We often get questions from clients about putting a mortgage on a property they purchased for cash. Sometimes, in a hot real estate market, paying cash and closing quickly is a necessity, but it isn’t always best in terms of leveraging wealth and/or tax considerations.* The IRS has guidelines regarding mortgage interest deductibility (see a partial summary below) when a home is bought with cash and then the buyer wants to get some of their cash back.**
The other thing to know is that lenders have their own rules on mortgaging a property that was purchased with cash. Admittedly, what follows is technical. If you don’t feel like trying to figure it out please give me a call. If you like details, here is a recap of some of the rules that may apply.
Delayed Financing Cash Out Refinance:
For loans processed through DU or LP, borrowers who purchased the subject property within the past six months prior to the loan application date are eligible for a cash-out refinance if all of the following requirements are met:
The loan must be approved via DU with an Approve / Eligible feedback or LP with an Accept Eligible feedback.
The new loan amount is not more than the actual documented amount of the borrower’s initial investment in purchasing the property, plus the financing of closing costs, prepaid fees, and points (subject to the maximum LTV, CLTV ratios for the transaction).
The purchase transaction must have been an arms-length transaction. If the seller of the property was an LLC, the principals of the LLC must be documented.
The purchase transaction must be documented by the HUD-1, which confirms that no mortgage financing was used to obtain the subject property. The preliminary title search or report must also confirm no liens on the subject property.
The LTV/CLTV of our refinance must be based on the lesser of the original sales price or the current appraised value.
Multiple Financed Properties that exceed 4 to a maximum of 10 are eligible for an investment property or second home delayed financing cash out transaction for DU ONLY.
The source of funds for the purchase transaction must be documented by providing bank statement, personal loan documents, HELOC on another property, etc. Any loans used as the source for the purchase transaction will be required to be repaid on the new HUD-1 for our refinance.
NOTE: Borrowers may not be reimbursed for gift funds received and used for the purchase of the property in the Delayed Financing Cash Out Refinance. Any reimbursements to a donor will need to be completed in a regular cash out refinance after the required 6 month waiting period.
All other cash-out refinance eligibility requirements must be met and cash-out pricing is applied.
IRS Publication 936, Part II. Limits on Home Mortgage Deduction / Home Acquisition Debt…
Mortgage treated as used to buy, build, or improve home. A mortgage secured by a qualified home may be treated as home acquisition debt, even if you do not actually use the proceeds to buy, build, or substantially improve the home. This applies in the following situations.
You buy your home within 90 days before or after the date you take out the mortgage. The home acquisition debt is limited to the home’s cost, plus the cost of any substantial improvements within the limit described below in (2) or (3). (See Example 1 below.)
You build or improve your home and take out the mortgage before the work is completed. The home acquisition debt is limited to the amount of the expenses incurred within 24 months before the date of the mortgage.
You build or improve your home and take out the mortgage within 90 days after the work is completed. The home acquisition debt is limited to the amount of the expenses incurred within the period beginning 24 months before the work is completed and ending on the date of the mortgage. (See Example 2 below.)
Example 1… You bought your main home on June 3 for $175,000. You paid for the home with cash you got from the sale of your old home. On July 15, you took out a mortgage of $150,000 secured by your main home. You used the $150,000 to invest in stocks. You can treat the mortgage as taken out to buy your home because you bought the home within 90 days before you took out the mortgage. The entire mortgage qualifies as home acquisition debt because it was not more than the home’s cost.
Click here for the IRS Publication 936 and be sure to consult your tax advisor. *Emery Financial, a division of W.J. Bradley Mortgage Capital, LLC does not give any tax advice; be sure to consult with your tax advisor before buying, selling, or financing real estate. ** Mortgage interest deductibility is very much in the news and its status may change at any time.
I hope this helps. If your eyes are glazed over, please give me a call and I’ll help you through this and I can recommend a few tax specialists if you don’t already have one you like.
