02.17.11
Posted in Family Law, Litigation, Real Estate Law at 13:30 by Administrator
Q. It is generally understood that spouses have a moral duty to deal fairly with each other, which includes disclosing certain facts to each other as well as conforming one’s conduct to certain standards. However, in today’s society, many people want to decide for themselves what is (and by implication, what is not) encompassed by this moral duty, which invariably leads to different interpretations and different results for different couples, even though the relevant facts are the same. What (uniform) duty does California law impose on spouses?
A. California imposes fiduciary duties – the highest form of duty recognized in the law – on, and between, spouses. The existence of spousal fiduciary duties is the reason that a different legal standard and procedure applies when entering into premarital agreements (entered into before marriage) and marital agreements (entered into during marriage) – both of which may accomplish, among other things, the same objective of “opting out” of California’s community form of marital property laws. See, Technicalities of Marital Agreements, http://earlelaw.com/blog/2011/01/22/technicalities-of-marital-agreements-2011-03/
For a period of time, there was some tension and ambiguity in California law between, on the one hand, the presumption that title to real property correctly reflects ownership of that property and, on the other hand, community property law which provides that, with certain narrow exceptions, all property acquired during marriage – regardless of how title is held – is community property. This issue has been settled, with the marital (community) property presumption prevailing over the title presumption. See, Who Owns that House?: What Spouses Need to Know, http://earlelaw.com/blog/2011/01/07/who-owns-that-house-what-spouses-need-to-know-2011-01/
The recent case In re: Marriage of Fossum, B214824 (Second Appellate District, January 28, 2011), provides further elucidation and guidance on the issue of marital fiduciary duty.
The court’s opinion in Fossum starts out in rather unremarkable fashion. Fossum involved a couple who divorced after a number of years of marriage. Many years prior to separation, one spouse transferred to the other, the former’s community property interest in a parcel of real property. The reason for the transfer was solely to facilitate financing. However, notwithstanding a promise to do so, the latter never reconveyed that community interest back to the former. The Fossum court held that, consistent with previous similar cases, the presumption regarding marital property trumps the title presumption. The court then disregarded the record title of sole ownership and deemed the parcel of real property to be a community asset which was subject to equal division. If this were all the court held, the decision in Fossum would hardly be worth noticing or mentioning.
What makes Fossum interesting, however, is its discussion of an additional issue concerning a credit card cash advance taken less than one year prior to separation and filing for divorce, but not disclosed to the other spouse. The court held that the failure to disclose the cash advance to the other spouse constituted a violation of the fiduciary duty owed by the spouse who obtained the cash advance. To emphasize the seriousness with which the law regards such conduct, the court further held that relevant statutes require trial courts, upon proper request, to make orders requiring spouses who violate their fiduciary duties to pay attorney fees incurred by the other the spouse to obtain legal remedy for such violation.
Because it is not reasonable to expect non-lawyers to be aware of all statutes and court decisions, the Fossum decision can also be understood as a reminder to consult with your attorney as soon as potential legal issues arise, and to disclose all facts during your attorney-client privileged conversations.
*Anthony F. Earle, Esquire is a California attorney and real estate broker who maintains a practice in the Silicon Valley area of northern California. He can be reached at: anthony.earle@earlelaw.com. This article is intended for information and educational purposes only, and is not intended to constitute legal advice.
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02.11.11
Posted in Litigation, Real Estate Law at 15:22 by Administrator
Q. I am attempting to negotiate a short sale agreement with my mortgage lender, as the California home that I own is now worth much less than the balance of my mortgage loan. The lender, as a condition of agreeing to a short sale, wants me to sign a promissory note which would obligate me to repay the difference between what is owed on the first trust deed and the short sale price. Is this legal?
A. The California legislature, during 2010, passed Senate Bill 931 (SB931), which, effective January 1, 2011, created and added section 580e to the California Code of Civil Procedure. The purpose of Section 580e appears to have been to prevent mortgage lenders from obtaining deficiency judgments – civil court judgments for the difference between the payoff amount due on a mortgage loan and the (lesser) sale price of the home (deficiency amount) – where the lender accepts an amount less than the loan payoff when releasing its security interest in a residential property.
The perceived need for Section 580e arose, apparently, from the practice of mortgage lenders, such as your lender, requiring borrowers to execute an unsecured promissory note in an amount equal to the deficiency amount, as a condition of agreeing to a short sale transaction. Section 580e, ostensibly, solves this “problem.” But does Section 580e, perhaps unintentionally, create another problem? Will this new statute actually do what it purports to do? Let us look at two issues.
First, any law which prohibits mortgage lenders from attempting to recover deficiency amounts in this fashion creates a disincentive for lenders to accept short sale agreements. California may be able to force mortgage lenders to forgo attempted recovery of short sale deficiency amounts; however, the state may not (at least not yet) force mortgage lenders to enter into short sale agreements. Thus, the foreseeable result is an increase in foreclosures above that which would have occurred in the absence of Section 580e.
Second, this new statute may not actually accomplish that which it purports to accomplish. Section 580e provides only that “[n]o judgment shall be rendered for any deficiency under a note secured by a first [deed of trust or mortgage] . . . [and that agreement to a short sale] shall obligate [the mortgage lender] to accept the sale proceeds as full payment and to fully discharge the remaining amount [on the secured loan]. (Underline added.)
It is not inconceivable that some mortgage lenders might take the position that Section 580e does not in any way affect their short sale protocols. The argument would go something like this: the mortgage lender did accept proceeds from the short sale as full payment of the secured note and did fully discharge the remaining (deficiency) amount due on the secured note. The unsecured note – which was executed after the remaining amount due on the mortgage loan had been fully discharged – is a new and different promissory note, is fully enforceable, and that any judgment entered thereon (were the former homeowner to default on that note) would not be a judgment for a “deficiency under a note secured by a first deed of trust or first mortgage for a dwelling” but, rather, would simply be a judgment on an ordinary, unsecured note.
Because Section 580e is but a few weeks old, no appellate (or other) court cases interpreting the statute have been decided as of this writing. Borrowers and real estate professionals should continue the prudent practice of obtaining the assistance of an attorney when considering any short sale transaction.
*Anthony F. Earle, Esquire is a California attorney and real estate broker who maintains a practice in the Silicon Valley area of northern California. He can be reached at: anthony.earle@earlelaw.com. This article is intended for information and educational purposes only, and is not intended to constitute legal advice.
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02.02.11
Posted in Litigation at 19:58 by Administrator
Q. My legal life needs some help. My spouse and I have decided to divorce. Also, unrelated to the divorce, my small business has a contract dispute with another business. I can’t afford a lawyer, can’t afford a long, drawn-out court case(s), and just want a fair resolution for both my divorce and contract case. What options do I have?
A. There are many alternatives to traditional court proceedings which are available to litigants such as yourself, who seek to resolve disputes without investing the time and expense required by traditional litigation. Broadly speaking, these methods are known as Alternative Dispute Resolution (ADR).
Methods of ADR include traditional mediation, collaborative law processes, arbitration (binding and non-binding), and private judging. One common requirement for all private (e.g., non-court-ordered) ADR processes is the willingness and consent of adverse parties to participate in the process. One party, whether plaintiff or defendant, may not compel an unwilling adverse party to participate in ADR. One exception to this rule is where a party to a contract consents in the contract to arbitration, but later withdraws that consent. Usually, the attempt to withdraw consent will not be given effect. Many (if not most) courts now require all parties to participate in some form of non-binding ADR before the court will schedule a trial date.
For purposes of this discussion, the types of ADR are either non-binding or binding. Non-binding ADR can be defined as any method of dispute resolution which requires the agreement of each party in order to resolve the case. Arbitration where one or more parties can reject the arbitrator’s decision and force the case back into court is an example of non-binding ADR. Other examples include mediation and collaborative law processes, both of which require the parties to affirmatively accept settlement terms. A significant drawback of non-binding ADR is the potential additional expense involved if the process fails and the parties end up back where they started: in court. This consideration is made more acute where, as in most family law cases, the court may order one party to pay some or all of the other party’s attorney fees and costs.
Binding ADR, that is, binding arbitration or private judging, effectively solves the problem of increased costs due to one or more parties rejecting a non-binding resolution of a case. But in solving one problem, other potential problems are created.
The significant issue presented by binding arbitration is that the arbitrator’s decision – right or wrong, correct or incorrect – will, in all likelihood, be final and non-appealable. On the other hand, one possible advantage is that statements made during arbitration are privileged and, thus, may not used outside the context of the arbitration.
Private judges are persons who are not judicial officers; that is, private judges have not been appointed or elected to a judgship. Rather, they are private persons, usually attorneys with significant knowledge and experience in a particular area of law, whom the parties to a particular dispute authorize to act as a judge and decide contested issues. Unlike an arbitrator’s decision, the decision of a private judge is appealable in the same manner as would be the decision of an elected or appointed judge. Proceedings conducted by private judges do not enjoy the same confidentiality as arbitration proceedings.
Regardless of which form of ADR parties to a lawsuit may choose to use, each party still retains the right to be represented by an attorney. However, if the goal is to resolve a dispute as economically as possible, perhaps because a final decision is needed but the amount in controversy is not too great, some or all parties may simply want to act as their own attorney.
*Anthony F. Earle, Esquire is a California attorney and real estate broker who maintains a practice in the Silicon Valley area of northern California. He can be reached at: anthony.earle@earlelaw.com. This article is intended for information and educational purposes only, and is not intended to constitute legal advice.
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01.26.11
Posted in Litigation, Real Estate Law at 17:22 by Administrator
Q. I hired a general contractor to perform some remodeling work at my California home. Although I have paid the general contractor a large sum of money, I have concerns that the general contractor may not be paying the sub-contractors. What are my rights? What can I do to protect myself?
A. California law, as you may be discovering, provides significant protection for those who provide labor or materials for the development or improvement of real property. The public policy on this issue is so strong that the right to mechanics’ liens is found, in the first instance, in the California Constitution.
The current mechanics’ lien statutes, which implement the right found in the state constitution, have been in effect since 1969. The statutes are a bit complex and have been criticized for not providing sufficient protections for property owners such as yourself. Recent revisions to the law may, however, provide property owners with some relief.
Assembly Bill 457, which became effective January 1, 2011, amended California Civil Code §§ 3084 and 3146, which relate to the enforceability of mechanics’ liens on private (non-governmental) projects. The provisions of AB 457 impose a new requirement that contractors (including sub-contractors) must now give the owner of the property notice of a lien. Additionally, a notice of pending action (lis pendens) must now be recorded no later than 20 days after the filing of a lawsuit to enforce the lien. The requirement that a lawsuit to enforce the lien be filed no more than 90 days after the recording of a mechanics’ lien remains unchanged.
Other major changes mandated by AB 457 are that: (1) certain mandatory language is now required in mechanics’ liens, the purpose of which is to set a minimum level of disclosure regarding the nature of the claim; (2) the lien must now be served on the property owner by registered or certified first-class mail; (3) a proof of service must accompany the lien; and (4) failure to serve the property owner with a copy of the lien renders the lien “unenforceable as a matter of law.”
Further changes to the mechanics’ lien law are scheduled to become effective July 1, 2012.
Although property owners now have significantly greater rights since AB 457 became law, the procedural labyrinth associated with mechanics’ liens and related lawsuits to enforce such liens, can still be quite daunting. As such, you should retain an attorney to assist you with your case, if at all possible.
*Anthony F. Earle, Esquire is a California attorney and real estate broker who maintains a practice in the Silicon Valley area of northern California. He can be reached at: anthony.earle@earlelaw.com. This article is intended for information and educational purposes only, and is not intended to constitute legal advice.
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01.22.11
Posted in Family Law, Litigation at 18:41 by Administrator
Q. I am planning to get married soon. My future spouse and I are considering whether to enter into a prenuptial agreement. What should we know about such agreements? Do we need an attorney?
A. In California, martial property is governed by community property laws (as opposed to the common law of marital property). “Community property” is defined as “all property acquired by a married person during marriage while domiciled in California,” Family Code § 760, except for certain limited exceptions.
Participation in the California community property system is voluntary. Married persons who agree to do so, may opt out of the community property system. The reasons a couple might choose to opt out are many and varied, and include routine business purposes such as asset protection. See, http://earlelaw.com/Newsletters-2010/EarleLaw-Newsletter-2010-29.pdf.
The method for opting out of California’s community property system is the marital agreement. Martial agreements may be entered into either before or during marriage, although more stringent procedures apply once the parties to the agreement marry each other.
In addition to opting out of the community property system of marital property, couples also may address the issue of spousal support (alimony) in their marital agreements. Although waivers of spousal support are allowed, a court may refuse to enforce waivers in exceptional circumstances.
Additionally, any provision of a marital agreement which is deemed “promotive of dissolution [divorce]” will not be enforced. Whether a provision (or the entire agreement) is, on the one hand, unenforceable because it is promotive of dissolution or, on the other hand, enforceable because it merely “reorders property rights” often requires a very fact-specific analysis.
The rules relating to marital agreements have changed significantly over the years and often are not intuitive. For example, prior to the year 2001, a premarital agreement was enforceable as long as it was: (1) entered into voluntarily, (2) not unconscionable, and (3) the party against whom enforcement is sought had actual or constructive knowledge of the other party’s assets, unless a valid waiver had been executed.
In the year 2000, the California Supreme Court held that a premarital agreement between major league baseball player Barry Bonds and his wife, whose native language is Swedish, was enforceable, even though the agreement was executed on the eve of the parties’ wedding and despite the fact that Bonds’ fiancé had not been represented by an attorney. The California legislature responded by enacting more stringent procedures which must be followed when parties enter into premarital agreements. One such provision deems an agreement to have not been entered into voluntarily – and thus unenforceable – unless the person against whom enforcement of the agreement is sought had at least seven days to review the agreement before signing it, and was advised to seek the advice of an attorney.
The statutory language of the 2000 amendments is sufficiently vague so as to allow for several different, yet reasonable, interpretations of its requirements. One such ambiguity involves whether the seven day waiting period starts anew each time a revised draft of a proposed agreement is presented by one party to the other. This situation typically arises when, as negotiations progress, changes are made to the original proposed agreement.
In the recent case Cadwell-Faso v. Faso, A126524 (California Court of Appeal, First Appellate District, January 11, 2011), the court avoided the issue by holding that, because the waiting period was designed to protect unrepresented persons, it does not apply where, as in Caldwell v. Faso, each party was represented by counsel during negotiation of the agreement’s terms.
Due to the substantive and procedural complexities of the law, couples who contemplate entering into a marital agreement should each retain separate counsel.
*Anthony F. Earle, Esquire is a California attorney and real estate broker who maintains a practice in the Silicon Valley area of northern California. He can be reached at: anthony.earle@earlelaw.com. This article is intended for information and educational purposes only, and is not intended to constitute legal advice.
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01.13.11
Posted in Bankruptcy, Litigation, Real Estate Law, Taxation Law at 08:48 by Administrator
Q. I own a California home, but like many residential properties, the value of my home has declined so much that I now owe much more on it than what it is worth. I have two mortgages on this property, a “first” and a fairly sizable “second” loan. Fortunately, I have access to a modest amount of cash, which I could use as a down payment on a new home. I am considering the purchase of a new house to use as my principal residence, so I can take advantage of the current “buyers’ market” for residential housing. If I purchase a new home, I would consider converting my current home into a rental property. What are the possible legal issues associated with this strategy?
A. Your idea sounds like a good one. It is also an idea many homeowners in your situation are considering. However, there are at least three potential complications associated with the strategy you describe.
Because you are “upside down” with respect to your current home, that is, you owe more against that property than it currently is worth, chances are that the rent it will generate will not be sufficient to pay the mortgages. Thus, it is likely you will have a monthly loss associated with that property, a loss which you will have to cover from other income or assets.
This likelihood of negative cash flows creates the possibility of the first legal issue: eventual foreclosure.
Second, in the event of a foreclosure on your current California home/prospective rental property, you may or may not be exposed to a deficiency judgment with respect to the first loan. A deficiency judgment is a civil judgment for the difference between the amount owed on a property and the amount ultimately obtained for that property at a foreclosure sale.http://earlelaw.com/news_family.html.
Regardless of the status of your first loan, there is a significant likelihood that you may be subject to a deficiency judgment with respect to the second, or junior, loans on this property.
Any California deficiency judgment obtained against you will be valid for 10 years, and can be renewed for additional 10 year periods.
Furthermore, a deficiency judgment can be recorded as a lien against your new home, or against any other interest in real property which you may own, purchase, or acquire. Any lien recorded against a parcel of real property must, of course, be satisfied before that property can be sold.
Third, there are potential tax consequences, relating to the cancellation of debt, which might require that you pay income tax on any deficiency amount related to a foreclosure, even if a deficiency judgment is not obtained.
Whether you are a home/property owner who is in the undesirable position of deciding what to do with a distressed property, or a lender (institutional or private) who owns distressed loans, you would be well-advised to consult with an attorney before embarking on a course of action designed or intended to mitigate your monetary loss.
*Anthony F. Earle, Esquire is a California attorney and real estate broker who maintains a practice in the Silicon Valley area of northern California. He can be reached at: anthony.earle@earlelaw.com. This article is intended for information and educational purposes only, and is not intended to constitute legal advice.
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01.07.11
Posted in Family Law, Litigation, Real Estate Law at 14:53 by Administrator
Q. My spouse purchased a house, taking title as the sole owner. In order to assist my spouse in acquiring title to the house, I signed a quitclaim deed in reliance on my spouse’s oral promise to add my name to the title after the purchase had been completed. My spouse never did add my name to the title and now, we are contemplating divorce. If we do divorce, will the court consider the house to be my spouse’s separate property or will the house be considered marital property?
A. The situation you describe is quite common. Husbands and wives often purchase real property during marriage, while taking title to the acquired property in the name of only one spouse. Typically, this is done to facilitate financing, where the interest rate on the loan obtained to finance the property is lower if only one spouse’s name is on the title.
As a general matter, the law presumes that title to property is held in the manner described in the deed. California Evidence Code § 662. This presumption may be rebutted with clear and convincing evidence, a standard which is higher than the preponderance of the evidence standard which applies to most civil cases, but lower than the beyond a reasonable doubt standard which applies in criminal cases.
Married persons may, of course, purchase property from third parties. Married persons may also enter into transactions between themselves. However, different legal rules apply to these very different types of transactions. When married persons, either individually or jointly, purchase property from third parties, “normal” contract rules apply: transactions are presumed to have been made at “arms length” and no special relationship usually exists between buyer and seller.
In California, spouses owe each other a “fiduciary duty”, California Family Code § 721, which is the highest duty the law can impose on one’s relations with another. This duty owed by each spouse to the other is that of the highest good faith and fair dealing, and requires that neither take any unfair advantage of the other.
To give effect to this fiduciary duty, California law presumes that any interspousal transaction that advantages one spouse over the other was the product of undue influence. Undue influence, in turn, comes in many legal flavors, one of which is the use of confidence or authority to obtain an unfair advantage. California Civil Code § 1575. A spouse who gained an advantage over the other spouse may rebut this presumption by a preponderance of the evidence.
The presumption relating to transactions between spouses, created by Family Code § 721, trumps the presumption relating to title, created by Evidence Code § 662.
Thus, in the situation you describe, a California court should find that the house is community property, subject to equal division. Your spouse, however, is entitled to reimbursement of any of your spouse’s separate property funds which were used, for example, for the down payment which was needed to purchase the house.
The legal issue described above was addressed by the California Court of Appeal in Starr v. Starr, B219539 (Second Appellate District; filed September 30, 2010, published October 15, 2010). A copy of the court’s opinion may be downloaded without charge at: http://earlelaw.com/news_family.html.
*Anthony F. Earle, Esquire is a California attorney and real estate broker who maintains a practice in the Silicon Valley area of northern California. He can be reached at: anthony.earle@earlelaw.com. This article is intended for information and educational purposes only, and is not intended to constitute legal advice.
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12.30.10
Posted in Taxation Law, Trusts and Estates at 10:59 by Administrator
Q. My spouse and I have been procrastinating when it comes to regular reviews of our estate plan. Now, with another new year about to being, and a new tax law just around the corner, we would like to know whether there is any compelling reason to have an attorney review our estate plan now.
A. The Middle Class Tax Relief Act of 2010 (”2010 Tax Act”) was enacted during December 2010. However, contrary to its name, the 2010 Tax Act does not offer much relief at all. In fact, in the area of estate taxation, tax rates increase from 0% in 2010 to 35% in 2011, on that portion of estates which exceed $5 million. But that is only the tip of the taxation iceberg.
Using the new $5 million estate tax exclusion, married couples can avoid estate taxes on the first $10 million of their combined estates. If the first spouse to die does not fully use his or her exclusion, the unused portion can be used by the surviving spouse. However, with an A-B Trust – a type of trust which commonly was used prior to 2011 – the transferability of all or part of a deceased spouse’s $5 million exclusion may cause problems which reasonably could not have been anticipated when the A-B Trust was created.
The problem arises in the interplay between the “unlimited marital deduction” (”UMD”), on the one hand, and the $5 million exclusion which was created by the 2010 Tax Act, on the other hand. Many existing estate plans were drafted with an eye toward taking advantage of the UMD, without, of course, any consideration of the newly-enacted 2010 Tax Act.
In most cases, the UMD provides that, regardless of the size of an estate, there are no estate taxes on the first death. Because A-B Trusts typically were drafted to take advantage of the UMD, and did not transfer assets to take advantage of an exclusion that did not exist prior to 2011, continued use of an A-B Trust may result in married couples being subject to estate taxes on that portion of their estate which exceeds $5 million, rather than on full $10 million exclusion that they should be able to enjoy.
Thus, beginning on January 1, 2011, A-B Trusts will be obsolete. Accordingly, most, if not all, A-B Trusts should be reviewed and revised to take advantage of the new $5 million exclusion.
Now, as Paul Harvey might have said, here is the rest of the story: A-B Trusts, in order to take advantage of the UMD, intentionally waived a step-up in basis to avoid estate taxes because, with the exception of 2010, estate tax rates have always been significantly higher than capital gains tax rates. Now, however, use of an A-B Trust may expose the estate of all married couples – regardless of the value of the estate – to a loss of their step-up in basis which, in turn will increase their exposure to capital gains tax, while simultaneously doing nothing to protect against or mitigate estate taxation.
Estate plans should always be reviewed and updated any time there is either a change in the law or in your personal circumstances. So resolve now to put a review of your estate plan (or creation of an estate plan, if you do not already have one) at or toward the top of your 2011 list of “To Do” items.
*Anthony F. Earle, Esquire is a California attorney and real estate broker who maintains a practice in the Silicon Valley area of northern California. He can be reached at: anthony.earle@earlelaw.com. This article is intended for information and educational purposes only, and is not intended to constitute legal advice.
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12.22.10
Posted in Litigation, Real Estate Law at 10:29 by Administrator
Q. I own a California home which currently is worth less than what I owe on the loan which is secured by the property. Will the new California short sale deficiency law make it easier for me to negotiate a short sale agreement with my lender?
A. California Senate Bill (SB) 931, which makes it unlawful for mortgage lenders to require borrowers, as a condition of approving or accepting “short sale” agreements, to repay deficiencies, has been signed into law and, on January 1, 2011, will become section 580e of the California Code of Civil Procedure.
For purposes of section 580e, a “short sale” is defined as a transaction in which a mortgage lender agrees to release its security interest in a parcel of real property, while accepting less than the outstanding balance due on the loan which is secured by that property. A “deficiency” is the difference between the outstanding amount due on the mortgage loan and the lower amount which is realized from the sale of a property which has declined in value.
Section 580e provides, in relevant part: “No judgment shall be rendered for any deficiency under a note secured by a first deed of trust or first mortgage for a dwelling of not more than four units, in any case in which the trustor or mortgagor sells the dwelling for less than the remaining amount of the indebtedness due at the time of sale with the written consent of the holder of the first deed of trust or first mortgage.”
Section 580e will apply to residential properties consisting of one to four units, which need not be owner-occupied. Unlike prior law, section 580e will apply to refinanced loans as well as purchase money loans. However, section 580e will apply only to first loans, and not to second or other junior loans. The protections of section 580e also will not be available in cases in which the borrower has committed fraud.
Although the provisions of section 580e may, at first, appear to be favorable to owners of distressed residential properties, section 580e may actually make it more difficult for these borrows to convince lenders to accept short sale agreements.
Under prior law, lenders could use short sale agreements to convert what had become partially worthless secured loans (”underwater” mortgage loans) into a potentially valuable unsecured loans (short sale agreements with a deficiency repayment clause). Because section 580e purports to eliminate the ability of lenders to attempt to mitigate their losses in this fashion, there will be less incentive for lenders to accept short sale agreements.
In the end, section 580e may actually cause an increase in the number of California foreclosures, especially in cases where a deficiency judgment is otherwise allowed by law.
*Anthony F. Earle, Esquire is a California attorney and real estate broker who maintains a practice in the Silicon Valley area of northern California. He can be reached at: anthony.earle@earlelaw.com. This article is intended for information and educational purposes only, and is not intended to constitute legal advice.
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12.17.10
Posted in Real Estate Law, Taxation Law at 18:43 by Administrator
Q. My spouse and I are interested in buying our first home. Considering the current downturn in the economy in general and the real estate market in particular, what should we consider when purchasing a residence?
A. Depreciation in the value of residential real property, combined with mortgage interest rates which currently are at near historic lows, make this an excellent time to purchase real estate.
For example, a recent search of multiple listing service (MLS) listings for single family residences (SFRs) in the Silicon Valley area of northern California revealed that a 3-bedroom, 2-bath home (3/2) can be purchased for $750,000. The MLS also contains listings for 3/2 SFRs starting at about $500,000 and exceeding $1 million.
If one were to make a ten percent down payment on a $750,000 SFR, a loan for the balance would be needed in the amount of 675,000. Assuming a 30 year loan with an interest rate of 5%, monthly payments of principal and interest would be approximately $3,624. Interest on the mortgage would be deductible for income tax purposes (IRS Publication 936, Home Mortgage Interest Deduction), unless the mortgage interest deduction (MID) is removed from the tax code, as has recently been discussed in Congress.
Another recent search of MLS listings for the Silicon Valley area revealed that a four-unit residential property can be purchased for $1 million. Less expensive and, of course, more expensive four-unit complexes are also available.
Assuming a ten percent down payment, a loan of $900,000 would be needed to purchase a $1 million fourplex. Monthly principal and interest payments on a 30 year loan with an interest rate of 5% would be approximately $4,831. Interest attributable to units which are rented to tenants would be deductible for tax purposes as a business expense. See, Chapter 4, IRS Publication 535 (Business Expenses) and IRS Publication 527 (Residential Rental Property).
Assuming a fair market rental value of $1,200 per month for each unit, and a ten percent vacancy rate, rental income generated by three of the four units should be $3,240 per month. If you and your spouse used the fourth unit as your residence, your effective mortgage payment or “rent” would be $1,591 per month, which is $2,033 per month less than your mortgage payment would be if, as in the first example, you purchased a SFR.
You will, under each of the above examples, incur expenses for routine maintenance, property taxes, and insurance. These expenses will be mostly tax deductible if you own the fourplex, but mostly not tax deductible if you own the SFR. Additionally, if you own the fourplex, you will have an additional deduction for depreciation, a deduction which will not be available if you purchase the SFR.
Finally, when you and your spouse sell the fourplex, you should be able to take advantage of tax rules relating to “like-kind” exchanges, to defer capital gains tax. However, if you and your spouse purchase the SFR, the amount of capital gain which can be excluded from taxation may be limited.
The SFR will likely provide you and your spouse with a home that is more comfortable and aesthetically appealing than a fourplex, but becoming an owner of residential rental real estate should be a good first step on your road to financial prosperity and independence.
*Anthony F. Earle, Esquire is a California attorney and real estate broker who maintains a practice in the Silicon Valley area of northern California. He can be reached at: anthony.earle@earlelaw.com. This article is intended for information and educational purposes only, and is not intended to constitute legal advice.
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