price, you can safely bet that you can make money.
BUYING EQUITY IN A RESORT
A final note: there is a new concept under which you can buy a share of a resort, called an undivided resort interest. It is being touted as an alternative to buying a resort condo or time-share. As The Wall Street Journal has pointed out, marketers of this concept would like buyers to believe that it is an improved version of time sharing. However, the Journal also noted that the undivided resort interest has yet to prove itself.
Under the new tax laws, you will not receive any tax benefits for shares in an undivided resort.
Tax exempt San Diego real estate
There are some properties that are partially or totally tax exempt. All real property that is owned by the federal, state, county or city government is automatically tax exempt.
Property of non-profit organizations used for religious, charitable, medical or educational purposes is tax exempt.
Property tax appeals
Over-assessments can be taken to the appeals board.
People who feel that the assessment of their real estate is not correct may appeal the assessment. Appeals would be directed to the Board of Equalization (the property tax assessment appeals board) between July 2nd and August 26th. After it considers the case, the Board may reduce an assessment, or it may increase it, or it may issue a new assessment if the San Diego real estate has not been assessed before.
Supplemental property tax bills for San Diego, California real estate
The law (SB 813) requires value reassessment of property immediately when they change ownership or when new construction is completed. While the amount of the supplemental assessment is still determined in accordance with Proposition 13 (see above), the actual effect is to “speed up” reassessment of property. In fact, prior to the change in the law, property was generally not reappraised until January 1st.
The Office of Assessor enters the new property value onto the assessment roll as of the first of the month following the month in which the property changes ownership or new construction is completed.
Depending upon the date you purchase San Diego, California real estate, or the date construction is completed, you will receive one or more supplemental tax bills in addition to your regular tax bill. Taxes on the supplemental tax roll become a lien against the real property on the date of change in ownership or the date new construction is completed.
Special Assessment Tax on San Diego, Ca real estate
A SPECIAL ASSESSMENT TAX is levied by a city council or a county board of supervisors, with the voters’ approval, for the cost of specific local improvements such as streets, sewers, irrigation or drainage. It differs from property taxes in that property taxes finance the general functions of government, whereas a special assessment is levied once (usually) by the city, county or “improvement district” for a particular work or improvement.
The official body that levies a special assessment is called a SPECIAL ASSESSMENT DISTRICT BOARD. According to state law, any self-governing area, such as a city or county, may establish a special assessment district for the purpose of levying a special assessment.
As a rule, a district issues its own bonds to finance particular improvements such as water distribution systems, parking facilities, street lighting and many other types of developments. To repay the funds borrowed through the bonds issued, these districts have the power to assess all lands included in the district on an ad valorem basis. Such loans constitute liens on the land until paid. These liens can be foreclosed by sale similar to a tax sale and have priority over private property interests.
Special assessments are for improvements only. If you purchase a lot for $40,000 and assume a $1,200 assessment bond, your cost basis for income tax purposes would be $41,200.
The STREET IMPROVEMENT ACT OF 1911 finances street and highway improvements through an assessment to property owners based upon the frontage they enjoy facing the improved street. Also called the Bond Act of 1911, it allows San Diego real estate owners, through the issuance of municipal bonds, up to 30 years to pay off their portion of the improvement assessment.
Proposition 13
PROPOSITION 13 limits the amount of taxes to a maximum of 1% of the March 1, 1975, market value of the property plus the cumulative increase of 2% in market value each year thereafter. Improvements made after March 1, 1975, are added to the value in the year they are made. If ownership has changed after March 1, 1975, the tax is limited to 1% of the market value plus the 2% cumulative increase each succeeding year.
Real property tax base is transferable
Under the following conditions, homeowners may be permitted to transfer their current Proposition 13 tax base with them when they move:
- Homeowners over the age of 55
- Replacement home of equal or lesser value
- Purchased within two years of original sale
- New home must be in the same county; or another participating county (check first).
This allows “empty-nesters” to purchase a new home while holding on to their low tax base, thus freeing up larger multiple bedroom San Diego homes for younger families.
Homeowner’s property tax exemption on San Diego, Ca homes
Homeowner’s property tax exemption is $7,000 of assessed valuation. Not the same as a homestead exemption. The HOMEOWNER’S PROPERTY TAX EXEMPTION is a deduction, on the property tax bill, of the first $7,000 of assessed value of an owner-occupied property.
A homeowner’s exemption on your home does the following:
All personal property of the homeowner is exempt from property taxes.
A resident owner receives a $7,000 homeowner’s exemption in assessed value if the property is the principal residence on the 1st of March.
The time to file for the homeowner’s exemption is from January 1st to April 15th in order to receive the full exemption. Once the exemption is filed, it remains on the property until the homeowner terminates it. If the exemption is terminated, a new claim form must be obtained from, and filed with, the assessor to regain eligibility.
Qualifying San Diego, Ca homes that are owner-occupied receive a $7,000 homeowner’s exemption. For example, an assessed value of $200,000 minus the homeowner’s exemption of $7,000 is $193,000.
Any resident who served in the military during a time of war is entitled to an annual $4,000 property tax exemption against the assessed value of one property. This exemption also applies to the widow, widowed mother, or pensioned father of a deceased veteran. However, the exempted property is limited to an assessed value of less than $5,000 for a single veteran or $10,000 if he or she is married. For disabled veterans who qualify, however, the assessment limit can be raised up to $100,000. Note: A veteran cannot have a veteran’s exemption and a homeowner’s property tax exemption on the same property.
Documentary transfer tax on San Diego, California real estate
Paid only on the new amount of money (cash down and new financing), not on any assumed financing. The DOCUMENTARY TRANSFER TAX is a tax that is applied to the consideration paid or money borrowed when transferring San Diego, California real estate, except for any remaining loans or liens on the property. This tax is computed at the rate of 55 cents for each $500 of consideration or any fraction thereof that exceeds $100. The consideration is any amount of cash payment plus any new loans. However, this tax does not apply to any liens or encumbrances that remain on the property as part of the transfer. If a house were sold for $230,000 and a buyer assumed the old loan of $30,000, the documentary transfer tax would be $220.
$200,000
———– x $.55 = $220
$500
The documentary transfer tax is charged to the seller and is handled as part of the escrow. If any old loans or liens are to remain on the property, this fact must be stated on the deed or on a separate paper filed with the deed. Then add the value of the cash down payment and any new loans together with any remaining loan on the property to find the total selling price.
Delinquent tax sale of San Diego, California real estate
Each year, on or before June 8th, the county tax collector publishes a list of tax delinquent San Diego, California real estate. This is his or her “notice of intent to sell” all such properties on which the property taxes have not been paid for one year. Strictly speaking, this is not a true sale, but is a formality that starts a five year redemption period. If the property is not redeemed within five years, it will be deeded over to the state.
Real estate may be redeemed upon the payment of taxes, interest, costs and redemption penalties. The tax collector gives a receipt called a “certificate of redemption” as evidence of payment. If the owner cannot pay for all past due taxes and costs at once, he or she may pay them in five annual installment payments, providing all current taxes are paid.
If taxes are not paid on or before June 30s, the property is sold to the state. This sale starts the running of the redemption period which is five years.
Second sale (after five years)
After five years, if the property has not been redeemed, the delinquent property is deeded to the state. This is the official sale, and the former owner may now only redeem the property if the state has not sold the property at public auction.
Although property taxes are not paid, an owner can remain in possession and could redeem for 5 years.
Sale to the public
The county tax collector will sell the state-owned real estate to other taxing agencies or to the highest bidder at a public tax auction. The minimum bid is established by the tax collector and approved by the county board of supervisors. All such sales are for cash at the time of the sale. The purchaser then receives a tax deed. Most title insurance companies will insure the tax deed sale after one year has elapsed. But, if any difficulties are encountered, the buyer may clear title through a “quiet title” court action.
Conditions that restrict a fee estate (fee simple defeasible estate) for San Diego, CA real estate
If there are conditions to the property’s use, it is a FEE SIMPLE DEFEASIBLE ESTATE. Breaking any condition of the transfer may be grounds for terminating or revoking the property transfer. The transfer can be undone (“defeased”) and would revert to the grantor or the grantor’s heirs. There are two categories of conditions:
- condition precedent
- condition subsequent.
A CONDITION PRECEDENT is an event that must happen before San Diego, CA real estate can be transferred. For example, a property owner will give the city a parcel if the city agrees to build a college on the site. In such a case, if the city did not agree, the owner would not transfer the property. A CONDITION SUBSEQUENT is an event that happens after (in the future) the property is transferred that causes the property to revert (go back) to the grantor. The above example could become a condition subsequent by stating that “if actual construction of the college has not started within five years, the property will revert to the grantor.”A “fee simple defeasible estate” is an estate that can be defeated if a condition placed upon the estate is violated in the future (condition subsequent). For example, if a person takes title subject to a condition that liquor not be served on the promises, and then turns around and breaks this promise, the previous title holder has grounds to reclaim title through a court action. A fee simple defeasible estate, with a condition (precedent or subsequent) hanging over it, has less value than a fee simple estate.
PROTECTION AGAINST FRAUD DURING THE SALE OF SAN DIEGO HOMES
A lawyer’s most important role in the selling of San Diego homes might be keeping clients out of hot water somewhere en route to the closing. There are a handful of attorneys whose tremendous knowledge qualifies them as good real estate negotiators. Unless you have this kind of attorney – chances are you do not – let your attorney deal with the legal questions of the documents you are about to sign, not the business questions. Do let your attorney handle communications with your buyer’s attorney. You should not be involved in direct talks with someone else’s lawyer. Your own lawyer can give you the instructions you need. In general, attorneys kill more deals than they save. So keep your attorney’s focus where it belongs – on the legal aspects of the deal.
HOW ELSE CAN A LAWYER HELP A SELLER?
For starters, lawyers are good at putting pressure on a bank to expedite your loan. Untangling the complications caused by divorce and the subsequent sale of jointly owned property calls for a lawyer too. Under normal conditions on a $400,000 house, with the buyer putting $50,000 as a down payment, a bank would give the buyer an $350,000 mortgage. The bank would then turn over the cash to the seller. With a divorce situation, the divorcing husband and wife each would walk away with $175,000 in cash. But what if the two of them disagree? Perhaps the house was his, or hers, before the marriage. Perhaps he, or she, did major remodeling after the breakup. These issues crop up time and time again. Who is entitled to what, and for how much? When these are in question during the sale of San Diego homes, transactions can be held up until lawyers steps in to mediate.
WHEN YOU ARE BUYING AND SELLING SAN DIEGO, CA HOMES AT THE SAME TIME
One day a woman called me saying her husband had just been notified that he was being promoted to a new assignment in his company’s headquarters in the southern part of San Diego county. Her assignment: to sell their home in the north county and buy a new one within 90 days. How was she supposed to go about it? Her situation was one with which many of us are familiar, since few of us buy or sell a home in a vacuum. Commonly, we sell our current house – or think we need to sell it – because we are buying another. There are special problems associated with doing both at the same time. For people like these folks, driving around or being taken around by a broker day after day can become exhausting. After a while, you become bleary-eyed from viewing too many San Diego, CA homes in too short a time. That can be an uncomfortable, blurred viewpoint from which to make a decision as important as buying a home. Take a deep breath, stop peeking at your watch, and relax. You have more time than you think. “Unless you are moving from a very hot real estate market to a very slow market, your best bet, right off the bat, is to put your current house on the market and rent a place,” I told the woman. Most of the real estate industry disagrees with this philosophy because it does not sell enough homes. Still, it is silly (and fiscally harmful) to sell in a panic for too low a price.
THE “RENT” APPROACH
The rent approach is one I recommended to another couple from San Diego. You can use the same questions I put to them to decide if it is the proper one for you. In a few months, the two of them, both in their thirties, were transferring. Should they sell? Buy? Rent?
There are many people who wish they had kept their first two or three homes they owned. Today, those places are probably worth a lot more. So if you can get a good licensed, bonded property manager, I would keep the California home. The manager would charge between 3 and 6 percent of the rent a month to handle the affairs of the house. How could they be better off financially holding on to the property? A survey indicated that residential real estate in that area was appreciating at 9 to 11 percent per year. In 10 years their house would be worth twice the current worth.
Property of San Diego, Ca real estate
Proration question: Who owes whom how much?
If the seller of San Diego, Ca real estate has paid both the 1st and 2nd installments of the property taxes for a total annual bill of $2,760, what is the proration of property taxes for both the seller and buyer if the buyer takes possession on May 1st?
Remember: Escrow prorates property taxes using old (seller’s) assessed value (tax bill).
The first step is to determine the amount of taxes per month. The annual tax bill of $2,760 is divided by 12 months to determine that the monthly tax is $230. Since the seller paid the property taxes through the month of June (the end of the fiscal tax year, which is July 1st through June 30th), and the buyer took possession on May 1st, two months of paid property taxes are owed the seller. The buyer would owe the seller for two months (May and June) that were already paid by the seller. This amount would be $460 (2 X $230).
When a property is sold, the buyer will receive one new property tax bill, but it may be followed by other updated property tax bills, referred to as supplemental property tax bills.
Income Taxes on San Diego, California real estate
In this day and age, income taxes play an important role in real estate owners’ decisions, from buying or selling their personal residences to decisions involving the most exotic San Diego, California real estate investment properties. Because the tax laws are always changing, it is important to stay abreast of them. Some basic tax definitions and calculations stay the same from law change to law change. We will discuss income taxes as they relate to business and investment property as well as to a personal residence.
San Diego real estate held for business and investment has some distinct differences in federal income tax treatment from property used as a personal residence. We will begin with the concept of depreciation.
Depreciation
The two most obvious and important characteristics of real estate investments are income and expenses. San Diego real estate is one of those assets that benefit from a special accounting device for a special kind of expense called depreciation.
Depreciation is a method of accounting for the wear that results from the use of a capital good. A capital good, such as a piece of equipment or a building, does not last forever. As it is used, it wears out or becomes obsolete; at some point the owner must replace it or substantially repair it. Depreciation is used to reflect this replacement cost. The main reasons depreciation is allowed are to encourage investment in real estate and to reflect, in accounting terms, the real costs of property ownership. Only investment or income property may benefit from depreciation. (Today we use a recovery system instead of depreciation, but the word depreciation has been around for so long that it is still used.)
For depreciation purposes real estate can be divided into two categories:
- Residential property
- Nonresidential property
Residential property is where people live – for example, single-family residences, duplexes, triplexes, fourplexes and multiunit apartments. Nonresidential property is property that is not residential in nature – for example, industrial, commercial, and office buildings and other similar types of properties. Since January 1, 1987, all real property must use the straight-line method of depreciation.
Generally, residential rental property must use a useful life of 27.5 years and nonresidential property must use a useful life of 39 years. Either residential or nonresidential property may elect to use 40 years.
To explore the tax implications of investment properties, one must understand the concept of basis and know how to compute the original basis, depreciable basis and adjusted basis correctly. The original basis (OB) is used to determine the depreciable basis and adjusted basis. The depreciable basis (DB) is used to determine the amount of allowable depreciation. The adjusted basis (AB), which changes as time progresses, is required to calculate the gain on the disposition of a property.
Original basis
The original basis of a property is the sum of its purchase price and the buying expenses on acquisition. When a buyer purchases San Diego real estate, the escrow statement includes the sale price and a listing of other costs and expenses. These amounts can be classified into four basic groups:
- Purchase price (PP)
- Operating expenses (OE)
- Buying expenses (BE) (nonrecurring closing costs)
- Nondeductible items (ND) such as impound accounts
The purchase price
The purchase price (PP) is the amount the buyer is willing to pay and the seller is willing to accept in payment for the property. On the escrow statement the PP usually is on the top line and is called total consideration. Generally, the PP is financed in some manner. These loans do not affect the basis. Furthermore, if the buyer takes out a new loan, refinances or takes out a second mortgage, these loans also do not increase the basis.
Operating expenses
Operating expenses (usually recurring costs such as interest, insurance and taxes) are written off against the income produced by the property. Points (loan origination fees) are nonrecurring interest costs that are amortized over the life of the loan; they are not operating expenses.
Buying expenses
Buying expenses are defined as nonrecurring escrow costs (excluding points to obtain a loan). The buying expenses are added to the purchase price, making up the original basis. Points are never added to the basis.
Original basis = Purchase price + Buying expenses
Depreciable Basis
The depreciable basis is defined as the original basis multiplied by the percentage of improvements to land.
Depreciable basis = Original basis x Percentage of improvements to land
An alternative formula is Depreciable basis = Original basis – Land value
