Is that mortgage tax deductible?Barry HabibAlternative Minimum Tax, home equity line of credit, purchase-money second lien
Part of offering clients great advice often involves a strategy
on how to maximize tax advantages. But so many originators are very
weak in the area of taxes, and that weakness can become their
competitors' advantage. We are not just talking about reading a tax
return here. We are talking about the necessary knowledge of how to
structure a mortgage plan so it helps the client reach his overall
financial goals.
"What tax bracket are you in?" That's a question you should
never ask your client. You need to tell him the tax bracket he is
in. This can quickly help you begin to establish yourself as a
financial professional. The grid on tax brackets can be found
within the Mortgage
Market Guide site and at www.irs.gov. But it is much more than
just the tax bracket, so let's take a look at some key tax points
that must be looked at on every mortgage transaction.
Do you and your clients understand the Alternative Minimum Tax
(AMT)? You should. As the name suggests, this is a way for the IRS
to make sure it has an alternative way to collect a minimum level
of tax. Each of us has two sets of tax filters to go through, the
first being the tax brackets that are set based upon income. But
then there is also the AMT. After looking at both, the taxpayer
will pay the highest tax due. AMT has a lower maximum bracket, but
it virtually eliminates deductions.
Who can be victimized by AMT? Individuals with a high ratio of
write-off to income often wind up paying the extra tax. State
income taxes and property taxes can be big deductions on our
federal tax return, but they can also trigger the AMT. This means
that those write-offs against income get disqualified, and that can
hurt. In a recent issue of Kiplinger's Tax Letter, it was reported
that the AMT problem is a growing one. Right now, 50 percent of
homeowners in California, Massachusetts, New Jersey and New York
are subject to AMT. Other states may currently have lower
incidences of AMT, but the numbers are getting higher. Luckily for
us, a tax-deductible mortgage loan is usually protected from AMT,
making it very valuable. But not all loans are created equal.
When it comes to taxes, there are two important types of
mortgage debt--acquisition debt and home equity debt. Mortgage
interest on an owner-occupied home (primary, secondary or in
combination) can qualify for a tax deduction. The most that is tax
deductible is $1 million. If the money is used at the time of
purchase, it is considered acquisition debt, and acquisition debt
is protected from AMT. Acquisition debt can even be in the form of
a home equity line of credit (HELOC) or purchase-money second lien.
But once the loan is paid down on a property, the acquisition debt
cannot be recovered on that same property.
The other type of tax-deductible debt on a home, called home
equity debt, can be used above the remaining balance on the
acquisition debt, but there are some differences. First, some good
news--although the home equity debt is limited to $100,000, it is
not part of the $1 million acquisition debt limit. Additionally,
unlike acquisition debt, the money on home equity debt can be paid
down and pulled out later and still be deductible, making the home
equity debt very flexible. But there is a big catch--home equity
debt is not protected from AMT. So, any borrower who is subject to
AMT will not have any tax benefit from home equity debt. However,
he will still get a full deduction for acquisition debt, even if he
is trapped by AMT.
In an effort to make sure the tax laws on this subject are
enforced, the IRS is talking about a plan to change the 1098 forms
from lenders, which show the amount of interest paid for tax
purposes. The change comes in the way of a new check box to
indicate if any cash out was taken. "Cash out" means a new loan on
the same property that is greater than the balance of the loan
being paid off. That means a borrower who pays off a part of his
loan cannot take an acquisition debt deduction on the new financing
above the remaining principal balance.
Have you ever had a client who purchased a home for cash? Maybe
he did it to close quickly, in order to get a better price. But if
he doesn't obtain a loan within 90 days of closing, he will lose
the acquisition debt benefit. So, let's say a client buys a
$400,000 home for cash. He takes out a mortgage more than 90 days
later for $300,000 at 6.5 percent. He can only deduct $100,000 as
home equity debt, which means that any future HELOC taken will not
be deductible, because the maximum was eaten by the first mortgage.
And, if he is subject to AMT, he will not see any tax benefit at
all, because the home equity debt portion is not protected against
AMT. If he were in the 35 percent tax bracket, this error would
cost about $7,000 a year! This can be a great opportunity. Think
about all the times the real estate agent tells you that he has a
cash buyer. Well, now you can help both the real estate agent and
client with this information and maybe pick up a few more
loans.
There are some ways that cash out can still qualify to get the
favored tax treatment. If the cash out is used to improve the home,
it can qualify under acquisition debt. Helping your clients
understand this can save them a bundle as they plan their cash-out
refinances. This is one small part of understanding the tax picture
and using it to help your client while beating your competition.
Other areas you need to master include understanding the capital
gains tax on homes, as well as the difference between profit and
proceeds. Understanding gift tax, estate tax, deductibility of
points and closing costs are all part of what makes a great
originator and professional mortgage planner. If you get your
Certified Mortgage Planning Specialist designation (www.cmpsinstitute.org), you
will have mastered these areas.
The game has changed. Everyone is a genius in a hot market, but
in markets like the current one, you get a chance to shine if you
know your stuff. You can show why you are better then the other guy
and why your client needs you. I have been in this game for more
than 20 years and have seen many millionaires made. The interesting
thing is that they built their business in the slower times. They
were then poised to reap big rewards when the market heated up. The
next boom may be around the corner. Are you positioning yourself as
a mortgage planner?
Barry Habib is a nationally renowned mortgage originator and
industry speaker, as well as CEO of The Mortgage Market
Guide. He may be reached at (800) 963-1900 or e-mail
[email protected].
