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The Real Deal
Cash May Be One Of The Best Incentives
By Jeff Klein
Unless you have been on Mars the last 12 months, you realize that the California real estate market is hot. Most buyers must be at or near the highest bid to be successful, but there are other factors that determine success. In fact, in a recent transaction in Menlo Park the lowest offer was actually selected by the seller. Of the 10 offers that a Menlo Park widow received, nine of them came from contractors intending to tear the home down. The lowest offer came from a family that would live in the home. After 50 years in her home, the seller was willing to leave more than $100,000 on the table in order to sell to a suitable family.
Perhaps the single most important issue (besides price) determining success is the seller's confidence in closing. One way to reassure the seller is to get preapproved for a mortgage. An even better way to reassure the seller is to close the transaction 24 hours after acceptance. Of course you may have to let the seller stay rent free until they have a chance to vacate. Since most mortgages cannot be put in place in that short of time, the buyer (you) would have to pay all cash for the home. While this may disqualify some, there are a surprising number of buyers that do have the means to pay all cash for a home.
However, there are many reasons that a buyer may prefer a mortgage. Often the buyer has substantial net worth tied up in securities that they do not want to liquidate due to capital gains taxes. Another reason to get a mortgage is the ability to leverage and by paying cash the buyer gives up this feature. Perhaps the most important reason to get a mortgage is the mortgage interest tax deduction.
There is a solution for someone with a large portfolio of securities that wants to offer an immediate close and not give up the benefits of a mortgage. The buyer might obtain a "margin" loan against securities to get sufficient cash to buy the home outright. This allows for a quick close and does not require the sale of securities. After closing on the home, the buyer can put a new mortgage on the home to pay back the margin loan, obtain the desired leverage and get the mortgage interest deduction.
This is where it gets a little bit tricky. Most people are aware that the IRS allows you to deduct interest on a "purchase mortgage" (a loan used to purchase a property) up to a loan size of $1 million. The IRS also allows you to deduct interest on an "equity mortgage" (a mortgage against the equity in a home) up to a loan size of $100,000.
Since a purchase money mortgage is 10 times the size of an equity mortgage, does our hypothetical borrower give up 90 percent of the benefit by using a margin loan to close quickly and obtaining a mortgage after the purchase is completed? Not necessarily. If the taxpayer can "trace" the use of the loan (that occurs after closing) to the purchase of the property, then the IRS considers it a purchase mortgage. In fact, the taxpayer does not even need to trace the use of the mortgage if it is closed within 90 days of the purchase.
Thus, by using this strategy the buyer can achieve all of the desired results. To recap, the margin loan can be done quickly so the buyer can offer a quick close. The margin loan does not require the sale of securities that may trigger capital gains. Leverage can be achieved after closing on the home. And the mortgage will be treated as a "purchase money mortgage" as long as it closes within 90 days of the purchase.
Jeff Klein is associated with Absolute Mortgage Banking. Information provided in this column is presented by the Realtor members of the Silicon Valley Association of Realtors. Send questions on any topic to: Ask Your Realtor, c/o SILVAR, Los Altos District, 345 San Antonio Road, Los Altos, CA, 94022; call 650.949.9115; or send email to ppompei@siliconvalley-realtors.org
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