Hammer Sells Homes - Puget Sound Blog

July 8, 2020

Taking Advantage of Homebuying Affordability in Today’s Market

 

Taking Advantage of Homebuying Affordability in Today’s Market | MyKCM

Everyone is ready to buy a home at different times in their lives, and despite the health crisis, today is no exception. Understanding how affordability works and the main market factors that impact it may help those who are ready to buy a home narrow down their optimal window of time to make a purchase.

There are three main factors that go into determining how affordable homes are for buyers:

  1. Mortgage Rates
  2. Mortgage Payments as a Percentage of Income
  3. Home Prices

The National Association of Realtors (NAR), produces a Housing Affordability Index, which takes these three factors into account and determines an overall affordability score for housing. According to NAR, the index:

“…measures whether or not a typical family earns enough income to qualify for a mortgage loan on a typical home at the national and regional levels based on the most recent price and income data.”

Their methodology states:

“To interpret the indices, a value of 100 means that a family with the median income has exactly enough income to qualify for a mortgage on a median-priced home. An index above 100 signifies that family earning the median income has more than enough income to qualify for a mortgage loan on a median-priced home, assuming a 20 percent down payment.”

So, the higher the index, the more affordable it is to purchase a home. Here’s a graph of the index going back to 1990:Taking Advantage of Homebuying Affordability in Today’s Market | MyKCMThe green bar represents today’s affordability. We can see that homes are more affordable now than they have been at any point since the housing crash when distressed properties (foreclosures and short sales) dominated the market. Those properties were sold at large discounts not seen before in the housing market.

Why are homes so affordable today?

Although there are three factors that drive the overall equation, the one that’s playing the largest part in today’s homebuying affordability is historically low mortgage rates. Based on this primary factor, we can see that it is more affordable to buy a home today than at any time in the last seven years.

If you’re considering purchasing your first home or moving up to the one you’ve always hoped for, it’s important to understand how affordability plays into the overall cost of your home. With that in mind, buying while mortgage rates are as low as they are now may save you quite a bit of money over the life of your home loan.

Bottom Line

If you feel ready to buy, purchasing a home this season may save you significantly over time based on historic affordability trends. Let’s connect today to determine if now is the right time for you to make your move.

July 6, 2020

Interest Rate Update: Week of July 6th

Good Monday Morning!

 

The June Employment Report came out last Thursday and was very positive. There were 4.8M jobs created in June on expectations of 3M. The Unemployment Rate dropped to 11.1% on expectations of 12.3%. The Manufacturing sector created 365,000 new jobs which is a particularly good sign for the economy as we begin the 3rd Quarter. One area of caution in the Jobs Report is the fact that 40% of the new jobs were in the hospitality industry which is particularly vulnerable to a potential pull-back in reopening plans for states across the US as we see a resurgence in COVID-19 cases. This is a very light week for domestic economic news. We can expect interest rates to stay at current levels. Have a great week!

 

 

Information for this post provided by:  

George Lane

Sales Manager

2006 65th Avenue W

Fircrest, WA 98466

O: 253-460-6200 | M: 253-209-1895

 NMLS #374974 | Company NMLS #3274

Equal Housing Lender

www.​guildmortgage/georgelane 

July 1, 2020

What Are Experts Saying About the Rest of 2020?

 

What Are Experts Saying About the Rest of 2020? | MyKCM

One of the biggest questions on everyone’s minds these days is: What’s going to happen to the housing market in the second half of the year? Based on recent data on the economy, unemployment, real estate, and more, many economists are revising their forecasts for the remainder of 2020 – and the outlook is extremely encouraging. Here’s a look at what some experts have to say about key areas that will power the industry and the economy forward this year.

Mortgage Purchase Originations: Joel Kan, Associate Vice President of Economic and Industry ForecastingMortgage Bankers Association

“The recovery in housing is happening faster than expected. We anticipated a drop off in Q3. But, we don’t think that’s the case anymore. We revised our Q3 numbers higher. Before, we predicted a 2 percent decline in purchase originations in 2020, now we think there will be 2 percent growth this year.”

Home Sales: Lawrence Yun, Chief Economist, National Association of Realtors

“Sales completed in May reflect contract signings in March and April – during the strictest times of the pandemic lock down and hence the cyclical low point...Home sales will surely rise in the upcoming months with the economy reopening, and could even surpass one-year-ago figures in the second half of the year.”

Inventory: George Ratiu, Senior Economist, realtor.com

“We can project that the next few months will see a slow-yet-steady improvement in new inventory...we projected a stepped improvement for the May through August months, followed by a return to historical trend for the September through December time frame."

Mortgage Rates: Freddie Mac

“Going forward, we forecast the 30-year fixed-rate mortgage to remain low, falling to a yearly average of 3.4% in 2020 and 3.2% in 2021.”

New Construction: Doug Duncan, Chief Economist, Fannie Mae

“The weaker-than-expected single-family starts number may be a matter of timing, as single-family permits jumped by a stronger 11.9 percent. In addition, the number of authorized single-family units not yet started rose 5.4 percent to the second-highest level since 2008. This suggests that a significant acceleration in new construction will likely occur.”

Bottom Line

The experts are optimistic about the second half of the year. If you paused your 2020 real estate plans this spring, let’s connect today to determine how you can re-engage in the process.

June 29, 2020

Interest Rate Update: Week of June 29th

Good Monday Morning!

Interest rates are unchanged from last week as the bond markets have held steady while the stock markets experienced quite a bit of volatility. The stock and bond markets will close early on Thursday and remain closed on Friday for the July 4 holiday weekend. Most lenders will be conservative with their pricing on Thursday ahead of the long weekend. We have a lot of economic data packed into three days this week. Tuesday brings April S&P Case-Shiller Home Price Index, June Chicago PMI, and June Consumer Confidence as well as Fed Chair Powell testifying before the House Financial Services Committee on the CARES Act. On Wednesday we’ll get the Weekly MBA Mortgage Index, June ADP Employment Change, May Construction Spending, the June ISM Manufacturing Index, and the minutes from the June 9 / 10 FOMC meeting. On Thursday, we’ll see the June Payrolls report, May's Trade Balance, weekly jobless claims, and May Factory Orders. That’s a lot of data to digest. This could be a volatile week for the stock markets. Mortgage bonds should hold pretty steady until Thursday. If the Jobs Report surprises to the positive, we could see a jump in interest rates heading into the long weekend.

Have a great week!

Information for this post provided by:  

George Lane

Sales Manager

2006 65th Avenue W

Fircrest, WA 98466

O: 253-460-6200 | M: 253-209-1895

 NMLS #374974 | Company NMLS #3274

Equal Housing Lender

www.​guildmortgage/georgelane 

 

June 24, 2020

Should We Be Looking at Unemployment Numbers Differently?

Should We Be Looking at Unemployment Numbers Differently? | MyKCM

The New York Times recently ran an article regarding unemployment titled: Don’t Cheer Too Soon. Keep an Eye on the Core Jobless Rate. The piece suggests we should look at unemployment numbers somewhat differently. The author of the article, Jed Kolko, is a well-respected economist who is currently the Chief Economist at Indeed, the world’s largest online jobs site. Previously, he was Chief Economist and VP of Analytics at Trulia, the online real estate site.

Kolko suggests “the coronavirus pandemic has broken most economic charts and models, and all the numbers we regularly watch need a closer look.” He goes on to explain that the decline in the unemployment number reported by the Bureau of Labor Statistics (BLS) earlier this month was driven by a drop in temporary layoffs. If we strip those out, we’re left with what Kolko calls the core unemployment rate. Many economists have struggled with how to deal with the vast number of temporary layoffs, as a complete shutdown of the economy has never happened before. As the article states, in the last unemployment report:

“73 percent of all unemployed people said they were temporarily unemployed, which means they had a return-to-work date or they expected to return to work in six months. Before the pandemic, temporary unemployment was never more than one-quarter of total unemployment.”

The core unemployment rate handles this issue and also deals with another concern economists have discussed for years: the exclusion of the marginally attached. These are people who are available and want to work, but count as out of the labor force rather than unemployed because they haven’t searched for work in the past four weeks.

Kolko’s core rate does three things:

  1. Takes out temporary unemployment
  2. Retains the rest of the standard unemployment definition: permanent job losers, job leavers, and people returning to or entering the labor force
  3. Adds in the marginally attached

Removing the temporarily unemployed makes sense according to the article:

“Initial pandemic relief efforts focused on money for people to manage a temporary loss of income and funds to keep businesses afloat until they could bring their workers back. The hope and the goal is for the temporarily unemployed to return to their old jobs, rather than have them lose their jobs and have to search for new ones when jobs have become scarcer.”

The Bad News and the Good News

Clearly, the adjustments Kolko makes dramatically impact the way we look at unemployment. The bad news is, using his core rate, there was an increase in unemployment from April to May. The conventional rate reported by the BLS showed a decrease in unemployment.

The good news is that the core rate compares more favorably to the last recession in 2008. Here’s the breakdown:Should We Be Looking at Unemployment Numbers Differently? | MyKCM

Bottom Line

The unemployment rate is a key indicator of how the economy is doing. Heading into a highly contested election this November, the BLS report releasing next week will be scrutinized like no other by members on both sides of the aisle. Mr. Kolko’s take is just one additional way to evaluate how unemployment is impacting American families.

Posted in Economics
June 22, 2020

Interest Rate Update: Week of June 22nd

Good Monday Afternoon!

Last week the bond markets held steady throughout the week and we saw very little change to interest rates. This week is pretty quiet for economic news as well. The Fed has committed to buying mortgage bonds through the middle of 2021 so we can expect to see these low rates for another year. Good news for buyers! Enjoy the week, lots of sunshine!

Interest Rates: Monday, June 22, 2020

 

 

 

Based on a loan amount of $200,000 and

 

 

minimum credit score of 740

   

 

 

 

This Week

 

Last Week

 

Program

Term

Int. Rate

APR

Int. Rate

APR

FHA

30 Yr

3.625%

4.740%

3.625%

4.730%

FHA

15 Yr

3.000%

4.190%

3.000%

4.160%

VA

30 Yr

3.625%

3.930%

3.625%

3.920%

VA

15 Yr

3.000%

3.560%

3.000%

3.530%

Conv - 95 LTV

30 Yr

3.500%

4.100%

3.500%

4.110%

Conv - 95 LTV

15 Yr

2.875%

3.800%

2.875%

3.780%

Conv - 80 LTV

30 Yr

3.500%

3.640%

3.500%

3.630%

Conv - 80 LTV

15 Yr

2.875%

3.120%

2.875%

3.100%

 

 

A little old lady answered a knock on the door one day, and was confronted by a well-dressed young man carrying a vacuum cleaner.

"Good morning," said the young man. "If I could take a couple minutes of your time, I would like to demonstrate the very latest in high-powered vacuum cleaners..."

"Go away!" cried the old lady. "I'm broke and haven't got any money!" and she proceeded to close the door.

Quick as a flash, the young man wedged his foot in the door and pushed it wide open.

"Don't be too hasty!" he said. "Not until you have at least seen my demonstration!"

And with that, he emptied a bucket of horse manure onto her hallway carpet.

"Now, if this vacuum cleaner does not remove all traces of this horse manure from your carpet, Madam, I will personally eat the remainder."

The old lady stepped back and said, "Well you just stay right there while l get you a fork, cuz they cut off my electricity this morning."

 

Information for this post was provided by:

 

George Lane

Sales Manager

2006 65th Avenue W

Fircrest, WA 98466

O: 253-460-6200 | M: 253-209-1895

 NMLS #374974 | Company NMLS #3274

Equal Housing Lender

www.​guildmortgage/georgelane 

 

 

 

June 17, 2020

Summer is the New Spring for Real Estate

 

Summer is the New Spring for Real Estate [INFOGRAPHIC] | MyKCM

Let’s connect today to prepare your house for the sizzling summer market!

Posted in Selling Homes
June 11, 2020

Getting Your Home Ready for Inspection Day

The Inspection-ready Home

An inspection-ready home presents itself best for evaluation and helps the entire process go more smoothly. Pillar To Post Home Inspectors recommends sellers take these steps prior to the home inspection:
ACCESS
  • Provide keys to any locked areas.
  • Allow access to the attic, basement or crawlspace, garage, and yard.
  • Make sure our inspector will be able to readily access:
  • The electrical panel
  • Main water shutoff
  • Water heater
  • Furnace
  • Central AC unit
  • Gas meter
GENERAL INFORMATION
  • Sellers should plan to be away from the home for the duration of the inspection, which is typically 2-1/2 to 3 hours. It may take longer if the home is very old or very large.
  • Store small valuables and medications out of sight and in a safe location or consider taking these items with them when they leave.
  • Remove pets or keep them safely crated.
  • Provide copies of records/warranties for any major improvements – furnace, roof, etc. to show when the work was completed.

Shane

Shane Klinkhammer
REALTOR®
RE/MAX Northwest Realtors
M: 253-227-1609

www.hammersellshomes.com
Let's connect on Facebook

Five Star Zillow Agent

2017-2020 RE/MAX Top Producer

Top 1% Producer of Pierce & Thurston Counties

2019 - RE/MAX Hall of Fame & Platinum Club
2018 - RE/MAX Platinum Club

4801 S. 19th St, Suite 200

Tacoma, WA 98405

 

 

This post was graciously provided to us by:

Brendan Marchant
360-753-5025  pillartopost.com
Posted in Selling Homes
June 10, 2020

The Benefits of Homeownership May Reach Further Than You Think

 

The Benefits of Homeownership May Reach Further Than You Think | MyKCM

More than ever, our homes have become an integral part of our lives. Today they are much more than the houses we live in. They’re evolving into our workplaces, schools for our children, and safe havens that provide shelter, stability, and protection for our families through the evolving health crisis. Today, 65.3% of Americans are able to call their homes their own, a rate that has risen to its highest point in 8 years.

June is National Homeownership Month, and it’s a great time to reflect on the benefits of owning your own home. Below are some highlights and quotes recently shared by the National Association of Realtors (NAR). From non-financial to financial, and even including how owning a home benefits your local economy, these items may give you reason to think homeownership stretches well beyond a sound dollars and cents investment alone.

Non-Financial Benefits

Owning a home brings families a sense of happiness, satisfaction, and pride.

  • Pride of Ownership: It feels good to have a place that’s truly your own, especially since you can customize it to your liking. “The personal satisfaction and sense of accomplishment achieved through homeownership can enhance psychological health, happiness and well-being for homeowners and those around them.”
  • Property Maintenance and Improvement: Your home is your stake in the community, and a way to give back by driving value into your neighborhood.
  • Civic Participation: Homeownership creates stability, a sense of community, and increases civic engagement. It’s a way to add to the strength of your local area.

Financial Benefits

Buying a home is also an investment in your family’s financial future.

  • Net Worth: Homeownership builds your family’s net worth. “The median family net worth for all homeowners ($231,400) increased by nearly 15% since 2013, while net worth ($5,000) actually declined by approximately 9% since 2013 for renter families.”
  • Financial Security: Equity, appreciation, and predictable monthly housing expenses are huge financial benefits of homeownership. Homeownership is truly the best way to improve your long-term net worth.

Economic Benefits

Homeownership is even a local economic driver.

  • Housing-Related Spending: An economic force throughout our nation, housing-related expenses accounted for more than one-sixth of the country’s economic activity over the past three decades.
  • GDP Growth: Homeownership also helps drive GDP growth as the country aims to make an economic rebound. “Every 10% increase in total housing market wealth would translate to approximately $147 billion in additional consumer spending, or 0.8% of GDP, as well as billions of dollars in new federal tax revenue.”
  • Entrepreneurship: Homeownership is even a form of forced savings that provides entrepreneurial opportunities as well. “Owning a home enables new entrepreneurs to obtain access to credit to start or expand a business and generate new jobs by using their home as collateral for small business loans.”

Bottom Line

The benefits of homeownership are vast and go well beyond the surface level. Homeownership is truly a way to build financial freedom, find greater satisfaction and happiness, and make a substantial impact on your local economy. If owning a home is part of your dream, let’s connect today so you can begin the homebuying process.

Posted in Buying Homes, Economics
June 8, 2020

Tax Matters and Sales of Residences

The topic this week is tax matters!

We are not talking here about any huge new law, but refreshing all my readers’ memories of a law that was (and is) very favorable to many of your customers, but has been of little or no consequence during the past Recession, now long before our current COVID situation. It regards capital gains taxes and primary residences. I know I have your attention now as this affects all of you and most of your customers as we have had a huge increase in market values since that last recession.

You may want to save this information in your library as the first part DOES go over, in pretty good detail, the actual rules, but there were a few changes that occurred as late as “The Housing Assistance Tax Act of 2008” that are probably new to most of my readers as we were all focused on other matters back in 2008-2014. Listen up, if you rent out your properties at some point in time as these rules (well, new as of 2008) can affect how much capital gains tax exclusion you can take if you have a property with what we called “blended-use” that is partly owner-occupied and partly non-owner occupied property.

 

THIS HOMEOWNER EXEMPTION IS BETTER THAN SLICED BREAD…

The exclusion of up to $500,000.00 of capital gains tax as a result of the sale of one’s primary residence can be a great tax benefit to homeowners especially since they only use the exemption a few times during their lives.

We, as real estate professionals, ALWAYS need to encourage all of our customers to seek legal or tax advice as all areas of taxation are complicated and there can be traps for the unwary. The goal of this article is to address some of those traps.

 

LET’S TALK ABOUT THOSE WHO INVEST IN REAL ESTATE…IS THAT POSSIBLY YOU?

For those who invest in real estate, this special tax code creates potentially wonderful tax planning opportunities. Imagine if you will, you want to convert your rental property into a primary residence in an attempt to take advance of the primary residence tax exclusion and preclude, not only the capital gains as the property was held as an investment but to tack on along the time period of the primary residence holding. When combined with the fact that this exemption can be used every two (2) years, this could be wonderful for you as a property investor.

Sorry. You weren’t the first to look at this opportunity. In fact, this whole scenario goes back many years ago when this whole exemption came into being. However, there are still opportunities but read on. Congress has made some changes:

A. They in the past did preclude depreciation recapture from being eligible for favorable homeowner exemption treatment.

B. They required a longer holding period (5 years) in a Section 1031 tax-deferred exchange for those parties who converted the use of their investment property.

C. More recently back in 2008, Congress has forced gains to be allocated between periods of “qualifying” use and periods of “non-qualifying” use of the property.

 

THE NUTS AND BOLTS OF THE HOMEOWNER EXEMPTION…(SECTION 121 OF THE TAX CODE)…

Let's talk about the basic rules of the homeowner's exemption. It was created in 1997 by Congress. No longer do we have to buy a new property [That was an old law]. No longer do we have a once in a life-time $125K exemption [That is also old law]. Our current law is called: “The Taxpayer Relief Act of 1997” and has been modified ever since then.

There are lots of special rules within it and the devil can be in the details. The Publication from the IRS for the layman is not a walk in the park, but PUBLICATION 523 can be a great help to understand some of the nuances. Just Google Publication 523 and you can download and print it out. Again, this short article does NOT replace a good consultation with a tax attorney.

That Act allows a homeowner (individual) to exclude up to $250K of capital gain on the sale of a primary residence ($500K for a married couple), so long as the property was owned and the party used the property as their primary residence for at least two (2) of the previous five (5) years.

 

PRACTICE POINTER: Keep in mind that BOTH SPOUSES don’t have to own the house even though this is a community property state. One of the two can own, but BOTH must live at that property to qualify for the $500K exclusion. Isn’t that cool?

One does not have to occupy the property at the time of sale. It is just 2 of the last 5 years. In other words, the time does not need to be even continuous. We just need 720 days in the last 5 years to qualify. If one moves out after qualifying for the initial two (2) years, then one has three (3) years to then sell the property and take advantage of the exclusion rule. Make sure you understand this clearly as it creates many misunderstandings among professionals and homeowners alike.

 

PRACTICE POINTER: If you do not meet the two (2) year rule, still talk with your tax counsel as you can get a partial prorated exemption if a change in place of employment, change in health, or “unforeseen circumstances” all of which require a tax attorney or tax counsel to review and advise. As the economy improves folks, sellers will soon again be experiencing this type of issue.

 

LIMITATION ON USE OF THE EXEMPTION…ONCE EVERY TWO YEARS…

This exemption can be used once every two (2) years. Remember, so long as the requirement is met there is no limit to the number of times an individual can use that exemption during his or her life. I wonder how many of our customers out there want to move every two years?



VARIATION ON THE THEME…WHAT ABOUT RENTAL PROPERTY?

Most of our customers are not real estate investors. They use this tax savings tool as they move through their life growing a family and later getting smaller as their families mature and move on. During the “good times of rapid appreciation” prior to the recession, many of my clients would “buy up” over time and take advantage of this exemption over and over again. Remember that this is an EXEMPTION and not a deferral. You don’t have to account for that accrued gain afterward as you do in a tax-deferred exchange.

Those same people would many times also own rental property and would creatively attempt to move into their rental property taking advantage of the holding period and then excluding ALL of the gain (not only the gain while they lived in the property as well as the gain while it was used as an investment property). Pretty great ideas!!!! In addition, because of depreciation, the gains in the investment part would generally accrue faster and thus a pretty good bang for their tax savings buck if they could pull it off!

 

WHAT IS TOO GOOD TO BE TRUE IS GENERALLY TOO GOOD TO BE TRUE…ALONG COMES CONGRESS…

Over a period of time, Congress modified Section 121 (the residence exemption rule) to limit those strategies. The initial rule eliminated the exemption to apply to any gains attributable to depreciation taken on the property when it wasn’t being used as a primary residence. This came into effect on May 6th, 1997 when the original exclusion rule came into effect. So even if you have a blended property and you meet the two-year residence rule, that portion of the capital gains that were attributable to depreciation taken would be subject to recapture at generally 25% rates. However, one must read on.

 

IN 2008, CONGRESS PASSED FURTHER LIMITATIONS…HOUSING ASSISTANCE TAX ACT OF 2008…

So we have to read what happened above and understand that in 2008 Congress further limited the use of this wonderful exemption (in Section 121(b)(4)) specified that the exemption was only available when we have the property ACTUALLY used as a primary residence. The date of that Act is January 1st, 2009.

So this is interesting. Congress deemed all gains were occurring pro-rata during the whole period of ownership whether owner-occupied or not. Periods, when the property was owner-occupied, are “qualifying”. Periods, when used for investment, were “non-qualifying”. Non-qualifying gains are not exempt!

LET’S TALK ABOUT THIS WHOLE SUBJECT AND TAX DEFERRED EXCHANGES…

Now tax exchanges are back in full swing. This issue of blended property or converting rental property or investment property into a primary residence is a big issue for discussion. Folks this is huge.

 

Notably, there is an additional “anti-abuse” rule that applies to rental property converted to a primary residence that was previously subject to a 1031 exchange. For instance, let’s imagine a situation where an individual completes a 1031 exchange of a small apartment building into a single-family home; rents the single-family home for a period of time; then moves into the single-family home as a primary residence; and ultimately sells it (trying to apply the primary residence capital gains exclusion to all gains cumulatively back to the original purchase, including gains that occurred during the time it was an apartment building!). Does this sound like you?

To limit this activity, Congress created “The American Jobs Creation Act of 2004” (now IRC Section 121(d)) affecting specifically tax-deferred exchanges. That Act stipulates the capital gains exclusion on a primary residence that was previously part of a 1031 exchange is only available if the property has been held for 5 years since the exchange.

The strategy to exchange an investment rental for a new investment rental in a location where you may wish to retire takes some advance planning but will maximize your tax savings in the end. When one exchanges their current investment rental property into a new investment rental property, they defer the tax they would normally have to pay on the gain. This is reflected in the lower basis assigned to their new replacement property. This, of course, is basic Section 1031 knowledge.

When you sell your current principal residence, you may exclude the gain up to the Section 121 limits. Then, after you convert your replacement property into their new principal residence, you become eligible once again for exclusion of up to $250,000/$500,000 of gain after you have owned the replacement property as primary residence for five years. The five-year ownership rule on a principal residence only applies to properties that have come to you from an exchange. Capital gains tax will be due on gains above the Section 121 limits and any depreciation taken (that is “recapture) after May 6, 1997.

If you just acquired a property by doing a like-kind exchange, you must hold the new property as an investment, rental, or business property in order to qualify for the exchange itself. We look at the facts and circumstances surrounding the exchange at the time of the acquisition. No one can tell you how long the exchange replacement property must be held in investment status before you convert it to personal use, but most attorneys recommend not less than two (2) years. IRS issued Revenue Procedure 2008-16 which defines a safe harbor and includes a two-year holding period of limited personal use and a rental period if you want to be safe.

Another issue we need to revisit in relation to tax-deferred exchanges is that effective January 1, 2009, the IRS Section 121 was changed to require parties whether inside or outside an exchange to allocate gain based upon use. Before the President signed H.R. 3221, the Housing Assistance Tax Act of 2008, on July 30, 2008, a revenue-raising provision first promoted by Representative Charlie Rangel (D, N.Y.) was included by the conference committee as Section 3092 of the bill. This provision was an amendment to Section 121 and has had a major impact on small landlords and taxpayers who were planning to convert their rental or second home to a principal residence and then exclude any gain from their income when they sell the property.

The term “Period of Non-Qualified Use” referenced in the amendment is very important and means any period during which the property is not used as the principal residence of the taxpayer, the taxpayer’s spouse, or a former spouse. Importantly, the period before January 1, 2009, is excluded. January 1, 2009, is the date upon which this statute became law.

In addition, subsection (4)(C)(ii) of the amendment provides additional exceptions to the Period of Non-Qualified Use. These exceptions are (1) any portion of the five-year period (as defined in Section 121(a)) which is after the last date that such property is used as the principal residence of the taxpayer or spouse, (2) any period not exceeding 10 years during which the military or foreign service taxpayer, or spouse, is serving on qualified official extended duty as already defined, and (3) any other period of temporary absence (not to exceed a total of two years) due to change of employment, health conditions, or such other unforeseen circumstances as may be specified by the HUD Secretary.

The amendment states “gain shall be allocated to periods of non-qualified use based on the ratio which (i) the aggregate periods of nonqualified use during the period such property was owned by the taxpayer, bears to (ii) the period such property was owned by the taxpayer.”

How does this affect your planning?

EXAMPLE FOR ILLUSTRATION: Suppose the married taxpayer exchanged into an investment property and rented it for four years. They moved into it at that time and lived in it for two additional years. The taxpayer then sold the residence and realized $300,000 of gain.

Under prior law, the taxpayer would be eligible for the full exclusion and would pay no tax. Under the new law, the exclusion will have to be prorated as follows: four-sixths (4 out of 6 years) of the gain, or $200,000, would be taxable and thus would be ineligible for the exclusion. Two-sixths (2 out of 6 years) of the gain, or only $100,000, would be eligible for the exclusion.

Importantly, non-qualified use prior to January 1, 2009, is not taken into account in the allocation for the non-qualified use period but is taken account for the ownership period.

EXAMPLE FOR ILLUSTRATION: Suppose the taxpayer had exchanged into the property in 2007, and rented it for three years until 2010, and then converted the property into a primary residence. If the taxpayer sold the residence in 2013, after three years of primary residential use, only one year of rental, 2009, would be considered in the allocation for the non-qualified use. Thus, only one-sixth (1 out of 6 years) of the gain would be ineligible for the exclusion. Why? The period before 2009 is not counted as the law was not in effect until 2009.

 

SPECIAL RULES FOR PRIMARY RESIDENCE CONVERTED TO RENTAL PROPERTY

In general, the allocation rules only apply to time periods prior to the conversion into a principal residence and not to all-time periods after the conversion out of personal residence use. Thus, if you convert a primary residence to a rental and never move back in, but otherwise meets the two-out-of-five year test under Section 121, the taxpayer is eligible for the full exclusion when the rental is sold. This rule only applies to non-qualified use periods within the five-year look-back period of Section 121(a) after the last date the property is used as a principal residence. The rule allows the taxpayer to ignore any of the non-qualifying use that occurs after the last date the property was used as a primary residence although the 2 out of the last 5 rules must be satisfied.

EXAMPLE FOR ILLUSTRATIVE PURPOSES: You own a primary residence. You bought it and lived in it since 2008. You get a job offer from California in 2014, but the economy is still in recession and you decide NOT to sell then but to hold on until the market improves. You rent it out in 2014 and take depreciation on the house. It is now 2015 and you want to list the property with me for sale. Can you take advantage of Section 121 or will you be a landlord or will you be required to allocate your gain?

Even though there have been one (1) or potentially two (2) years of non-qualifying use as a rental it won’t count against you and all amounts will be excludable except for depreciation recapture. Even though you do not live in the house as a primary residence, you have still used the property as a primary residence for two of the last five years (as you lived there in 2012 and 2013 before renting in 2014).

Shane

Shane Klinkhammer
REALTOR®
RE/MAX Northwest Realtors
M: 253-227-1609

www.hammersellshomes.com
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**This information is not to be used in lieu of direction by a professional real estate attorney. Most of this information was shared, with permission, from McFerran Law, P.S., and can be contacted for further discussion and representation.