Claiming a depreciation expense allows you to take a dollar amount that equates to about 3.6% (residential) or 2.5% (commercial) of the value of an investment property building (excluding the value of the land) as an expense for a number of years (27.5 for residential and 39 for commercial) to lower your annual taxes due to the IRS. This means when you calculate your net income each year for a residential investment property that is worth $300,000 (excluding the land value), you would deduct $10,909 from your net profit number before you calculate your tax liability. This means you are not paying taxes on that $10,909 if you record your depreciation expense.
When you are ready to sell the property, taxes do become due on the amount you deducted each year but it is still best to take the deprecation expense. Even if you don’t claim the expense each year, the IRS will calculate your capital gains taxes as if you had.
To avoid taxes on capital gains when you sell an investment property, consider a 1031 exchange. If you plan to take your profit from one investment property and use it to buy a similar investment property this option might work for you. Speak to your accountant about this option and make sure you understand the requirements. There are various rules regarding the handling of funds and deadlines that must be met in order to avoid the tax implications.
(Please note this blog should not be construed as financial advice. It reflects my opinion and experience only, which might not apply to you. Always consult your accountant before you make financial and tax decisions.)
I recently met a couple that bought a single-family home about five years ago. They were first-time home buyers, and at the time they were represented by an agent I do not know. The home they purchased was recently renovated, including the entire kitchen. Their transaction seemed to go smoothly, and they were confident that they got a great deal on the price—until their home ownership dream quickly turned into a nightmare. In just a few months after closing, they started having extensive plumbing problems, and eventually their entire upstairs bathroom started sinking down into the kitchen directly below.
This sounds unimaginable, but this type of scenario can happen when renovations are completed without the owner taking the proper steps. The prior owner had removed a supporting wall to redesign the kitchen and failed to consult with an engineer and carpenters to ensure that a proper supporting beam was installed. In addition, the owner had renovated without applying for a permit or obtaining a certificate of occupancy (CO). The new buyers were completely unaware of the seller’s negligence. They were left with an overwhelming expense that they could not afford, and soon afterward the home went into foreclosure.
I tell this story because it is one that could have been avoided. Often, the importance of a CO is communicated to sellers, but it is even more important that CO’s be fully understood by buyer agents and homebuyers. The process for obtaining a CO starts with applying for a permit. Each town has a list of the types of renovations that require a permit and CO. Obtaining a permit requires paying a small fee (generally $10 to $13 per $1,000 worth of planned work) and presenting an outline of the work planned for the home. You might also have to visit several town departments to verify information about your home beyond your work’s scope.
Through this process you will get feedback from your local building department and other town agencies that will help you adjust and finalize your plans. Once the work is completed, an inspector will visit your home and determine if the project was completed in accordance with current building codes. If the inspection goes well, you will receive a CO for your records, which you can share with future buyers. The process is quite simple and requires just a few hours of time and interaction with experts that can turn out to be very helpful. You will gain knowledge about various town departments and how their services protect you, your home, and the property values in your community.
If you are a potential buyer and you notice renovations in a home that you plan to purchase, you should always ask for a CO. If there is none, you can request that the seller apply for a permit retroactively and obtain a CO before you close. Buyers that don’t require this tend to be experienced contractors or tradesmen. These types of professionals often have confidence that they can inspect renovations themselves and are comfortable with the risks involved with doing so. Most homebuyers should avoid that type of risk.
You can learn more and apply for permits online in most lower Fairfield County towns. Click the link for your town.
SONO (South Norwalk, CT) is super cool these days. I can’t wait until the new Bloomingdales is complete. A mix of “mom and pop” shops with a quality retail brand as an anchor is great for their development plan.
I am spreading joy this Fall and Winter and also building my email list. I am raffling off a free home inspection for every 20 new potential clients that join my email list between now and the end of the year. Each raffle winner gets a free home inspection (useful for buyers and sellers) as long as they complete a transaction with me within the next 2 years. Tell anyone who plans to buy, sell or invest in the next couple of years and they will thank you.
Also, don’t feel any pressure to wait two years. Spring market is over and every buyer and seller should consider the advantages of making deals in the Fall and Winter. Sellers are happy in the winter since buyers tend to be more qualified, serious and decisive. There is less wear and tear on homes from buyer traffic; and buyers have less home options to choose from so your property can truly stand out.
Buyers also have advantages in the Fall and Winter. Sellers tend to be more serious about selling and prices and negotiations tend to be more efficient. Buyers also have less competition from other buyers.
Everyone is more agreeable if they want to complete a move before the holidays. If you are not the ultra-competitive type, buying this time of year might work for you.
The good news this mid-year is that sales volume is not declining for single family homes or condos compared to last year. Demand is outpacing last year by 7% and 4% respectively, even though demand for homes is weakening nationally. In regard to prices, the median price PSF for single family homes in Stamford is up 2%, so we are still seeing a gradual, sustainable improvement. Condo buyers are still applying smaller budgets in general reflected by the median price decline of 7%, but they are also paying slightly more per square foot. This reflects a continued focus on condition, location and floor plan as factors that are just as important as size. It is still a great time to buy. Prices are affordable compared to area income and mortgage interest rates continue to be historically low. This will not be the case forever. Check out the stunning homes with the highest sold price for both mid-years linked below. I have also included homes that reflect the median, highest and lowest prices per square foot.
Home ownership requires a lot of paperwork, estimates, receipts, agreements and contracts. Having a system for filing these records will create benefits long-term. You will easily locate records when you need them to compare pricing, contracts and service levels across the vendors you use over time. You will also become a resource for helpful information that you can share with friends and family whenever they have similar needs.
Furthermore, there are tax benefits that you can access if you have the proper records. Make sure to save records of all home improvements and expenses. You will need this when you are ready to sell your home and at tax time if you have a home-based business office.
Here are a few tips:
Keep all of the documents related to the sale of your home (deed and loan docs) in a safe place. A fireproof or safe deposit box is best.
Keep a file with estimates from contractors and service providers. You will need to compare these over time.
Keep manuals and warranties and service records together for easy access. You will also want to show these to future buyers of your home. These provide evidence that you have maintained your home over time.
Keep a list of model numbers, receipts and photos of major purchases and capital improvements. You will need these for insurance claims if there is ever a fire in your home or loss from theft or natural disaster. Keep a copy of this off-site at your work location or with a family member. Many insurance companies have apps that assist in recording inventory. Examples include: Liberty Mutual Home Gallery and the State Farm Home Index and the Allstaste Digital Locker. If you don’t wan’t to learn a new app, start a Google-docs or Evernote inventory list and start recording possessions by room. Make sure to include photos, purchase price and date, bar codes, item/model numbers, where you purchased the item and scanned receipts.
Keep a separate file for major home maintenance projects. These will be helpful to provide to a future buyer when you sell. They will also be needed calculate capital gains when you are ready to sell.
Create a complete budget for your home based on your monthly and annual expenses and emergency savings fund. This will help you make financial decisions when it is time to change jobs, make other financial investments or create college savings accounts for your kids.