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Wednesday, March 28, 2007

Tax tricks of the real estate rich

Tax tricks of the real estate rich

Some straightforward strategies can reap big rewards at filing time
By Matt Woolsey
Forbes
Updated: 11:58 a.m. MT March 27, 2007
Using real estate to lower taxes doesn't require an army of CPAs or numbered bank accounts — just the craft to cut through the tax code.

"There's a reason why the rich are rich," says Sandy Botkin, chief executive of the Washington, D.C.-based Tax Reduction Institute. "In real estate, people are missing things they shouldn't be missing, and it's costing them a fortune."

Some of the more sophisticated tricks require a keen eye for predicting future home and neighborhood values and the willingness to buy significant fixer-uppers.

But for the most part, real estate tax planning is straightforward. And the payoffs are huge, especially if you do like the wealthy.

In a real estate transaction, you can end up paying thousands of dollars in title insurance, attorney fees, appraisal fees, pest inspections and bank fees, none of which are deductible.

Points paid, however, are. A point is equal to 1 percent of the loan amount and is paid to a lender to lower the interest rate. For tax deduction purposes, points are amortized over the life of a loan.

At purchase, negotiating with a bank to absorb fees — in exchange for paying an extra point or two — means the same cash flow for the bank and makes more of your cash outflow deductible because you're paying points, not fees. A few years down the line, homeowners are confronted with the problem that refinancing isn't immediately deductible. But, since most people sell before the full length of their loan, unamortized points at sale or refinance become deductible.

Aggressively challenging valuations, which determine property taxes, is another tactic.


"Many communities have been revaluing properties upwards during the housing price run-up since 2001," says Anthony Sanders, real estate chair of finance at The Ohio State University. "Tax assessors have often raised the value of the house to a higher amount than the actual current value of the property."

That discrepancy can cost serious tax dollars, especially during the current slowdown in home sales price growth. To combat this issue, experts advise hiring independent appraisers and aggressively challenging city estimates of property value. While success rates vary by area, if you can effectively demonstrate property worth against like-kind home sales, it is possible to lower your tax basis.


The state of the housing market has a lot to do with the success of appeals. Just ask Warren Buffett, who in 2003 lost the fight to keep his Omaha home value at $500,000 after a state appraisal boosted it to $700,000. Four years later, in a tapering market, Buffett's case is much stronger.

A 1031 exchange may be the most glamorous use of real estate for tax protection. Also called a "like-kind" exchange, it allows a multiple-property owner to reinvest the gains made on the sale of one home into improvements on another. This simple transfer means no capital gains are recognized. Instead of paying taxes on the gains, the homeowner can build a new guest house at their vacation residence.

A 1031 exchange may be the most glamorous use of real estate for tax protection. Also called a "like-kind" exchange, it allows a multiple-property owner to reinvest the gains made on the sale of one home into improvements on another. This simple transfer means no capital gains are recognized. Instead of paying taxes on the gains, the homeowner can build a new guest house at their vacation residence.

Thinking big in terms of renovations and repairs carries tax advantages even when you don't own multiple properties. Instead of making patchwork repairs to a driveway, roof or yard, consider upgrading entirely. Building an entirely new roof for example, and improving the value of your home, makes the expense deductible, whereas simply fixing it carries no tax benefits.

Present tax benefits are not limited to home ownership. Even for those who can afford to buy big, there are advantages to short-term renting.
Instead of taking on a long-term mortgage, or even a shorter five- or three-year adjustable-rate mortgage, it often makes sense for both lower-income buyers and the super-rich to forgo the tax benefits of owning a home and reinvest the money saved by renting.

At the top end, if you're an exec relocating to Dallas, say, or an athlete or celebrity with an uncertain time frame, the wisest thing to do from a tax perspective might entail renting. Instead of tying up money in a home investment that may only be appreciating at a modest clip, putting the saved money in a high-yield fund instead can pay off better in a volatile housing market.


The same may go for small fries.

Median home prices, on average, fell across the country in 2006. Some markets resisted the trend, but very few appreciated at a better rate than many stock funds. The one-year return on a Vanguard Selected Value fund in 2006 was 19.1 percent; the return was 15.1 percent on a Fidelity Value Fund.

So while the interest deduction available to buyers makes owning a home a tempting plan, for those in the lower tax brackets, whose deduction may pale in comparison to those buying luxury homes, "it may," says Sanders, "be in the best interest from a tax viewpoint to sell their dwelling and rent."

© 2007 Forbes.com
URL: http://www.msnbc.msn.com/id/17816184/

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