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Tips and Strategies for an Ailing Credit Score

Provided By Jason DiLorenzo, President of Doctors Without Quarters, LLC

Many physicians rely on financing to purchase new equipment and expand their practice. The quality of your credit score can have major implications on several decisions regarding your business and personal financial plan. A good credit score not only makes it easier to secure favorable interest rates on loans, but it helps keep your insurance premiums affordable as well. It also makes renting a car or opening a checking account significantly easier. As your credit score improves, the potential opportunities to save money increase as well.

Typical day-to-day business activities that doctors face are capable of negatively impacting their credit score. For example, when you submit an application requesting credit, your score will be checked by the financial institution that would act as the lender. These hard inquiries (requested by someone other than yourself) can deduct from your credit score, some by as many as 10 or 15 points. Multiple applications in a short period of time can dramatically drop your score as well. If you’ve had an application turned down, it’s important that you raise your score and check with management about specific requirements and criteria before re-applying.

Medical School Loan Repayment

The good news is if your credit score is less than ideal, it’s possible to improve this relatively quickly. By wielding credit in a responsible manner, you can start to see improvements to your credit score within 30 to 60 days. Developing certain personal finance habits can really pay off by boosting your credit score which in turn lowers the cost of borrowing.

Getting the Complete Picture

Your credit score is a measure of your creditworthiness that lenders use to judge whether you’ll be able to pay back debts. First and foremost, you’ll want to obtain a recent copy of your credit report so you can gain a complete picture of your credit history and standing. The three major credit bureaus (Equifax, Experian and TransUnion) are required to provide you with one free copy per year, so it’s entirely possible to receive a complimentary copy every four months so that you can check up on your credit throughout the year. You can request a copy of your credit report from annualcreditreport.com

A 2013 Federal Trade Commission study found that one in four consumers had errors on their credit reports that could affect their credit score. Mistakes happen, so if you see any errors when reviewing your credit report, dispute them immediately. Check for correct information regarding your identity such as the spelling of your name and your current address. Also, make sure that your proper credit limits are listed and that there are no fraudulent accounts that you do not recognize.

If you spot a mistake like a paid-off medical school debt appearing as unpaid, contact the lender or creditor that reported the inaccurate information and ask them to update your account. The three major credit bureaus all have forms on their websites for submitting disputes as well. If neither of these options resolves the dispute, you can contact the Consumer Finance Protection Bureau (CFPB) and ask them to intervene on your behalf. A proactive approach to fixing errors on your report can give your credit score an immediate boost.

Factors to Be Aware Of

It’s nearly impossible to over-emphasize the importance of paying your bills on time. Your payment history, including the ones you pay late or skip altogether, is the single largest factor that influences your credit score. This component accounts for 35% of your FICO score. Accounts 90 days past due have a more negative impact on your credit score, so if you have multiple outstanding bills, prioritize them by paying off the most past-due accounts first and then gradually catch up on the rest. Using automated payments where possible can also help clean up your payment history.

The second most important factor to consider is your credit utilization ratio. This is the percent of available credit you’re using and accounts for 30% of your FICO score. The lower your utilization rate, the better your credit score will be. To calculate your rate, just divide your total credit balances by your total credit limits. Consumers with a credit utilization ratio of 10% or less will generally have a higher credit score than consumers with a rate over 20%. According to FICO, consumers with the best credit scores use just 7% of their revolving credit lines.

One simple way to lower your utilization rate is to request higher credit limits from your card issuers. Sometimes this happens automatically, but you can also make the request online or by phone. It never hurts to ask, right? You can even transfer a portion of one card’s spending limit to another card, provided that both cards are under the same issuer. However, this method is only effective if you don’t increase your spending habits in accordance with your credit limit.

Other Helpful Tips

Although it can be tempting to trim down a cluttered wallet, you should refrain from closing old cards when possible. This will cause your available credit to drop, which can set off a red flag with the bureaus. Approximately 15% of your credit score is determined by the length of your credit history. Closed accounts in good standing will remain on your report for about 10 years, but once removed will lower the average age of all your accounts and your score as well. One easy way to keep a card active is to use it for a recurring charge such as a utility bill.

Keeping your medical school loan repayment on schedule can give your score a boost and demonstrate to future lenders that you can be trusted to handle money responsibly. Having a variety of different kinds of credit can be helpful as well. For example, you could buy an appliance for your break room or piece of furniture for the waiting room and pay it off with an installment plan. The important thing is to avoid any derogatory marks that could substantially hurt your score. Bankruptcy, foreclosure, accounts in collections, tax liens and other civil judgments could all have lasting consequences for your credit.

If you have a rating below 700, many of the aforementioned tips can be helpful in getting you back in good standing with creditors. You don’t need a perfect score of 850 to enjoy the best rates as a consumer. In fact, the Fair Isaac Corporation that calculates FICO scores estimates that only 0.5% of consumers achieve a score of 850. A score in the 720 range is usually sufficient for securing reasonable interest rates on loans. These strategies won’t instantly cure what ails your credit history, but if adopted by lenders they can certainly be effective in getting your report back on the right track.

Have Questions?

Not all Related Services are offered directly from Larson Financial Group or Larson Financial Securities but may be available through the Doctors Only network of companies. Also this: The information provided is for informational purposes only and should not be construed as a recommendation or advice.”

The information provided is for informational purposes only and should not be construed as a recommendation or advice.

Evaluating a Physician Employment Contract

When we work with young physicians who are getting ready to finish residency or fellowship, it’s common for us to hear:

This is my first real job I’ve ever had.

I have no idea what to look for in a contract.

After spending close to a decade in training and accumulating nearly $180,000 of debt in the process, now comes the critical time when you officially enter your chosen field. When performing a physician contract review, compensation is an obvious starting point but there are other factors that need to be considered as well. Qualitative factors such as will this be a positive work environment that will allow you to reach your career objectives and thrive can be just as important. Many line items in your contract may determine not only how you operate in your professional life, but in your personal life as well.

Physician employment contracts can be lengthy and the underlying language can vary substantially. For example, a university hospital with a research department may want to own any intellectual property that you create. A small practice focused on serving patients may not care about research you do on your own time. You don’t want to just sign a legally binding document that you understand very little of and hope for the best. You need a professional that is capable of boiling down complex legal terminology into language that is easy to understand.

By working with a financial advisor that specializes in physicians, like Larson Financial Group, you’ll:

  • Get access to the latest industry benchmark data to ensure you’re being offered a fair salary, sign-on bonus, and incentive methodology.  Other data points include:
    • CME
    • Vacation Days
    • Retirement Benefits
    • Productivity Metrics (Collections or wRVUs) for your specialty
    • All this broken down Nationally, by Region, by Employer type, and more!
  • Play Good Cop/Bad Cop: you’ve heard this term, but probably not in this context!  By working with a financial advisor who specializes in negotiation, you don’t have to be the one that is asking for a higher sign-on bonus to meet market rates, leave that to us!  This lets you walk in on your first day on the job and not feel like you were “on the other side of the table” as your new employer.
  • Have access to a knowledgeable resource when you have questions on the financial implications related to non-compete/restrictive covenants, liquidated damages, etc.
  • Receive recommendations to expert healthcare employment law attorneys, when applicable.

Compensation and Bonus

Sample Benchmark Analysis – PM&R 2019

First and foremost, it is necessary to understand how each organization measures a physician’s productivity before you can forecast compensation and determine if it’s reasonable.

FOR PRIVATE PRACTICES

Performance incentives are typically based on collections. However, the reimbursements for a procedure vary depending on how the patient will pay for the treatment:

  • Are they enrolled in Medicare or Medicaid?
  • Do they have private insurance or are they paying cash?

Knowing the practice’s current payor mix should help you determine if the incentives for the collections-based model in the contract are realistic. Knowledge of how incoming patients are allocated will also allow you to forecast collections with a greater degree of certainty.

Is there the potential for ownership in the practice in the future? If so, the contract should lay out when the partnership could be offered and how the buy in is structured.

HOSPITAL SYSTEMS

Hospital Systems usually base their performance-incentive model on a measurement of productivity calculated by the Center for Medicare and Medicaid known as RVUs (relative value units). This is different than the collection model run by smaller practices. Your contract should include a conversion formula to specify the dollar amount of each RVU. The Medical Group Management Association (MGMA) has comprehensive data on how many RVUs a physician typically generates in relation to their specialty. Your potential employer should also be able to provide you with an estimate of how many RVUs you can anticipate so you can then determine whether the thresholds for performance incentives in the contract are feasible.

Under the university hospital arrangement, the RVU model is typically preferable to collections if there are performance incentives in the contract because the payor mix in an academic setting is often less than ideal. If you decide to pursue a career in academics, you’ll want to make sure the contract stipulates how your time will be allocated. This will let you set expectations for what percentage of your time will be devoted to research, teaching, treating patients, etc. While the compensation may not be as high for university hospital positions as they would be at a private group, there could be some intangible rewards. If you’re passionate about research and working with students, this route could align more closely with your career objectives.

THE NEGOTIATION

At the crux of financial negotiation of physician employment contracts is ensuring that you are compensated fairly and commensurately for the work you’re providing to your employer.  If you’re able to align your expected productivity with your associated compensated, then we consider this a fair offer.  For example, if you’re looking at the sample benchmark report, we would expect that after being in a job for more than 2 years and, a PM&R physician generating 4,733 wRVUs (Median Work RVUs for this specialty in 2019), would earn an estimated $292,110 (Median Total Compensation) for this specialty.  What we don’t want to see is the expectation that you’re generating 6,017 wRVUs (the 75th percentile) but only getting paid $242,754 (the 25th percentile).

Having access to the data keeps your negotiation and unemotional, a key to improving your offer to match market rates.  Meet with an advisor today to evaluate your contract.

Work Atmsophere

Physicians are in a period of transition when fielding job offers, and as many as 70% of physicians across all specialties change jobs within their first two years. Therefore, it’s important to select a location with a setting that will allow you to flourish professionally. When negotiating the terms of your employment, you’ll want to inquire about the facilities and resources that are at your disposal. There is usually a clause or series of clauses that discuss staff and other items necessary to fulfill the duties of a physician. This will help you determine if you have the space and staffing to meet the group’s productivity expectations. The current technology standards and provided equipment should also be discussed at this juncture.

An employment contract should lay out in black and white where you will be working and what type of schedule you will have to maintain. If you are expected to have evening or weekend clinic hours, this should all be expressed in the language of the contract. If working for a large system with multiple locations, the contract should also specify the exact location and include a clause that guarantees that any changes to your schedule or location will be mutually agreed upon.

What are your priorities?

There are generally three reasons why people choose a job:

    1. Location
    2. Work environment
    3. Compensation.

The perfect job is the one that is strong in all three, but that’s a very rare scenario. Generally, if a job can hit 2 of 3, then it’s worthwhile to take the offer seriously.  There’s no ‘right’ way to view it, it’s just being honest with yourself about what’s important and if this particular job checks those boxes.

Geographic Trends

As with most professions, compensation varies by region. The amount of the signing bonus and when it is given can usually be negotiated. The same can be true for relocation bonuses as well.

Another important benefit is medical malpractice insurance and what happens regarding coverage when employment ends. Many states require physicians to have certain levels of professional liability coverage during the period of time that falls under the state’s statute of limitation in which a suit can be brought. Your contract should specify the type of tail coverage offered.

Even if the contract is non-negotiable, it’s still important to have an understanding of what is being offered and what occurs when the contract is terminated. Depending on the contract termination language, you may be geographically restricted as far as where you can practice. You should know the non-compete rules like the back of your hand, and the non-compete provisions of your spouse if he or she is a physician as well. They can and usually do factor into personal decisions, such as if and when to buy a home.

Physician Contract Review

There are several reasons why you should have your physician employment contract reviewed by an attorney and a financial advisor, and by scheduling time to talk to us, we can help you determine what you need most.

Your attorney can analyze the legality of the document, while your advisor can help to verify that the benefits are reasonable and that the expectations for performance incentives are realistic. Your advisor can also help make you aware of retention bonuses and when they are awarded, so that if you decide to transition to another practice you’ll, be able to time the move so that you won’t lose out on a bonus (or worse, owe money to your former employer).

The value of a written agreement is that it dispels ambiguity and backtracking that cause confusion and perception problems. The best employment contracts establish principles that encourage shared responsibility and collaboration while creating opportunities for innovation, continuous improvement and shared benefits. You have invested far too many resources in your medical training to sign a contract without having it reviewed by a professional.

 

Real Estate Investments Could Potentially Lead to Steady Income

Real estate has a reputation for being a profitable albeit complex investment if done correctly. Investing in real estate has historically been an attractive asset class for those willing to take on more risk within this market segment. According to Standard and Poors, the S&P Global REIT index had 15-year annualized returns of 11.22% as of 9/30/2014. There are various methods available for investing in real estate and each has their own unique benefits and drawbacks.

Real Estate Mutual Funds and ETFs

There are hundreds of mutual funds and ETFs whose underlying holdings are real estate based. These funds may directly own Real Estate Investment Trusts (REITs) or companies that deal solely in real estate. They can provide a level of diversification and liquidity which supplies an investor with exposure to the real estate market without putting too much exposure in any one property or property manager.

Physician Financial Advisor

This method of investing does not present the owner with any control over the actual property and offers no direct tax benefits associated with property depreciation. Risks are inherent in all investments and real estate mutual funds are no exception. Typical risks include market risk, interest rate risk, default risk of debt-related investments and a drop in real estate values.

REITs

Publicly-traded REITs are another option for those who’d prefer not to be as actively involved in the purchase and upkeep of properties. The majority of REITs are Equity REITS where they own and operate income-producing real estate. Additionally, some REITs may offer higher dividend yields than some other investments. While they can present a diversification opportunity for a portfolio, they tend to be more narrow in their focus than an index-based mutual fund.

As with mutual funds, there are no direct tax benefits from property depreciation. The restrictions regarding liquidity can also be more expensive from a fee-perspective to the owner than divesting a mutual fund. Another risk associated with REITs is that they are largely interest-rate sensitive, which can result in higher volatility when interest rates change. Publicly-traded REIT share prices can also fluctuate wildly based on regional, national and stock market influences and trends. REITs are a complex product and investors should research the appropriateness based on their individual circumstances prior to investing.

Private Equity

In addition to REIT’s, it’s possible to further diversify a real estate portfolio by investing in a private-equity real estate fund. There are multiple private-equity funds to choose from with varying philosophies and degrees of risk. A conservative fund would typically involve lower risk equity investments in stable U.S. properties using relatively little leverage. A more aggressive fund would typically involve high risk equity investments in U.S. or international properties while using higher leverage.

Private-equity funds are traditionally only open to accredited investors and are not offered to the general public. They do not offer the liquidity and transparency of publicly-traded REITs. The fees and expenses incurred from private-equity real estate funds can be higher than one would normally expect with conventional investments such as mutual funds.

One challenge of the private equity real estate fund model is that investing strategy could be in response to capital flows rather than market conditions, with liquidating assets at predetermined fund termination dates for closed-end funds being a primary example. There are also scenarios where an asset could be sold to meet redemption demands in open-ended funds, which may result in less strategic decision making on acquisitions and divestitures. Be prepared to invest for at least 10 years before being able to realistically evaluate the success of the investment.

Direct Ownership

An investor also has the option to independently secure a property in their own name by paying in cash or obtaining a loan to purchase the asset. Buying real estate within an LLC may also offer increased asset protection. This could be a rental home or a building occupied by the LLC.

Investors who prefer to have direct ownership and control of their assets might find this strategy advantageous. However, the increased autonomy comes with a cost. A large repair or vacancy could potentially erode monthly or even annual profits. The task of researching properties and the maintenance and upkeep once purchased can easily take up a greater amount of time than anticipated. Many physicians who go that route may erode their investment returns by outsourcing these responsibilities to a property manager.

To match the diversification offered by many REITs, an individual would need to own multiple properties. A drawback of this strategy is that a lot of cash will be tied up in assets that are illiquid. Another risk is loss of money on the sale of the property or assuming full liability for any incident that occurs on the property past the limits of insurance coverage.

Risk is inherent with real estate, as with any investment. It may offer an opportunity to supplement and/or diversify income. Leveraging tax deductions and other asset protection strategies can increase the likelihood of having a consistent income stream from real estate investments. As with any investment, carefully consider the associated risks and your own financial situation before investing.

Have Questions?

This article was written by Larson Financial Group, LLC and provided courtesy of Paul Larson, President and CEO. Advisory Services offered through Larson Financial Group, LLC, a Registered Investment Advisor. Securities offered through Larson Financial Securities, LLC, Member FINRA/SIPC.

Information gathered from sources believed to be reliable but is not guaranteed. This is not an offer to sell nor a solicitation to buy any security or investment vehicle described herein. Diversification does not guarantee a profit or protect against loss. Consider objectives, risks and associated fees and expenses before investing. REITs and real estate investing are complex in nature. Carefully review the prospectus or other offering documents. Quoted index performance is for illustration purposes only. Indices are unmanaged and it is not possible to invest in an index itself.

Physician Tax Returns Could Present Challenges

We’ve all felt that time crunch as tax deadlines approach. In addition to being complex, tax code is subject to change at any time. Doctors are among the busiest of professionals and have little spare time to learn about the latest developments in tax law. In preparing your own taxes, you run the risk of missing out on potential tax deductions for doctors that could reduce your taxable income or unknowingly exposing yourself to an audit from the IRS.

Income and Material Participation

It’s important to recognize commonly used tax terms due to the nuances unique to physician tax returns. Having a good understanding of how income is defined will help clarify some of the more complicated tax concepts and strategies. Active income (sometimes called earned income) is what is reported on W2 and 1099 documents. This income is derived from your labor and is the most heavily taxed form of income. In addition to Federal and state income taxes, you’re also subject to Social Security and Medicare taxes also known as FICA witholdings. You may also be obligated to pay local income taxes depending on the municipality in which you practice or live.

Physician Tax Deductions

Passive income (or unearned income) is income derived from your assets instead of your labor. One example of this would be any income from your investment portfolio such as interest, dividends or capital gains. On the federal level, you could be subject to either long-term or short-term capital gains depending on how long you’ve held an investment. You may be responsible for paying taxes at your state’s rate as well. The cost of acquiring and selling an investment will affect your cost basis, so accurately tracking this information may lower your overall tax consequences. For tax purposes, cost basis is defined as the original value of an asset (usually the purchase price) which can be adjusted for stock splits, dividends, commissions and return of capital distributions. (1)

Passive income or losses are defined as activities in which the tax payer does not materially participate. There are several criteria for defining material participation, and you only need to meet one to qualify (2):

  • Does the taxpayer and/or spouse work more than 500 hours a year in the business?
  • Does the taxpayer do most of the work? Even if 500 hour test is not met, is his or her participation the only activity in the business? (ex. Sole proprietor with no employees)
  • Does the taxpayer work more than 100 hours and no one works more hours?
  • Does the taxpayer have several passive activities in which he participates between 100-500 hours each and the total time is more than 500 hours? Cannot include rental activities or activities involving portfolio or investment income.
  • Did the taxpayer materially participate for any 5 out of the 10 preceding years (need not be consecutive)?
  • Did the taxpayer materially participate in a personal service activity for any 3 prior years (need not be consecutive)? Personal service activities include fields of health, law, engineering, architecture, accounting, actuarial science, performing arts and consulting.
  • Do the facts and circumstances indicate taxpayer is materially participating? Test does not apply unless taxpayer worked more than 100 hours a year. Furthermore, it does not apply if any person other than the taxpayer received compensation for managing the activity or if any person other than the taxpayer spent more hours managing the activity.

Tax Deductions for Doctors

Did you know that many of the professional expenses that are required of you as a physician are tax deductible? Continuing medical expenses, medical malpractice insurance and membership dues for professional and public service organizations can be deducted. (3) There is also physician tax deductions for practices that have incurred losses or damages due to a natural disaster. You automatically qualify for this deduction if your practice is located in an official federal disaster area. (4)

For self-employed doctors and practice owners, travel related to the operation of your practice is fully deductible. However, typical commuting expenses are non-deductible. Keeping adequate travel records may allow you to qualify for a $0.55 per mile deduction. Most business meals and entertainment expenses are only partially deductible. To account for these, you should keep a log noting the amount spent, date, time, place of expenditure and business purpose.

There are numerous options for structuring your business from a legal and tax entity standpoint such as sole proprietorship, partnership, or limited liability company. Each form has advantages and disadvantages, and your choice will impact how you pay your taxes and the amount that you’ll owe.

Rental Income

Real estate investments and rental properties are a popular source of alternative income. Historically, real estate has been an attractive investment by providing 11.22% annualized returns over the past 15 years, according to the S&P Global REIT Index. However, it should not be assumed that past performance is indicative of future results, and fluctuations do occur up and down. As you can imagine, there are quite a few guidelines in regards to claiming rental properties on your tax return.

With real estate, your basis in a property is not fixed. (5) This also applies to your personal residence as well, but rules regarding taxation of a personal residence differ from rental property. The cost basis of a property can typically be reduced by items that represent a return of your cost, including an insurance payment you receive as a result of a casualty or theft. (6) Remember, it’s important to keep track of any renovations or improvements you’ve made that could affect the value of your property.

One important distinction to be aware of in the context of adjusted cost basis is the difference between property expenses and depreciation. According to IRS.gov, “depreciation is an income tax deduction taken against expenses that allows a taxpayer to recover the cost basis of a property. It is an annual allowance for the wear and tear or obsolescence of the property.” This mainly applies to tangible property like machinery or furniture but there are some intangible properties such as patents or computer software that are depreciable as well. In order to be eligible you must own the property and use it for a business, and it must have a determinable useful life of more than one year. (7) For example, having a new roof put on your practice’s building is depreciable whereas repairing an existing roof is classified as an expense.

When selling business property, you need to be aware of potential recapture situations where you would have to add back the deduction from a previous year to your current income. You can defer paying taxes on any gains under IRC Section 1031, allowing you to reinvest the proceeds in a similar property as part of a qualifying “like-kind” exchange. (8) To qualify for this exchange, you have to identify at least three “like-kind” properties within 45 days of the transaction, and then close on one of these properties within 180 days from the date of sale. This can be tricky due to the complex nature of real estate transactions, so professional assistance is often necessary.

This is just scratching the surface of the tax code as it relates to physicians. There are countless exceptions and minutiae that have to be considered on a case-by-case basis. You shouldn’t make decisions based solely on the recommendations of your colleagues or from articles you have read. Getting assistance from a trusted professional can reduce the uncertainty regarding these decisions.

Have Questions?

Advisory Services offered through Larson Financial Group, LLC, a Registered Investment Advisor. Securities offered through Larson Financial Securities, LLC, Member FINRA/SIPC. Medical Malpractice Insurance offered through Larson Financial Brokerage, LLC

Larson Financial Group, Larson Financial Securities, and their representatives do not provide legal or tax advice. Please consult the appropriate professional regarding your legal or tax planning needs.

(1)http://www.investopedia.com/terms/c/costbasis.asp
(2) http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Passive-Activity-Loss-ATG-Chapter-4-Material-Participation
(3) http://www.ventocpa.com/about_us/
(4) http://www.physicianspractice.com/blog/income-tax-deductions-commonly-overlooked-doctors
(5) http://www.investopedia.com/terms/a/adjustedbasis.asp
(6) http://www.investopedia.com/articles/investing/060313/what-determines-your-cost-basis.asp
(7) http://www.investopedia.com/walkthrough/corporate-finance/2/depreciation/other-considerations.aspx
(8) http://www.investopedia.com/terms/s/section1031.asp

Sell or Rent: Deciding What to Do with Your Home

By Elaine Floyd

The decision on whether to sell or rent your home is trickier than other financial decisions because of the emotional ties you have to your home. To make the best decision possible, evaluate the income, growth, and tax advantages of selling vs. renting and how it would advance your long-term goals.

If you are relocating due to a job change or retirement, you may want to keep your present home and rent it out rather than selling it and transferring the equity to a new home or reinvesting the proceeds.

The first question to ask yourself is why are you considering this strategy? Here are some of the more common reasons:

  1. Your home has appreciated considerably and you don’t want to sell while prices are still in an uptrend.
  2. You would enjoy receiving rental income as a supplement to other retirement incomes
  3. You are not sure the relocation is permanent and want to keep the home in case you decide to move back.
  4. You want to keep the home in the family for children or grandchildren.

Understanding your long-term objectives will provide direction in analyzing the sell-versus-rent question.

Appreciation

If your main objective is further price appreciation, when will you know when it’s time to sell? In other words, what is your exit strategy? If you see the home as a growth investment, is this the best growth investment right now, considering your objectives and the rest of your portfolio? If you had a lump sum of cash equal to the equity in the home, would you buy this home and rent it out or invest in something else?

Physician Mortgage Loans

The purpose in this line of questioning is to find out if you have an unhealthy attachment to the home as an investment—not uncommon when a particular asset has “been good” to you. If emotions are clouding your judgment, try viewing this asset within the context of other possible investments and ask yourself how much more you think the house might appreciate. If it’s already worth far more than you ever imagined, you might deem the house overvalued and reconsider the wisdom of keeping it.

Or it could be that your home hasn’t appreciated very much. In the event you have a loss on the home, you may be better off converting it to a rental before selling, since a loss on a personal residence is not tax deductible. Maintaining it as a rental may give the home time to appreciate. If it doesn’t, you could go ahead and sell it after renting it for a while and claim the loss on your tax return. (Be aware, however, that the IRS has disallowed loss deductions for rentals preceding a sale on the ground that there was no “profit motive” for the rental.) The property’s basis would be the lesser of adjusted cost basis or fair market value at the time of conversion and would need to be documented in order to claim the loss.

Income

Rental income can be a good source of retirement income—as long as the numbers work. One advantage of rental income is that it generally rises with inflation. However, the ability to raise rents varies with supply and demand in the local area, and this may change during the ownership period.

If you are keeping the house for income, you will need to do a market analysis to determine the appropriate amount of rent to charge and you will also need to fully understand the costs of ownership (maintenance, repairs, insurance, and so forth) in order to determine your net cash flow. Consultation with real estate agents and CPAs may be necessary.

There are numerous online calculators that can help you decide if your home is the best source of income or if you could do better with another investment. Most calculators will ask you for the expected monthly rent, ownership costs (taxes, capital improvements, and monthly maintenance costs), and the likely sale price of the home in order to calculate the “capitalization rate,” which you can then compare with the rate on long-term Treasuries.

If the cap rate is higher than the current rate on Treasuries, keeping the home as a rental is a good deal; if not, it’s not. Make sure you are not forcing the numbers to work by assuming too-high rent or too-low expenses. Accurate assumptions are crucial to understanding the investment merits of the deal. In the end, the sell-versus-rent decision will hinge on the ratio of rents to prices in the your neighborhood. Low rents and high home prices do not bode well for a client who’s thinking of leveraging his equity for an ongoing income stream.

In addition to the ratio of rents to prices, you need to understand the tax rules pertaining to income property. Rental income is taxable; however, the following expenses are deductible from rental income on Schedule E of Form 1040:

  • Real estate taxes
  • Management expenses
  • Maintenance expenses
  • Traveling expenses to look after the property
  • Legal expenses
  • Mortgage interest
  • Insurance premiums
  • Depreciation of the building (not the land) based on a 27 1/2 year recovery period
  • Depreciation of furniture, carpeting, and appliances based on a five-year recovery period

These tax breaks may make the deal more attractive than you had anticipated. On the other hand, the above list may make you aware of expenses you hadn’t thought about when calculating net cash flow. If you are investing for income, you need to be realistic about how much that net income will be.

Temporary rental

If you aren’t sure that the relocation will be permanent and you want to have the option of moving back into the home, renting it out for a period of time may be a good solution. However, you should keep an eye on the calendar and, if you’re going to sell, do it within three years in order to qualify for the $250,000 / $500,000 capital gains tax exclusion. According to the rules, even if a home has been converted to a rental, sellers can qualify for the capital gains tax exclusion if they’ve lived in the home as a principal residence two out of the five years preceding sale. Be sure you allow enough time to get the house on the market, sold, and closed before the three-year window closes.

Leaving it to heirs

As more young people get priced out of the housing market, you may want to keep your home for your children and grandchildren, renting them to the kids or to unrelated tenants. This is also a good tax-planning strategy because your heirs will receive a step-up in basis when they inherit the property. Remember, if you are renting the house to family members at below-market rates, you may only deduct expenses to the extent of the actual rent received (i.e., you can’t claim excess losses).

Analyzing the investment merits of a principal residence converted to a rental property is slightly trickier than analyzing any other investment because of your emotional connection to the property. You’ve enjoyed living in the home, made money on the home, and now want to keep the home as an investment. But as with any investment, it must be evaluated on the basis of its economic merits in light of your personal objectives and taking into account the property’s prospects for income, growth, and/or tax advantages.

As director of retirement and life planning for Horsesmouth, Elaine Floyd helps advisors better serve their clients by understanding the practical and technical aspects of retirement income planning. A former wirehouse broker, she earned her CFP designation in 1986.

Elaine Floyd is not affiliated with Larson Financial Group.

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