Sell it or rent it? Our spreadsheet can help you decide what to do with a former residence.Should I sell it or rent it out? How will you respond when your clients ask you that question when they're they're Contraction of they are. they're be moving out of a home? CPAs can provide a valuable service by helping clients think through this issue in a structured way. To help, we've we've Contraction of we have. we've have created an Excel A full-featured spreadsheet for Windows and the Macintosh from Microsoft. It can link many spreadsheets for consolidation and provides a wide variety of business graphics and charts for creating presentation materials. spreadsheet spreadsheet Computer software that allows the user to enter columns and rows of numbers in a ledgerlike format. Any cell of the ledger may contain either data or a formula that describes the value that should be inserted therein based on the values in other cells. (www.aicpa.org/ download/pubs/jofa/2005_06_witmer. xls) that compares the net present value of the cash flows from renting a house with those from selling it immediately. It is important to understand that there are qualitative as well as quantitative considerations to the decision. The spreadsheet will be most helpful in dealing with the quantitative factors, while the following section addresses a number of the qualitative factors. DECISION FACTORS The decision of whether to sell or rent a home is complex. The spreadsheet will enable CPAs to help homeowners make a more informed choice, but several of the variables that affect the rent-or-sell decision are not quantitative and thus cannot be incorporated in the decision model in the spreadsheet. CPAs should discuss them with their clients in addition to reviewing the spreadsheet results. Some of these nonfinancial Adj. 1. nonfinancial - not involving financial matters financial, fiscal - involving financial matters; "fiscal responsibility" factors are * Adequate funds. Can your client afford two homes? The homeowner may be able to refinance Refinance 1. When a business or person revises their payment schedule for repaying debt. 2. Replacing an older loan with a new loan offering better terms. Notes: When a business refinances they typically extend the maturity date. or borrow against the equity of the old home for the purchase of the new one. Generally, there will be periods during which the rental is vacant, thus generating no income. CPAs should make sure their clients have sufficient funds to cover both homes for several months. * Rental market. Investigate the local supply and demand for rental housing. There must be sufficient demand for rental properties in your client's area. Determine the rents charged for similar residences. Real estate agents, rental management companies, local newspaper classifieds and local renters offer this information. Research zoning restrictions to prevent unpleasant surprises. * Problem tenants. A vacant rental is better than a bad tenant--but neither is desirable. It can take months to evict someone. In the meantime Adv. 1. in the meantime - during the intervening time; "meanwhile I will not think about the problem"; "meantime he was attentive to his other interests"; "in the meantime the police were notified" meantime, meanwhile , tenants can cause severe damage to the property. Check local laws regarding eviction The removal of a tenant from possession of premises in which he or she resides or has a property interest done by a landlord either by reentry upon the premises or through a court action. and deadbeat dead·beat 1 Slang n. 1. One who does not pay one's debts. 2. A lazy person; a loafer. adj. Not fulfilling one's obligations or paying one's debts: a deadbeat dad. tenants. Advise clients to consult an attorney about how to handle deadbeat tenants before renting. Run a credit check on the applicants and call previous landlords and other references. CPAs should prepare their clients for the possibility of bad tenants and the associated difficulties. An estimate of postrental repairs can be factored into the spreadsheet's outcome. * Managing the property. If the client is busy or lives more than an hour away from the rental property, it may be best to pay a professional manager to collect the rents and arrange repairs. Managers usually charge 8% to 10% of the rental income Noun 1. rental income - income received from rental properties income - the financial gain (earned or unearned) accruing over a given period of time . Discuss the advantages and costs of a rental management company with your clients. If they would like to have the property managed, you can enter a percentage into the variables section of the spreadsheet. * Taxes. Current tax law gives homeowners a great deal of flexibility when dealing with a former residence. If the taxpayer has lived in the home as a primary residence for any two of the previous five years, any gain on the sale of the house is excluded from taxation up to $500,000 for married taxpayers filing a joint return and $250,000 for single taxpayers. And so, with careful planning, your client can avoid taxation on the sale of a former residence, even after converting it into an income-producing property. See "Tax Implications of Renting Your Home," page 88, for a more detailed discussion of the factors CPAs must consider in helping their clients make those plans. WORKING WITH THE SPREADSHEET The spreadsheet provides a structure for obtaining the information needed to help CPAs formulate formulate /for·mu·late/ (for´mu-lat) 1. to state in the form of a formula. 2. to prepare in accordance with a prescribed or specified method. a recommendation to clients. You can download To receive a file transmitted over a network. In any communications session, "download" means receive, and "upload" means send. The download/upload often implies a big/little scenario, in which data is being downloaded from the "big" server into the "little" user's computer. the spreadsheet from www.aicpa.org/ download/pubs/jofa/2005_06_witmer. xls. The lead worksheet See spreadsheet. worksheet - spreadsheet of the spreadsheet contains a section into which CPAs must enter a number of variables marked in red. The black numbers are intermediate calculations used in the recommendation (see exhibit 1, below). A separate section of the lead worksheet is the outcome section that will show which alternative provides the greater net present value of the calculated cash flows (see exhibit 2, below). Begin by obtaining some basic information about the client's former residence, such as its cost, portion of the cost allocated to the land, the size of the down payment that was made, the mortgage rate, how many years the client is into that mortgage and how many years the client envisions renting the property (Decision horizon --Years). This basic information can be entered into the spreadsheet in the appropriate cells. Another important set of variables is the status of the local residential housing sales and rental markets. Your experience may be sufficient to answer these questions, or you may need to consult with a real estate professional in the area. Are houses in the local market selling at fair value or at some discounted amount (market depression factor)? At what percentage of fair value are houses currently being rented? CPAs also will have to provide some guidance in the determination of the return-on-alternate-investment variable used to compare the returns the client can expect from renting vs. selling. Take into consideration the client's investment position and risk-return preferences. For a simple solution, assume the proceeds will be used to reduce the mortgage on the new home and use the interest rate on the new mortgage for this variable. When all the variables are filled in, the spreadsheet will show which alternative provides the greater net present value of the cash flows. In addition to providing a recommendation, CPAs can perform some sensitivity analysis by modifying some of the softer assumptions to see the effect on the recommendation.
Exhibit 1: Data Input Sheet
Assumptions
Acquisition Date of House
House Cost, including land $215,000
Amount Allocated to Land $ 50,000
Down Payment Percent 15.00%
Amount Financed $182,750
Mortgage Rate 6.00%
Assumptions Made Today
Years into Mortgage 6
Decision Horizon-years 9
Past Real Estate Returns 7%
FMV of House $322,657
Market Depression Factor 4%
Selling Price of House $309,751
Real Estate Commission Rate 5%
Return on Alternate Investment 3.00%
Mortgage Payoff amount (if
different from amortization schedule) --
Assumptions Made About Future
Estimate Future R/E Returns 4%
Estimated Value of House $459,242
Annual Rental Income (as 10%
percent of estimated fair value)
Beginning Annual Rental $ 32,266
Annual Rent Increase Percent 2.0%
Est. Repairs & Renovation
(in today's dollars) $100,000
Depreciation Period 27.5
Estimated Annual Costs to the Lessor $2,500
General Inflation Rate 4%
Property Management Fee 10%
Discount Rate 6%
Tax Assumptions
Taxpayer Assumptions
Tax Rates
State
Federal & Local
Marginal Tax Rates: 28% 6% 34%
Capital Gains 15%
Depreciation Recapture 25%
Exhibit 2: Results Sheet
Results
Fifteen-Year Mortgage
Mortgage Term 15
Mortgage Payment $ 1,542
Net Present Value of:
Rent Decision $150,919
Sell Decision $165,812
The Data Suggest that
Selling the Property is Preferred
Amount of the Benefit $ 14,894
Thirty-Year Mortgage
Mortgage Term 30
Mortgage Payment $ 1,096
Net Present Value of:
Rent Decision $128,901
Sell Decision $127,233
The Data Suggest that
Renting the Property is Preferred
Amount of the Benefit $ 1,668
RELATED ARTICLE: Tax implications of renting your home. IRC (Internet Relay Chat) Computer conferencing on the Internet. There are hundreds of IRC channels on numerous subjects that are hosted on IRC servers around the world. After joining a channel, your messages are broadcast to everyone listening to that channel. section 121 has increased homeowners' flexibility tremendously. Owners can rent their prior residences for up to three years of the past five years and still take advantage of the $500,000 ($250,000 single) exclusion of gain on the sale of a personal residence as long as the home was their personal residence for two of those five years. In this context, owners can move back into a former home and make it once again their principal residence. After two years as a principal residence, the property qualifies for the exclusion for the gain on a sale. It should be noted, however, that any portion of the gain attributable to depreciation taken while the home was rented is taxed at a rate of 25% under section 121(d)(6) and section 1(b)(7). Any gain not covered not covered Health care adjective Referring to a procedure, test or other health service to which a policy holder or insurance beneficiary is not entitled under the terms of the policy or payment system–eg, Medicare. Cf Covered. by the exclusion may be eligible for the reduced long-term capital gain Long-term capital gain A profit on the sale of a security or mutual fund share that has been held for more than one year. rate of 15% (5% for taxpayers in the 10% and 15% brackets brackets: see punctuation. ). The American American, river, 30 mi (48 km) long, rising in N central Calif. in the Sierra Nevada and flowing SW into the Sacramento River at Sacramento. The discovery of gold at Sutter's Mill (see Sutter, John Augustus) along the river in 1848 led to the California gold rush of Jobs Creation Act of 2004 provides that the exclusion for gain on the sale of a principal residence does not apply if the residence was acquired in a like-kind exchange in which any gain was not recognized within the previous five years. A detailed discussion of the tax issues is beyond the scope of this article. For more information see "The Home Sale Exclusion" in the JofA (Oct.02, page 85). Unrealized gain Unrealized Gain A profit that results from holding on to an asset rather than cashing it in and using the funds. Notes: Let's say you own a stock that has doubled, but you haven't sold it yet. This is said to be an unrealized gain. on a rental home also may be deferred by exchanging the property for other like-kind property Like-Kind Property Investment or business land/properties that are considered to be the same type and exchanging them is therefore tax-free. Notes: For example, you can exchange a car for another car tax-free, but not a car for a piece of land. under section 1031. Any gain on the sale of a rental home in excess of the amount of depreciation deductions taken is eligible for capital gain treatment. Losses on the sale of a rental home are deductible That which may be taken away or subtracted. In taxation, an item that may be subtracted from gross income or adjusted gross income in determining taxable income (e.g., interest expenses, charitable contributions, certain taxes). whereas a loss from the sale of a personal residence is not deductible. Mention to your clients that rental homes are subject to the tax law's passive loss rules. Thus, a rental loss may not be deductible against their nonpassive income. Fortunately, there is an exception from the passive loss limitations for taxpayers with adjusted gross income less than $150,000. Section 469(i) allows someone who actively participates in the rental of real estate to deduct de·duct v. de·duct·ed, de·duct·ing, de·ducts v.tr. 1. To take away (a quantity) from another; subtract. 2. To derive by deduction; deduce. v.intr. up to $25,000 of net passive losses from rental real estate. Active participation requires that the owner make management decisions such as approving tenants, repairs and establishing the rent charge. PHILIP P,. WITMER, CPA (Computer Press Association, Landing, NJ) An earlier membership organization founded in 1983 that promoted excellence in computer journalism. Its annual awards honored outstanding examples in print, broadcast and electronic media. The CPA disbanded in 2000. , PhD, and CLAUDIA L. KELLEY, CPA, PhD, are associate professors at the Walker College of Business at Appalachian State University History Appalachian State University began in the summer of 1899 when a group of citizens of Watauga County, NC, under the leadership of D.D. Dougherty and B.B. Dougherty, began a movement to establish a good school in Boone, NC. Land was donated by D.B. in Boone, North Carolina Boone is a town located in the Blue Ridge Mountains of western North Carolina. Boone is the county seat of Watauga County. The population was 13,472 as of the 2000 census. . Their e-mail addresses See Internet address. e-mail address - electronic mail address are witmerpr@appstate.edu and kelleycl@appstate.edu, respectively. |
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