Personal Finances

Will I Owe Taxes After a Short Sale?

December 5, 2011 By Jon Griffith Leave a Comment

(Please note that I am not a tax professional and you should seek the advice of a tax professional to answer tax questions.)

Here’s what I do know, and I learned this when I was a teenager working for tips at the local Pizza Hut.

When you make money, you’re responsible to report it to the IRS if your employer does not. That’s right. When they tip you, you’re supposed to report it.

When you borrow money, as in the purchase of a home or a car, a financial institution writes a check to pay for the asset and then retains the deed or title on that asset until you pay it off. If you don’t pay off the entire note, then the part that you don’t pay off, if forgiven, is viewed as income, even if it’s retro-active.

Since short sales involve such large dollar amounts, there’s no way to skirt the issue. If your lender doesn’t issue you a 1099-C (Cancellation of Debt) then you are just as responsible to report the forgiveness as income as the pizza delivery guys is responsible to report his or her tips.

Now, we all know that tips are taxable income, but what about when the bank approves a short sale?

The only answer I can actually give you is that you might be responsible for the income tax based on the forgiveness. You also might be able to write it off in accordance with the Tax Relief Act of 2007, which is expiring, by the way.

All of these are valid questions that you need to consult with your tax guy about, and make sure that you find the right tax advisor as there are plenty of “professionals” out there that don’t operate in the realm of real estate.

Filed Under: Personal Finances Tagged With: income tax, IRS, money, Tax Relief Act

Am I Liable for the Balance or Difference in a Short Sale?

February 21, 2011 By Jon Griffith 1 Comment

You’re thinking about selling your home, and you know it’s worth less than the amount you owe. You’ve heard from many people who have done it that you can simply get out of your house free and clear with no repercussions or financial consequence. You’re tempted to move forward, but you’re just not sure whether or not you should.

Some people are in a financial position that gives them no option but to move forward. Others could fulfill their obligation over time. One of the questions everyone is asking is whether or not they’ll be liable for the difference if their bank forgives them of the debt above and beyond what they can bring at sale.

This can all get a bit confusing, and there are many circumstances involved, but before I continue, I must make clear to you that some of these questions need the advice of an attorney and/or CPA, of which I am neither, and I don’t claim to know anything about the law. What I do know is what I’ve seen happen on others’ lives.

There is no simple answer, but let’s do some math and explain some of the potential consequences. Let’s make it simple. You owe $100,000.00 on a house that’s worth $80,000.00. You put it on the market, and find a buyer who is willing to pay your list price of $80,000.00. The bank agrees to the sale, and receives a net payment at close of escrow for $80,000 minus closing costs and broker commissions. For the sake of ease, let’s round it out to $5,000.

So you’ve managed to sell your home and bring a net payment of $75,000 to your lender leaving an outstanding balance of $25,000 on the original loan.

Potential Scenarios

These are some of the potential scenarios that you’ll face in the future, depending upon the conditions of your original purchase of the home, and the conditions on your lender’s agreement to sell short:

(note: In ALL cases, debt forgiveness or “cancelation” is taking place, which according to the IRS becomes reportable income [not necessarily taxable] to you.)

Your lender agrees to release the lien AND forgive you of the balance in full. They report “Paid in full for less than the amount owed” or something of that nature on your credit report, and send you a 1099-C for $25,000.00.
Your lender agrees to release the lien and leaves out any agreement to forgive the difference. The note remains, and you continue to pay it down until it’s satisfied.
Your lender agrees to release the lien and leaves out any agreement to forgive the difference, requiring you sign a promissory note for the amount owed and you pay it down over time.

These are a few of the possible scenarios on a single loan. If there are multiple loans on the property, then you’ll have varying combinations of potential outcomes. It’s key that you understand that there are 3 different issues that most people consider when going through a short sale:

a) are you liable for the difference.

b) will the debt cancellation become taxable income.

c) how will your debt history be affected (I loathe the term credit.)

Are You Liable for the Difference

I don’t know. You need to talk with an attorney to determine whether or not your lender will win if they pursue you in a lawsuit for the difference. The easy answer is, be prepared for it, cause it’s possible, even in a state with Anti-Deficiency Statutes like Arizona.

Will the Debt Cancellation become Taxable Income?

Maybe. It’s possible. But you also may be able to write it off in accordance with the Tax Relief Act of 2007. Consult your CPA.

How Will Your Debt History (Credit History) be Affected?

Let’s be real about this. Nobody in any financial sector has come to an agreement upon the standards regarding credit reporting. Everyone has their own opinion about how much it will be affected and how long it takes to heal. If you’re concerned about your credit report, consider studying a bit more about what it really means to your life, building wealth, and the future of your family’s financial tree. Credit does not define you.

Filed Under: Personal Finances Tagged With: Balance, Debt Cancellation, Potential Scenarios, Taxable Income

Right Of Passage: Why Don’t We Celebrate More?

February 21, 2011 By Jon Griffith Leave a Comment

My philosophy on money is strongly rooted in the laws of mathematics. I can form metaphors to help describe how I see money moving around in our lives, but the bottom line is this: one builds wealth by spending less than they make. It doesn’t matter if you make $10.00/hour or $200.00/hour. If you spend less than you make, you will grow your nest egg. The focus of your financial wealth is to build a nest egg that can grow itself in the amount of time you anticipate having left on this planet.

The first step one can take towards thwarting this goal is borrowing money. The largest loan that most of us ever experience is the home mortgage. The crisis that our nation has experienced over the past few years wouldn’t exist if we didn’t borrow money.

So why is it that we nurture our youth in the ways of borrowing? Why is it that parents have good intentions but seem to miss the mark more often than not when it comes to saving for our kids’ futures.

There are so many lies that we are told every day by the people around us who believe the lies themselves:

I’ll always have a car payment.
You can’t go to college without a student loan.
It’s impractical to buy a house without a mortgage.
You need a credit card to rent a car.
You need to be worried about your credit score.

Lies.

I am not under the illusion that I can change a culture with one single blog post, but I sure would like to treat homeownership differently in this country. In fact, what if…

…what if owning a home was a right of passage from youth to adult-hood? What if we didn’t encourage our children to enter into contracts with banks, and instead, taught them the power of building wealth with their income by saving, so they were able to purchase their home with cash? What if we were to teach them that it’s okay not to over-extend our wallets just because everyone else is doing it too so that they will have money when it comes time to make that big move? What if we showed them that we don’t have to have it now!

I believe that owning a home free and clear is a goal that everyone can achieve, if they simply reduce their lifestyle and stop behaving badly. A single man out of college who lands his first job earning $30,000 would be better off living way below his means while he builds up enough savings to purchase his first home without borrowing a single penny from the bank, regardless of what his friends are doing. Not realistic? Well, if you believe that, then you believe other lies about money too.

Imagine the celebration that a family could have as they push their son or daughter from the nest into a paid for house! It would be something that would become a blessing, not a curse.

But, unfortunately, people don’t believe they can do it…so they won’t.

Filed Under: Personal Finances Tagged With: borrowing, home, money, wealth

Tax The Ambitious at 3.8%

November 29, 2010 By Jon Griffith 2 Comments

In a country where talk of obesity and rising health care costs seem to flood every news channel on a constant basis, our all knowing, all powerful government, in its infinite wisdom, is punishing the ambitious, hard-working entrepreneur in order to extend Medicare benefits and to cover the cost of the impending national health care program. Actually, only half the cost as they have forecast.

The idea is this. If you as an individual show a gross adjusted income of more than $200,000 ($250,000 for married couples), then the government will require you to pay a 3.8% tax on the capital gains above and beyond those limits.

The National Association of Realtors lobbied heavily against this legislation as it cropped up at the last minute to solve the obvious question: “Who’s going to pay for it?”

Well, if you’re “rich” as the government defines, then YOU are going to pay for it. The more you make, the more you pay, which perpetuates the continual problem of a vast majority of the nation NOT paying taxes.

Robin Hood

I used to equate Robin Hood’s “stealing from the rich, giving to the poor” to the government taxing hard working Americans and giving it to the lazy people. Now, I think of it more like this. Robin Hood steals the money BACK from the government who stole it from the people and gives it BACK to the rightful owners. Go go gadget archer.

3.8% Example

A quasi-confusing document was released by the NAR which offers a few examples of how this new legislation will actually affect the home owner. While some have blown the tax out of proportion, not knowing the actual details of the law, assuming that everyone who owns a home is going to be taxed, that is simply not true. It’s just those of us who make “enough” money doing it.

Example 1: Suppose your adjusted gross income (AGI) for the year hits the $150,000 mark, and you sell some of your stocks and bonds for a net gain of an additional $150,000. That puts your new AGI at $300,000, or $100,000 above the $200,000 limit. $100K * 3.8% = $3,800.00

Your Tax Liability: $3,800.00

Example 2: You and your wife have a combined income of $190,000. You sell some stocks and bonds which net a capital gain of $60,000. In addition to that, you sell your residence which you purchased for $600,000 for $1.2Million for a gain of $600,000. Since you gained over $500,000 on the home, everything over $500,000 is added to your AGI and becomes taxable. So, $190,000 + $60,000 + $100,000 = $350,000. Again, you’re over by $100,000.

Your Tax Liability: $3,800.00

Example 3: This one blew me away. I’ll add this one as it’s written in the NAR brochure with no modifications.

In 2010, Ethan inherited a four-plex investment property from his great aunt. She had used it for many years as an investment rental property in San Francisco. At the time of her death, the adjusted cost basis of the property was $10,000. During her period of ownership, she had taken $240,000 worth of depreciation deductions on it. Its fair market value was $900,000 when she died. Because there was no estate tax for 2010 and because the carryover basis was in effect, Ethan’s basis in the inherited property is also $10,000. The prior depreciation allowances carry over to him, as well. He continues to use the property as an investment rental property.

Ethan later sells the property for $1.2 Million. He is single, and reports Schedule C self-employment income of $180,000.

Ouch. That hurts. That’s additional tax that Ethan is required to pay because of the health care program. What if we assumed that Ethan lived a rather responsible life, since he obviously knows how to make money ($180,000/year before any inheritance). We could assume he’s healthy, eats well, exercises, doesn’t smoke, isn’t an addict of sorts, etc. I think you may be able to figure out where this argument could lead.

When does this legislation go into effect?

January 1st, 2013.

I’m curious to know what you think about this plan, and what the effect of the cause will be. How creative are those of us who make an income that the government deems “too much” going to be?

Leave your comments below.

Filed Under: Personal Finances Tagged With: home, legislation, property, Robin Hood

Planning Prevents

November 8, 2010 By Jon Griffith 2 Comments

Following a good model of financial planning will make the difference between future success, and future failure. While there is no guarantee of success, however you may define it, there is certainly a guarantee of failure if you don’t take the time to plan according to your end goal. Of course, if you have no end goal, making a plan might be a bit more difficult than you imagined. Most people who succeed in life do so because they have a goal in mind, and they take the steps they need to take to reach that goal.

A majority of the valley is in turmoil when it comes to housing. There’s no need to explain what has happened over the past few years. More focus needs to be placed on how you’ve learned from it, and what you intend to do about it.

Just Start

The first step to planning your future is to be aware of where you are. I would bet that most of your financial stress is due to not knowing, and not knowing is due to a fear of finding out the truth. This circle of thought will prevent your from reaching your goals. Take inventory of your money. Figure out what’s going where, how much you actually make, and where you want it to go.

A Healthy Cash Flow Budget

In this order, 1) Feed Yourself, 2) Clothe yourself, 3) Keep a roof over your head, 4) Keep the lights on, and 5) maintain your transportation, whether it be a car, a scooter, or your walking shoes. Beyond that, you have room to solve your problems, or invest in your future.

If you have structured your life to give, spend and save appropriately (and I’ll define that next) then you cannot lose, and the degree to which you win will only be dependent upon the amount of income you can generate.

An appropriate method to live by goes as follows:

Give 10% of your pay away as soon as you get it. Don’t care where, but support something you believe in.
Keep your rent or house payment at or below 25% of your take-home pay.
Never borrow money.
Save 15% of your income FOREVER so it grows, and don’t choose to do anything that would jeopardize it.
Save 15% of your income for your kids’ college educations so they don’t end up in debt.
Invest, Give, and Spend the rest.

House Poor

The big one here that I’ll touch on is the housing expense. In our current market state, where our dollar has lost value, we have nearly 10% unemployment, and our homes are worth half of what we borrowed, it’s time to look at the above formula to see if our current spending matches our ideal spending plan. If you find that you are spending more than 30% of your income ( I know, I said 25% above, but the banks approve on 30% ) on your house payment, then you are robbing yourself of the future freedom to choose whatever you want to do. You’re blowing your future away, and your current level of comfort, and in many cases, your fears, are preventing you from taking action to solve the problem.

You have people around you, who aren’t qualified to make these decisions for you, pulling you in all directions with their opinions about what you should or shouldn’t do. Here’s a tip, and a hard truth: Taking advice from someone who is broke about how not to be broke, will keep you broke, so smile, and thank them for their opinion, and then get professional advice.

If you’re house poor, and you have come to the realization that it’s time to do something about it, and your house is worth less than you owe, then your solution is to sell the house. That will most likely involve a short sale. If you need more information about this topic, or you need to speak with me about how you can solve this monumental future financial problem, please call me and we can talk about it. Knowing the facts will give you peace of mind.

Filed Under: Living Debt Free, Personal Finances Tagged With: house, House Poor, housing, spending

Should We Stop Paying Our Mortgage?

August 9, 2010 By Jon Griffith Leave a Comment

That’s really not a question that I can answer for you. But, what I can tell you is that there are investors who hold notes on homes who will absolutely refuse to consider you for a short sale unless you’re past due by at least 30 days.

My initial response to this is complete rejection. Logically, there’s not going to be much of a difference between a seller who has decided not to pay who presents a short sale offer, and a seller who has actually stopped paying who presents the same offer. The only difference is 30 days.

Most creditors are NOT going to negotiate with someone who is actively paying their bill. It doesn’t matter if it’s a home mortgage, a credit card, or a personal debt. Short Sales, however, often have been an exception to this rule, as many investors see the value of cashing out as soon as they can before the values continue to fall, if in fact they fall. But recently, they’ve started to tighten the reigns.

If I loan you $100.00, and you agree to pay me $10.00/month for 10 months, and you continue to pay, I’m probably not going to be likely to agree to accept a settlement until it’s proven to me that you aren’t going to pay me anymore. If you pay me $50.00, and then stop paying me, then you approach me a few months later offering an additional $20.00 to settle the entire debt, I may be likely to simply take it and write off the remainder because I’ll want to get what I can when I can, rather than gamble losing it all in the end.

So, I cannot advise you to stop paying your mortgage, because I’m acting on behalf of your best interests, and your best interests include anything and everything that is non-destructive. When you stop paying, it will affect your credit negatively. What I can tell you that if you do stop paying, it will show your lender that you’re serious. Of course, if THEY tell you to stop, that’s a different story, and in my opinion, loony on their part.

Filed Under: Personal Finances, Short Sales Tagged With: default, late, mortgage, stop paying

The Debate Continues: One User’s Opinion on Renting vs. Buying

September 23, 2009 By Jon Griffith Leave a Comment

As with anything, there are pros and cons that change with every complicated variable involved. The concept of buying being better than renting is relative to the context of each side of the equation at any given time. No two situations are the same, but generally speaking, assuming certain conditions are already met, owning a home is MUCH BETTER for long term wealth building than renting.

In an article that I wrote back in 2008 on the SonoranHouse.com blog, I illustrated the financial benefits of renting vs. buying. Here’s what one user had to say, along with my thoughts on the response:

WRONG… Renting is FAR better and Cheaper than buying a house.

Not so fast. There are too many variables involved, and each situation is different, but the principle cannot be disputed. Owning is a long term prospect. Not short term. In order to conclude that owning is better, one must assume that the property will be held for as long as possible.

1. The down payment is $20,000 OUT OF YOUR POCKET on day one. SO by purchasing a house you are immediately $20,000 POORER the day you buy your house. In contrast, you can RENT and only pay a SMALL deposit equal to 1 months rent and keep the rest of your $19,000 to use as a safety net to pay the rent with and live an easy STRESS FREE life knowing you have the rent covered for 19 months if it’s a $1K a month rental.

When you pay a deposit to a landlord, it is a fee that can never be recovered. When you put money down on a house, you are instantly investing your hard-earned cash in an appreciating asset. You are not spending the money. Again, if your investment mindset is short term and you sell your home too quickly, you will certainly cut into your initial down-payment unless your property experiences unheard of appreciation in a short time period. Not likely to happen again. Buying real estate is a long term wealth building investment.

A rule of thumb for an emergency fund is 3 to 6 months worth of living expenses. If your rent is $1000.00/month, you have 19 months of rent paid for, but that doesn’t take into account the rest of your expenses. If a down payment on a house depletes your living expenses, they you are not ready to buy. Your down payment should be above and beyond your 3 to 6 months. So, if your expenses are $2000/month, you should sock away about $12,000. The rest can be used towards your future down payment. This all assumes that you are completely out of debt. If you aren’t, then you shouldn’t be buying a house in the first place. Most renters do not have this much money saved up and they live paycheck to paycheck, so they feel they NEED to have some sort of financial buffer to buy them time.

The problem with this is that they never get OUT of the rat race by behaving this way, and they never put their money to work for them. They will live the rest of their lives working for their money. What would be the difference between having 19 months of STRESS FREE living in a home that is appreciating in value versus apartment living with the same amount of a safety net? The difference is that part of your monthly payment is being added to the home’s equity. Some of that payment will be recovered. NONE of the rent will.

2. The Tax Deduction is nonsense… You spend $1.00 in Mortgage Interest to deduct .10 cents off your tax bill. HARDLY a “savings” at all. Your still LOOSING .90 CENTS in interest!! WAKE UP PEOPLE!!

Tax Deductions are a poor excuse for people who are poor to continue to be poor. The argument here is that it makes sense to pay the bank $1.00 in interest to avoid paying the government ten cents. Obviously that is flawed thinking. Spending 90 cents to save 10 is absolutely ridiculous. That is why the largest mortgage anyone should be financing is a 15-Year fixed. Obviously paying cash is the best way to buy a house.

3. When you own a house you pay PROPERTY TAXES each and every year. These taxes are about 1.5% of the value of your home or around $3000 a year. That’s $3K a year your LOOSING if you own a house.

Hmmm…let’s see. Property taxes at $3000/annually, deductible at your tax bracket rate, or $12,000 wasted on rent. Personally, I’d rather put the remaining $9,000 in growth stock mutual funds to offset the perceived loss, because by the time my $9,000 per year is invested over 30 years, it will pay the property taxes a few thousand times over.

4. When you own a house you pay Property INSURANCE on your house each year. This will be about 1% of the value of the home so figure $2000 a year on a $200K house.

I own a $200K home. Taxes and insurance annually do not exceed $3000.00. In fact, they don’t exceed $2000.00. This has everything to do with location and tax rates. Again, I’d rather cough up $2000/year for insurance than blow $12,000/year on rent. So based on points 3 and 4, which add up to $5000.00, I’m still ahead with $7,000 invested annually in growth stock mutual funds. Come to think of it, my down payment of $19,000 as used in this example will be reimbursed fairly quickly.

5. When you own a house you pay for ALL MAINTENANCE/REPAIRS/REMODELS. This means spending about 1.5% of the value of your home EACH YEAR to keep it in livable condition so figure another $3000 a year on maintenance/upkeep.

Nobody forces remodeling, so we’re going to remove that from the equation. Deferred maintenance is a price that everyone has to pay for, whether you own, or you rent. As the king of your castle, you determine what’s used on your property to improve and maintain it and you have a choice over the cost/savings realized from it. By renting, you have no control over these things, and the cost of rent is at the discretion of the landlord, who can easily raise it high enough to force you out to make room for someone else as a result of increased management costs. Owning your own home offers greater long-term housing security.

6. In order to “get your money back” out of your house you will need to SELL your house. This means FINDING SOMEONE ELSE TO BUY IT. You’ll have to pay Closing Cost, Real Estate fees, etc. and it can take a LONG TIME to find a buyer. THEN even if you sell, you will have to live somewhere so you would have to turn around and buy ANOTHER house or do what most smart people do in the first place… RENT.

False. As a long term investment, the asset appreciates and the value of the loan decreases over time. If you paid cash, you have an instant money making machine creating passive income. If you didn’t, you’ll eventually reach a point at which renting your home to someone else will generate positive income above what you owe on the mortgage payment. The tone of point number six seems to emphasize the dependence upon cash in the bank to provide a safety net. Obviously if you’ve been able to save $19,000, you’re making more than you’re spending, so the time that it takes to sell should be irrelevant unless you’re forced to move via relocation or other circumstance beyond your control. It’s true that if you sell too early, you’ll erase your gains because you didn’t have a long term mentality. There is so much more risk to buying a home when you borrow, but if you are able to pay cash for a home, then I’d say you’re living well financially. One’s intelligence is not a factor determined by the decision to rent or buy. One’s wealth, however, is. If you want to get rich and live free like nobody else, then you’ll invest wisely. Renting is not investing.

Owning a house ONLY makes sense IF you could pay CASH for it. Even then, your still going to “Throw money away” on Taxes, Insurance, Maintenance, and the excess bills that come from owning a house when if you RENTED many of those bills are included in the rent.

Paying cash for a home ISN’T THE ONLY time it makes sense to buy a home. It is the BEST practice for sure, but you’re not throwing money away on taxes because your home is appreciating in value, and in theory, you’re renting that home out, collecting $1000.00/month rather than spending it. Can you imagine how nice it would be to be able to put $12,000.00 less a few expenses every year without having to work for it?

The fact that there are additional bills when you own versus renting is also a false assumption. Do the math over a long period of time. Take the appreciation of real estate and the potential passive income from owning a rental and see where it would be in 30 years if invested wisely, long term. Compare it to the real costs of owning. Remember, we’re talking about ownership versus renting. We’re not talking about owning a high cost property that has no potential to generate future income. That would not be a wise investment. Of course, you could just keep on throwing your hard-earned money away. In fact…

…I’ll look forward to renting one of my properties to you because you sound like the perfect tenant.

Filed Under: Personal Finances, Real Estate Basics Tagged With: appreciation, Buying A Home, equity, investment, ownership, Renting, Rich, wealth

Cash For Clunkers, The Final Deathblow

August 20, 2009 By Jon Griffith 1 Comment

My recent article entitled Cash For Clunkers Is Absolute Ultra Stupidity was the most viewed article on my site on the day that I released my August newsletter, probably because of how provocative the title was. I recently caught Blake Thompson’s @ramseyshow tweet which turned me on to the following video by Dave Ramsey, author of the #1 best seller The Total Money Makeover: A Proven Plan for Financial Fitness.

I read this book, well, I actually purchased the audio book and listened to it 7 or 8 times after listening to Dave’s radio program for about a year, and the book solidified all of the callers’ answers that Dave offered during that time by teaching me the theory behind what Dave teaches. I highly recommend reading it if you intend to build wealth and become financially independent.

Have a look at Dave’s view on cash for clunkers:

Filed Under: Personal Finances Tagged With: Clunkers, Dave Ramsey, money, ramseyshow, Stupidity