Effect of Second Home on EFC

Paying for College
21

<p>

</p>

<p>If your family sells their PRIMARY residence, the do get capital gains protection from the sale IF they reinvest the money into another primary residence within a period of time (I believe it’s two years…). I am NOT a tax expert…so please take what I’m saying with a grain of salt. I’m simply a homeowner…and parent of a college student.</p>

<p>If your family sells the home while you are in college and puts the profits into a bank account (let’s say that they net $100,000 from the sale), that $100,000 in savings would be considered an asset by both FAFSA and PROFILE.</p>

<p>I have to ask a question…just what kind of financial aid are you hoping to get when you go to college? The aid that you get based on the FAFSA is not really enough to cover the costs of attendance at a four year college…more like the costs of a community college/live at home arrangement. </p>

<p>I think what you should do is what others have suggested…RUN A FINANCiAL AID CALCULATOR and get some estimates for yourself.</p>

<p>One related comment…I DO believe purchasing a second home with no down payment is unlikely unless you are buying it from a friend with a private mortgage. CTofthehouse mentioned agreeing to a higher purchase price and that was part of the mortgage. In times when the market is good, that can happen, but right now folks are finding, in some cases, that their appraisal barely meets their price off or is even lower. And banks are really looking at what THEY are financing right now…if you add the down payment into the mortgage, the bank IS financing that amount.</p>

22

<p>cpt, the real estate market has changed dramatically in the last year and so has the mortgage game. I sold a house just this week (not my primary residence) and the hoops both buyer and seller must jump through to get loan approval are unbelievable. “Off the books” transactions are not allowed and lenders are putting every deal under the microscope. Although there was nothing questionable about our deal, it cost many thousands extra just to help get the loan approved for a buyer with “perfect” credit, more than adequate income, and a military pension to boot! My agent told me these requirements did not exist a year ago. In short, it was a nightmare compared to my six previous real estate transactions.</p>

23

<p>I’ll try also here in a simplistic way and I do admire your curiosity…questions in reverse order since the last question is easier! When your parents sell your primary residence (the house you ultimately live in) there is tax protection now that wasn’t there 15 years ago which is what your dad is referring to. This is based on the premise that a house is worth more each year. So the increased value is not taxed as a “gain” under current regulations. Our government likes to change tax laws all the time, so one cannot always assume that the tax laws will be the same in 5, 10 or 15 years. However, this is a geneally popular tax law and I for one am hoping it stays the same. The rental property is different. The day you own a rental property there is a value of the property, called a basis, when that property is sold the difference between the basis and what it is sold for minus certain expenses is taxable and called generally a gain or capital gain. If your parents buy a new home (to live in) then they will establish a basis for the house they are leaving and starting to rent. They will have to do this anyway for the taxes they fill out early next year (assuming they do all this in thie year). You use the basis to compute depreciation, etc. Capital gains are extremely complex and there are ways to mitigate them…this is stuff for the experts so I won’t even attempt to explain that. </p>

<p>

</p>

<p>Sorta. I’m assuming that your parents still “owe” on the soon to be rental. Unfortunately it’s not necessarily “tit for tat.” I generally use my tax forms as my guiding principle for what gets reported as “income” from the rentals on financial aid documents so everything “matches”. I use market value each year to value the rental properties by calling a friend who is a real estate agent and having her check sales of comparable properties, make a note of what they sold for and stick the note in a file. It’s a pain, but generally it’s “good” to know the value just because. It helps to be doing the taxes and the financial aid forms all at the same time.</p>

<p>

</p>

<p>Chances are it won’t increase alot because chances are your parents are purchasing the house with a mortgage that is close to the value of the home so each year their equity will increase…as long as the market value increases each year…however the rental property (your old home) is now an asset and that is different from a primary residence on the FAFSA and none of us here know the details of what it’s worth, what your parents owe etc. Again, you’d have to run scenarios on the calculators. Finally I have no clue and can’t advise how individual colleges look at the specifics of various items on the Profile…in other words I can’t tell you how the “mortgage” payments on the new home will impact evaluation on the CSS. It sounds like you are running numbers and that is the best thing you can do at this point.</p>

<p>

</p>

<p>I would not assume that in such general terms and sorry if I mislead. While I tend to look at life as half full instead of half empty…in financial matters, my advice is plan for the worse and be happy when things turn out well. My advice as a parent is to make sure you are emotionally comfotable at your state school…which sounds like you’ve designated as your “financial safety” or find one that you like for your “list” just in case your Profile schools leave your family with too big of a gap.</p>

24

<p>

This has not been true for years.</p>

<p>What happens now is that if you are married, the first $500,000 in profit on the sale of your primary residence is tax free - $250,000 if you are not married. You do not have to roll it over, or anything else. You get to put it in your pocket.</p>

<p>There are some problems with converting your current residence into a rental for FA purposes. </p>

<p>First - presumably there is some equity buildup in your current house - this instantly gets converted into an asset that is considered for financial aid. Many private schools provide some level of equity exclusion from your assets on your primary residence; you will lose this protection if you convert the house to a rental. Every PROFILE school has their own way of treating the equity in your primary residence though - you will need to ask each school.</p>

<p>Quick example - you have $200,000 in equity built up in your primary residence and you apply to a school that doesn’t count equity equal to twice your income of $100,000. No contribution from your house equity is counted.</p>

<p>The minute it becomes a rental, they will add 6% of your equity, or $12,000, to your EFC. This is a serious hit to your financial aid possibilities.</p>

<p>Second - the depreciation you start taking on the property will likely give you a net loss from operating the rental (income - expenses - depreciation). (BTW, "incidental expenses, as you call them, can be considerable - property taxes, insurance, repair expenses, legal fees, commissions, utilities, etc). This lowers your taxes, which will raise your EFC, because you get a deduction for taxes paid. The loss lowers your income, which will lower your EFC. How it nets out - who knows.</p>

<p>However, some/many PROFILE schools will add depreciation back into your income because it is a “phantom” expense - you don’t pay it with out-of-pocket cash. This can push you into making a “profit” as far as the schools are concerned, which will also raise your EFC. It is a double-whammy - the lower taxes raises your EFC, and the added-back depreciation also raises your EFC. (The basis for depreciation, btw, is the lesser of your basis or the FMV on the day you convert it).</p>

<p>Third - if the property does generate a loss, whether you can deduct that loss at all depends on how much your parents make. The loss starts to phase out at $100,000 and you lose it completely by $150,000, and in any case it is capped at $25K (except under very specific circumstances your parents likely won’t meet). So there may not even be any tax advantages, or income-lowering advantages, <em>and</em> you will have to pay the loss out-of-pocket, which lowers the money available to pay your contribution.</p>

<p>Fourth - when the rental is finally sold, the profit/loss is business income/loss, it does not get capital gains treatment. You said “My dad told me that if they were to sell one of the houses a long time down the road then we could get lots of asset protection or something like that”, I’m not sure what you mean by this, this doesn’t make a lot of sense.</p>

<p>Fifth - owning rental property is not for the faint of heart. It can require a significant time investment, and there are many, many, many landmines for the unwary. Do you know what the Fair Housing Laws are? What the Consumer Credit laws are? Do you know how to find a quality tenant? Do you know what you can legally do if the tenant stops paying rent? Do you have sufficient financial reserves to survive a 6 month eviction process where you are getting zero income? If your house is older then 30 years old, do you understand the ramifications of the lead paint laws? Etc, etc, etc.</p>

<p>Screwing up any one of these can cost you thousands, which can directly impact your parents ability to pay for their contribution.</p>

<p>Without knowing the full details of your family’s financial circumstances, no one can say with certainty what the effects will be, but I’ve tried to outline some of the main points. Hope I didn’t scare you. :)</p>

25

<p>

</p>

<p>We haven’t sold one in probably 18 years, but plan on selling one next year when its depreciation runs out and if the market starts moving…is this true? Is this only true if the rental is set up as an LLC? Reminder to self…do some research before listing…</p>

26

<p>

My understanding is that the business structure it is in doesn’t matter, it’s the use that matters. So being in an LLC wouldn’t effect who the gains are treated.</p>

<p>I’m not a tax pro, I just know enough to be dangerous. :)</p>

<p>Here’s the opinion of a very well-known tax pro:</p>

<p>[How</a> Do You Report Real Estate Losses When You Sell? | TaxLoopholes](<a href=“http://www.taxloopholes.com/connect/blog/diane-kennedy/2009/02/how-do-you-report-real-estate-]How”>http://www.taxloopholes.com/connect/blog/diane-kennedy/2009/02/how-do-you-report-real-estate-)</p>

<p>If you are going to roll the profits into another property, you could do a 1031 exchange and avoid all the taxes.</p>

27

<p>Thanks notrichenough for the link, too. My husband is actually arguing at the moment for the LLC because all of a sudden he’s worrying about liability (probably because the rentals are falling down around us LOL) and I’m the data driven researcher in the fam so get to look at all the ins and outs and (cost) ramifications…sigh…it hurts my brain.</p>

28

<p>LLC’s have their uses, but they have their drawbacks as well:</p>

<p>1) they are costly - in my state it costs $500/year to maintain the LLC, times X number of properties… it adds up. You could use a Series LLC, but they are not available in every state, and the isolation between the cells has not been rigorously tested court-wise. Some states like CA ding each cell, and in CA it is like $800 per year per!</p>

<p>2) if you are managing the property yourselves, the LLC may not provide full protection because in any situation where you get sued, the owner (the LLC) and the employees of the LLC (you) or whoever is doing the management (again, you) will all likely get named.</p>

<p>3) if you have a mortgage, you will technically be in violation of your mortgage if you transfer title to an LLC. If you are current, the bank likely won’t do anything, although they are within their rights to call the mortgage. You can also transfer title but not record it, that way they will never find out. </p>

<p>4) you can’t refinance with any Fannie Mae or Freddie Mac lender if title is held by an LLC. You have to transfer it back into your name for 6 months before you can refi.</p>

<p>5) you need to make sure there is more than one member of the LLC. Courts are fairly regularly “piercing the veil” of single member LLCs.</p>

<p>6) Your taxes will get more complicated and expensive to do each year.</p>

<p>We’ve chosen to deal with the liability issue by getting a huge umbrella liability policy.</p>

29

I will tell you why we are considering it as a family. It costs over $1K a month/ $10K a year in loans for our son to have a place to live on campus and a meager meal plan. That place is half of a small bedroom!! For the same expense he could have a whole house to live in. We can also do the community service of renting out rooms at a cheaper rate than the dorms and give his classmates a better deal on living expenses. With that plan everyone wins. Classmates get a better deal, our son pays down a bunch of that debt, and there is an asset to sell at the end. If college dorm costs weren’t so exorbitant we wouldn’t even be considering it. We likely don’t have enough to qualify for a second home mortgage anyway, but that is why we are considering it.

30

Please use up old threads only for research.