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Blog :: 2010

Capital Gains Uncertainty

While it looks the tax compromise between the Republicans and President Obama will pass, I think the debate reminds us that the tax code is subject to change at anytime.

For real estate purposes, changes in the capital gains tax laws can have a huge impact on property owners in Vermont. Under the current tax code, when you buy or a sell a home in Vermont, you are subject to a number of potential taxes. One of thoses taxes is capital gains tax.

The capital gains tax is based upon the amount of gain you have in the sale of the Vermont real estate. For instance, if you purchase a home for $125,000 and sell it for $200,000, you have a gain of $75,000.

The current tax rate for long term capital gains is 15%.

Under the current tax code, a property owner's primary residence is exempt from tax if the gain is less than $250,000 for an individual or $500,000 for a married couple.

If the exemption was removed, the homeowner in the example above would owe a tax of $11,250 on the sale of the home in Vermont.

If the property is not the primary residence of the seller then the sale is likely subject to capital gains tax. If you are considering selling an investment property or already have your property under contract to sell, you may want to try to close prior to December 31st so you know what your tax liability on the sale rather than be at risk that Congress raises the rate.

Mortgage Interest Deduction

President Obama's Defecit Reduction Panel recommended eliminating the mortgage interest deduction for all properties other than primary residences of $500,000 or less.

While this seems like a good way to raise immediate tax revenue, I question whether the Panel thought through all of the implications of such an action.

My question is what would the impact be on the value of non-primary residence property values. Right now investment property owners utilize the mortgage interest deduction as a business expense.

For instance, say you purchase a 4 unit apartment building in Burlington for $400,000. You make a downpayment of $100,000 and borrow $300,000 from a bank for 30 years at 5%. Your montly mortgage payment would $1,610. The interest portion of your payment in the first year would be approximately $1,250. Thus, the interest expense in the first year of business would be $15,000.

Say you take in rents (gross revenue) of $40,000. Say your taxes and other expenses are $16,000. Your net operating income before loan payments (i.e. debt service) is $24,000. After deducting the mortgage interest as an expense your taxable income from the property is $9,000. Thus, you are making about a 9% return on your $100,000 and paying taxes accordingly.

Now lets assume you cannot deduct the interest as a business expense. You would have taxable income of $24,000 but only pocketing $9,000. Your return has now been diminished significantly due to the taxes due on the $24,000.

If your return is diminished then the price you are willing to pay will also be lower. The $400,000 purchase price might now be $375,000 or less so that you can make a comparable return.

If property values fall as a result of this tax change then revenues from Capital Gains taxes will also fall on investment properties. It would seem possible to me that any increase in revenues from the elimination from the tax deduction could be offset by the harm that lower property values does to our economy.

Comments

  1. Mayelis on

    Looks like you had so much fun.. The lights acsros the street are gorgeous, makes into a magical land..Your daughter also looks as if she can give that man a run for his money.. So glad you had some fun and enjoyed your trips!!

    Vermont Real Estate Prices

    There was a story recently that Vermont's real estate had actually appreciated in price by 17% from the 3rd quarter of 2009 to the 3rd quarter of 2010. While the data supports this statement, it is important to analyze the data to figure out the cause of the jump.

    The jump in prices was an increase in the median home price. The median home price of Vermont homes is the point at which half (50%) of the homes sell over that price and half (50%) sell for under the median price.

    The reason that the median prices increased in the 3rd quarter of 2010 is that it was the first quarter since 2008 that a first time homebuyer tax credit was not available. The first time homebuyer tax credit provided a great incentive for first time purchasers to buy and they did in droves while the credit was available.

    The result of the large number of the first time homebuyers in 2009 and the 1st and 2nd quarters of 2010 caused a drop in the median sales price. This occurred because first time homebuyers tend to purchase less expensive homes than people buying their 2nd or 3rd home.

    While I would like to be more optimistic about the data, I think buyers and sellers need to be realistic about what the data actually is showing. If we can see the same growth for consecutive quarters then I think the data would be valid.

    Vermont Ranked Healthiest State Again

    According to the Burlington Free Press, Vermont has been ranked the healthiest State in America for the the 4th consecutive year.

    Many observers believe that Vermont's vast outdoor recreational activities are one of the reasons that the State consistently ranks at the top. Whether its skiing in Stowe, Sugarbush, Killington, Okemo or Woodstock's Suicide Six or swimming at one of the beaches in Burlington or Colchester, there are plenty of opportunities in every Vermont city and town.

    Impact of National Franchises on Local Property Values

    First let's review how national franchise companies make money from local real estate transactions. The most common model of compensation is a percentage of every transaction is paid to the national company by the local brokerage firm. Typically a local brokerage firm will pay the national company 8-10% of their fee from every transaction. Thus, if a broker sells a home for $300,000 and charges a 6% commission, the broker pays the national company $1,800 of that commission.

    The question is not whether these companies make money (we know they do), but how does a national affiliation help a buyer or seller. The short answer is that they do not help buyers or seller locally.

    The level of service provided by brokers without national franchise affiliations is the same as those with national franchise affiliations. There is nothing locally (MLS, Realtor.com, Free Press, etc...) that requires a national affiliation or that is benefited by a relationship with a national franchise company.

    While the service level provided is the same, brokers with a national affiliation must charge buyers and sellers more. As described above, brokers who have national affiliations must pay the national franchise company. Because of this, they must pass along this cost to their clients. Therefore, if you choose a firm with a national affiliation, you will likely pay a higher rate or the broker will have less room to negotiate their fee because of the extra fees paid to the national company.

    Because brokers with national affiliations must charge more, the cost of these relationships eventually trickle down to each transaction and make property more expensive locally. As I pointed out in the last issue, broker fees are a transactional cost that is added to the price of property in every transaction. Ultimately, if the seller needs to pay their broker more because their broker has a national affiliation, then it only stands to reason that the seller must factor that into the price of their home when selling. The seller then passes that cost along to the buyer by making the buyer pay a higher price for the home to cover their broker's fees.

    Therefore, at the end of the day, property is more expensive locally when national franchise companies are present.

    Even though national brands may lend immediate credibility to a broker, they do little to directly help the clients of the broker. In fact, many of the most recognizable brands are owned by the same company (Realogy), including Coldwell Banker, Century 21, ERA and Sotheby's. It is difficult to see how clients benefit when such an inherent conflict exists in the national company supporting the various brands.

    The only way that national franchise companies can make more money is to sell more franchise units. They are constantly looking to increase the number of franchise units in the same market area. Most national companies are willing to have the same brand located within 1/2 mile or less of another office owned by a different broker. Thus, you might have the same brand in the same town with two or even three different owners.

    Flat Fee Real Estate has not and will not affiliate itself with a national franchise. We want to continue providing our services for a flat fee of $3,500 per transaction and do not believe that we could if we were to partner with one of these companies who keep pressure on brokers to maintain the traditional 6% commission based model. We also want to ensure that local property remains more affordable for our clients by not having to pass along the costs of a national franchise to our clients.

    Selling In the Internet Age

    Selling In the Internet Age

    The internet has dramatically changed the way buyers of real estate search for property.

    No longer do buyers spend hours on a weekend attending multiple houses. Gone too are the days when buyers read the paperto findreal estate listings. Buyers no longer even rely upon real estate agents to send them listings. Instead, buyers now do the majority of their own legwork and they do that legwork almost exclusively online.

    Buyers typically start their search at a well known website like Realtor.com. They enter their general search criteria. They then begin to weed out the listings based upon the content they find online. Buyers tend to be attracted towards listings with more online content. For instance a buyer is more likely to click on a listing if there is a link to a video tour because it helps give them a better sense of the property. In a similar vein, buyers are less likely to click on a listing if it has very little content such as only one exterior picture of the building.

    Once the buyers narrow down their list to 2-5 properties based upon their internet search, they will call their real estate agent and tell their agent which listings they want to see. The agent schedules the showings and helps the buyers in analyzing the property, buthas little to do with the actual selection of listings.

    Because of the changes in the search process, Sellers need to adapt their marketing efforts to distinguish their listing online. It is important that sellers try to provide as much online content as possible. For instance, sellers should not only have pictures posted online but if possible should also have a video tour produced that can be viewed online by buyers. Sellers should also consider creating a separate website for their property so that there is simply more interaction for a buyer to experience online.

    At Flat Fee Real Estate, we have adapted our marketing efforts to the new reality of the property search process. Since our inception we have created separate websites for our clients to help their listings standout online. We have also had videos produced for most of our listings. We have anecdotal evidence that buyershave beenmore attracted to our clients' listings as a result of the content provided online.

    In addition to changing the way buyers search, the internet has made real estate agents much more efficient. Buyers are doing most of their own searching so the total number of hours required of a buyer's agent has been greatly reduced. For listing agents, the information and online tools help greatly reduce the time it takes to perform a market analysis and communicate this information to prospective sellers.

    Because the interent has reduced the overall time commitment of each transaction, it stands to reason that the fees charged for the service should be reduced. That is why we have been able to offer a service that has historicallybeen charged at a 6% commisionfor a flat fee of $3,500 per transaction.

    UNDERSTANDING TRANSACTIONAL COSTS IN A REAL ESTATE TRANSACTION

    UNDERSTANDING TRANSACTIONAL COSTS IN A REAL ESTATE TRANSACTION

    This article is geared towards buyers of real estate but may provide sellers some insight into the costs of the services being provided to them and the impact those costs have on the sale of their property.

    When asked who pays the commission in a real estate transaction, nearly 100% of buyers unequivocally say "the seller". Even buyers who hire buyer buyer agents believe wholeheartedly that it is the seller that incurs the cost of the buyer's agent.

    While most buyers believe that it is the seller who pays the commission, it is ultimately the buyer, and not the seller, that pays for the commission in a real estate transaction.

    Every real estate transaction has "transactional costs". Transactional costs are those costs that are incurred in connection with the purchase of the home but that are not directly paid to the seller of the home. Transactional costs in a real estate transaction include but are not limited to inspection fees, bank fees, legal fees, taxes, town recording fees and wiring fees. Buyers must add these transactional costs to their budget when deciding how much they can afford to pay for a home.

    Rarely if ever do buyers consider fees to real estate agents as a "transactional cost". However, just like the fees to the bank, lawyers, town, etc..., the fees to the real estate agents are a transactional cost. Like these other fees, it is a cost paid to a party other than the seller in connection with the purchase of the property.

    The only difference between "traditional transactional costs", such as fees for an inspection, and agent fees is that "traditional transactional costs" are paid directly to the party providing the service. In the context of the real estate agents, the buyer pays the seller and the seller turns around and pays the agents.

    If you think about, the buyer could just as easily pay the agents directly and simply pay less for the property. The seller and both agents would be left with the same amount of money in their hands at the end of the transaction, but it would just be paid in a different manner. Thus, the money in the agents hand at the end of the transaction is really the buyer's money and a cost to the buyer.

    The easiest way to see that real estate agent fees are a cost to the buyer is to look at the sale of a home with 2 agents that charge commissions versus 2 agents that charge a flat fee for their service.

    COMMISSION BASED TRANSACTION: Seller will only sell their home if they can walk away with $325,000. The seller has agreed to pay real estate agents a 6% commission (3% to listing agent and 3% to buyer's agent) as part of the sale. Buyer agrees to pay $346,000 so that seller can walk away with $325,000.

    FLAT FEE BASED TRANSACTION: Seller will only sell their home if they can walk away with $325,000. The seller agrees to pay listing agent a flat fee of $3,500 and buyer's agent a flat fee of $3,500. Buyer agrees to pay $332,000 so that the seller can walk away with $325,000.

    As you can see, when the real estate agents work for a flat fee, the buyer pays $14,000 less for the property and the seller recognizes the same profit for the home.

    While there are few full service brokerage firms that are willing to work for a flat fee at this time, Flat Fee Real Estate of Burlington does. We even work as a buyer's agent for a flat fee.

    When we represent a buyer as a buyer's agent, we refund the amount of our commission that is above our flat fee of $3,500. In the "Commission Based Transaction" above, we would have received $10,380 as a commission. We would have then refunded $6,880 to the buyer. Thus, the buyer would have paid $339,120 rather than $346,000.

    Even though we are not able to save our clients the entire $14,000 from the two examples above, we are able to help save them a significant portion of that amount. Thus, our clients end up paying less and in some cases are able to afford more house than they otherwise could have thanks to the savings we provide.

    Below is a more detailed example of a typical transaction to help illustrate the points above.

    Example

    Jane and John Doe are interested in purchasing a home. They hire a buyer's agent to help assist them in their search and purchase. They are looking for a home priced between $325,000 and $365,000. They would like to be on the lower end of the price range but are willing to spend a little more if the value is there.

    Paul and Mary Smith would like to sell their home. They hire a real estate agent to assist them in the sale. Before listing their property, Paul and Mary review their finance and discuss their needs with the real estate agent. They tell the agent that they need to walk away from the closing table with $325,000. They estimate that the closing costs (before any real estate commissions) will be approximately $1,000. They have no mortgage on the property and so they need $326,000 to walk away with $325,000 after closing costs.

    The agent tells Paul and Mary that he believes that their property is worth between $325,000 and $350,000. The real estate agent's contract with Paul and Mary says the agent will receive 6% of the sales price as a commission for selling their home. He says that in order for them to walk away with $325,000 as they desire, they will need to factor the 6% commission into their sales price. Thus, they will need to sell their home for approximately $347,000 in order to walk away with $325,00.

    Paul and Mary put their house on the market for $349,00. Jane and John view many houses over a 2 month period, including Paul and Mary's home. Jane and John decide that of all the houses that have seen, they like Paul and Mary's home the most. It has everything that they have been looking for in a house.

    After consulting with their agent, Jane and John decide that the Paul and Mary's home should sell for $335,000. They make an offer of $335,000 to purchase the home. Paul and Mary review Jane and John's offer and determine that they must reject it because after they pay the closing costs and real estate commission of 6%, they will be left with $313,900 which is $11,100 short of their desired amount.

    Paul and Mary make a counteroffer to Jane and John of $347,000. While Jane and John believe they are overpaying for the home, they decide to purchase the home for $347,000. Paul and Mary are pleased because they will now be able to walk away with $325,000.

    At the closing, Jane and John are given a statement which shows all of the costs that they owe. In addition to the $347,000 to purchase the home, they also have legal fees, title insurance fees, taxes and bank fees. Their total costs for purchasing the home are $355,000. They receive a mortgage of $200,000 and pay $155,000 out of their pocket.

    After Jane and John deliver their check, the closing attorney disburses checks to the various parties around the table. The attorney delivers a check to each real estate agent in the amount of $10,410 (total $20,820). While the fund may have come at the closing, these funds actually came from the money provided to the closing attorney by Jane and John. Therefore, it was the buyer and not the seller that paid the commissions.

    Comments

    1. Next Day Flyers discount on

      Hey! Thanks for the nice post, very informative.
      • Samy on

        There may be no benefits at all. Estate agtens get a lot of criticism but good ones can be very useful at all stages of the transaction. They will keep a purchase moving. Private deals often fail through poor communication with lenders and solicitors. Agents will chivvy were needed having secured the best offer in the first instance.References : Was this answer helpful?

        THE INESCAPABLE CONFLICT: BUYER AGENT COMPENSATION

        THE INESCAPABLE CONFLICT: BUYER AGENT COMPENSATION

        In the majority of real estate transactions in Vermont, buyer agents get compensated by the seller of the property. They normally receive 3% of the purchase price as a commission.

        There is an inherent conflict in this system.

        The role of an agent is to look out for the best interest of their client. In the case of a buyer of real estate, the agent is supposed to try to get the buyer the property they want at a price they can afford.

        A serious problem arises however when the buyer and seller are close to agreeing to a price but because of the fees to the buyer's agent the two parties cannot finalize the transaction.

        Assume for a moment that a buyer finds a home that he would like to purchase and that it is listed for sale at a price of $275,000. The buyer informs his agent that his budget does not allow him to spend more than $265,000 for this home.

        Based upon his client's budget, the buyer's agent presents an offer of $265,000 to the seller. The seller informs the buyer's agent that the seller needs to net at least $259,000 from this transaction to cover all of their costs. The seller decides to reject the offer because after paying the buyer's agent a 3% commission, the seller will only be left with $257,050, which is not enough to cover their costs.

        The seller suggests to the buyer's agent that the agent reduce his commission from $7,950 (3% of $265,000) to $6,000 so that the seller can realize a return of $259,000 and cover their costs.

        What should the agent do in this scenario? If he adheres to his promise to look out for the best interest of his client, he will reduce his commission so that he fulfills his role of helping his client get the property he wants at a price he can afford.

        However, there are very few, if any, agents in Vermont that currently believe that they should reduce their commission to help finalize the transaction. Most agents view their compensation as distinct from the transaction between their client and the seller and this is where the root of the problem lies.

        The only way to eliminate this inherent conflict is for buyer agents to work for a flat fee. To our knowledge, we are the only brokerage firm in the State of Vermont representing buyers for a flat fee.

        When we represent buyers, we receive $3,500 for our services. If our commission is more than $3,500, we refund the balance of the commission to our client.

        For instance, if our client purchases a $300,000 home, we only keep $3,500 from the seller's commission and give the balance to our client. Thus, our client receives a $5,500 check from us at the time of closing.

        Unlike most agents who receive higher compensation when their client purchases a more expensive home, our clients actually save more money when they purchase a more expensive home. This removes the inherent conflict and allows our clients to know that we are acting in their best interest and not our own.

        Comments

        1. Gaby on

          The beginning of the pesorcs is to see how much of a mortgage you can qualify for. Once you know this you can look at areas in your price range. This is a good time to get a real estate agent to get you a list of homes in the area of your choice and price. Real estate agents can sort through the hundreds of homes for sale and narrow it down to what you what to see. Agents will schedual times to view homes. Agents will give you detailed full features sheets of each home you view. Agents will do market valuations of homes to verify the market value. This will give you an atvantage when putting in your offer. Agents will write up the purchase agreement and present it to the owner/owners agent and negoitiate . Agents will followup on the conditions and make sure they are complete and removed on time. Agents will make arrnagements to have all documents delivered to laywer. Agents will make arrangements to get keys on possession day. And much more,

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