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Blog :: 12-2010

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.

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