Yearly Archives: 2009

Estate tax vanishes Jan 1: But watch out for capital gains tax

If you thought inheritance taxes were complicated before, just wait for January 1.

The inheritance tax is abolished starting January 1. But it only stays abolished until December 31, 2010. On January 1, 2011, the old inheritance tax system returns, except that the amount that is free of inheritance tax changes to $1 million per person. Make sense? Of course not.

There is a new wrinkle that makes it all even more confusing. It’s this: Under the “old” system that expires December 31, 2009 and the new system that starts January 1, 2011, assets that the deceased owned received a “stepped-up basis.” This  means that the value of an asset is reset to its value on the deceased’s date of death. For example, if a client bought a house in 1980 for $100,000 then died in 2009 when the house was worth $300,000, and the house was sold after the deceased’s death, so no capital gains tax was due when the asset was sold because the “basis” or cost of the house was increased to $300,000. This applied to all property owned by the deceased.

Well, the stepped-up basis rules all change on January 1, 2010. Now, “stepped-up basis” is replaced by the term “carry-over basis.” This means that the basis of the deceased property owner carries over to the heirs and is not stepped-up (but of course there are exceptions, naturally).  If the asset is sold, capital gains tax must be paid by the heirs.

The new rules on carry-over basis are:

  1. $1.3 million or less in property still gets a stepped up basis.
  2. Any amount inherited over $1.3 million does not get a stepped-up basis. If this property is sold, capital gains tax will be paid by the heirs on the gain.
  3. An additional $3 million can be left to a surviving spouse and will get a stepped-up basis.

Complicating matters even more, Illinois decoupled from the federal inheritance tax system for a few years. This made is possible for large estates of over $2 million to pay inheritance tax to Illinois, but not to the U.S.  Thankfully,  for 2010, there is no Illinois inheritance tax to worry about.

What to make of all this? It is wise to review your will or trust with your attorney to address these complicated and ridiculous rules to be sure that you don’t call into a carry-over basis trap.

Still waiting for new form 5405

For closings after November 7, 2009, a new form 5405 is required to file for the $8000 first-time buyer tax credit and the $6500 move-up buyer tax credit as I discussed here.

Please don’t use the 2008 Form 5405 for closings after November, 7, 2009, because your tax refund will not be processed.

The IRS website is saying that the new form will be issued by January 8, 2010, so it won’t be too much longer.

What’s easier: Modify your loan or win the lottery?

A loan modification happens when a homeowner is a few months behind on mortgage payments. The lender agrees to modify the loan and adds the missed payments to the end of the loan in an attempt to help the homeowner avoid foreclosure.

The problem is that lenders reject many applicants for loan modification and most of those granted are temporary.  Matt Hernacki points out that a homeowner has about the same chances of winning the lottery as he or she does of getting a loan modification.

All of the generic media stories about foreclosure tell homeowners to “communicate early” with their lender. It’s a sad truth that the lenders are overwhelmed with delinquent mortgages. They really have no interest in talking with borrowers. They pay lip service to loan modifications and really do nothing to help the homeowner in trouble.

Buyers will need to wire funds to closing

In addition to the new HUD-1 form that will have to be used for closings after January 1, 2o10, buyers will have to wire funds to closing if they owe more than $50,000.00 to close.

Very few buyers wired funds to closing in the past. Most obtained a cashier’s check for the funds due at closing. Cashier’s checks will still be accepted for amounts under $50,000.oo.  The definition of “good funds” will include a title company check obtained from a sale closing.

New HUD-1 form released

Anyone that participates in real estate closings is dreading the new HUD-1 form that is required beginning 1/1/10.

The new HUD-1 form (this is the closing statement that shows all of the sellers and buyers costs and their “bottom lines”) includes a third page that references the good faith estimate given to the buyer by the lender.  It directly compares the figures from the good faith estimate with the final, actual figure.

It’s a step in the right direction, but it strikes me as complete overkill.  Predatory, overcharging lenders were a problem 4 years ago, not now.


Wait for new form to file for real estate tax credit

It’s great that the$6500 move up buyer tax credit was added and that the $8000 first-time buyer credit was extended.  But, IRS is advising buyers to wait until the end of December to file for the tax credit until it issues a new form 5405 that reflects the new changes.

Real estate writer Ken Harney (a consistently excellent writer) says that if you file for the credit using the “old” form 5405 (which is still on the IRS website), it is likely that the tax rebate will linger or not be processed at all.

So anyone who bought after November 6 of this year should wait until later this month for the new form 5405 before amending their 2008 taxes.

Long and winding road in evictions

It’s always hard to explain the eviction process to a client.  I put together this diagram that shows the flow of a forcible entry and detainer case, which is otherwise known as an eviction.

Landlords always  refuse to accept the fact that it’s  difficult to recover rent in an eviction case.  My estimate is that rent is collected (after the case is filed and judgment is entered) in about 10% of eviction cases. The plaintiff will get a judgment for the rent that remains open for 7 years. Getting paid for the judgment  is another story. A wage garnishment can be used, but this yields very little and expires every 90 days. The judgment for rent is reported to credit bureaus, but it seems that most tenants who are behind on rent are not concerned about this.

Generally, a landlord can get possession of the property back through the eviction case in about 60-90 days. The filing fees are about $400 and attorneys fees are anywhere from $300 to $700.  As the diagram illustrates, it isn’t easy or fast.

Drama queen: The mortgage contingency clause

All real estate contracts, except for cash deals, have a mortgage contingency. The mortgage contingency is the drama queen of the real estate contract. It brings out the worst in both seller and buyer and it confuses and frustrates everyone.

A mortgage contingency is a condition in the contract on the buyer  being approved for financing by a certain time at a certain interest rate. The contract usually says: “This contract is contingent on the Buyer getting an 80% mortgage for 6 per cent by December 31.” If the buyer is not approved, by December 31, the buyer’s attorney sends a request to extend the mortgage contingency. If the buyer does not obtain financing or if the seller does not grant the extension, the buyer can declare the contract to be dead and all earnest money will be refunded to the Buyer.

Most real estate deals have about 3 mortgage extension requests. Some out-of-control contracts have up to 20 extension requests. I call these deals, “draggers.”  A dragger is not fun for anyone. The worst situation in the world for seller and buyer is to have a real estate deal evolve into a dragger with 10 mortgage contingency extensions, only to have the buyer denied for financing at the last minute. Not fun.

Mortgage Contingency from Buyer’s perspective: All buyers think that they are approved for financing about 5 seconds after they sign the real estate contract, but the truth is that it takes about 30 days for a full, unconditional approval. Mortgage brokers often tell clients “You’re approved,” when they pre-qualify the buyer and this starts the confusion. Of course, what the mortgage broker means is that Mr. Buyer appears to have the credit score and income that he might qualify for financing.

A full mortgage approval requires: An appraisal of the property, verification of all of the buyer’s accounts, a credit check, submission of the loan to underwriting and the clearing of all conditions. When a loan comes out of underwriting, there are always many conditions on the loan approval. Typically, mortgage contingency extensions are requested until all of the conditions are cleared. The holy grail of mortgage approval is the “clear to close.”  Extensions are no longer needed once the loan is clear to close, which means that all conditions have been cleared.

Buyers don’t like mortgage contingency extensions because a mortgage contingency extension request implies that:  a. The closing will be delayed. b. The extension request casts an aura that the buyer is some kind of slacker who can’t get a mortgage.

However, the buyer really won’t like it when he or she is denied financing and then can’t get their earnest money back because the mortgage contingency expired.

From Seller’s perspective: The seller signs a contract and then gets roughed up by the buyer on the inspection. Mr. Seller bites the bullet and gives a $2k credit on the inspection, but then has to put up with 4 mortgage contingency extension requests from the buyer. With each extension request, the seller gets more frustrated because he feels he is stuck with an inferior buyer that will not qualify for financing.

Sellers often believe that the buyer’s earnest money is the sellers  (to keep) if the closing does not happen on time. Not really. The buyer’s earnest money will be returned, not given to the seller, if the contract is terminated while the mortgage contingency is still in force.

The best way to handle a mortgage contingency is to give at least 30 days to obtain financing. Too many contracts allow for only 10 to 14 days for the buyer to get financing and that means that there will be several mortgage extension requests. Other than allowing 30 days initially for the buyer’s financing, the parties just have to sit tight and realize that most closings will occur, some will close late, and there will always be two or three mortgage contingency extensions making both parties upset.

Credit cards and bankruptcy

Clients often ask if it’s okay to keep one credit card when they file bankruptcy. The answer is no. All debts must be disclosed and this includes all credit cards.

After filing bankruptcy, clients get many credit card offers. I have a client who filed chapter 7 (due to credit card debt) and has received 3 offers for credit cards (and he’s not even discharged from the bankruptcy yet). These are offers for secured credit cards, meaning he gives cash to the credit card company in advance, and then draws on that cash.