Mortgage / Tax Q.... Explain it to me like I'm stupid....

[fingpilot]

Hypothetical Q.

Assume $900k in a combo 401k, IRA account. $375k of it untouchable until I turn 66. The rest in cash management by Ameritrade earning (conservatively) between 5 and 11%. Some of it above 22%.

Have my eye on a piece of property and will put a modular house on it. Total outlay around $300k.

Do I pay cash for it (money guys idea) or large down and finance the rest? It can be real estate with the permanent foundation.

I would think tax advantages of deduction for mortgage interest would outweigh the loss of interest from earnings on the cash spent to buy outright.

Property is in California (Shasta County), and I am a Nevada resident. No income except from these retirement accounts anymore after that.

I know there is a way of running all of this out, but cannot seem to get a straight answer to what seems a pretty straight question.

I rest on the PP brain trust once again.

[Rick Lee]

Getting a mortgage for a modular home can be tough. And I don't think you can deduct the mort. interest from a lot loan, especially when you have no plans to make it your primary residence anytime soon.

[stevepaa]

from pub 936

For you to take a home mortgage interest deduction, your debt must be secured by a qualified home. This means your main home or your second home. A home includes a house, condominium, cooperative, mobile home, house trailer, boat, or similar property that has sleeping, cooking, and toilet facilities

[Hugh R]

CA has income tax, NV doesn't. Are you talking about borrowing against the IRA, if so 9% CA ordinary income and whatever on the Fed IRS tax rate. Not an accountant or CPA or anything like that.

[Dueller]

I'm not a tax expert by any means, but in my law practice I have a general knowledge sufficient for me to know when to refer someone to a CPA. Take the following as worth what you pay for it

You can deduct mortgage interest on a second home (or an RV for that matter) if you reside in it for a certain period each year...IIRC it may be as little as a few weeks a year. If you are renting it out, the rules change so consult an accountant.

I'm not quite clear what you're asking about your 401k or IRA...are you talking about borrowing against it? Do you have the cash outside of tax deferred retirement accounts to pay cash for it? Why age 66 to withdraw from your retirement? Usually 59 1/2 is the starting age? Some kind of annuity? Need more details. In MOST cases, borrowing against a retirement account when you have sufficient cash outside of retirement accounts is a losing proposition. There are fact specific exceptions but its rare.

Back to the mortgage interest deduction. For the sake of round numbers let's assume you're in the 33% marginal tax bracket. Further assume you borrow $300K and your payment is $2500/mo with $2000 per month being interest. Is it worth it to you to shell out $24,000 per year in interest to your lender (plus $6000 in principle payments for a total of $30,000) to save $8000 in federal taxes? Also keep in mind that if you take $300K out of investments you won't be paying tax on that investment income...while a home is not an investment in the purest form, it does appreciate tax free until you sell it. So if your taxable investment income on your $300K is 10% or $30,000, you'd pay an additional $10K /year in taxes. Your need for liquidity is another consideration. Finally the most often ognored factor is the risk on investments...do you feel more comfortable with money in Ameritrade or a vacation home?

The real question is this...if you owned the property outright and had $300K less in your portfolio, would you borrow $300K against the property to invest in your current portfolio?

You can use the numbers to rationalize doing it either way. For me personally I would rather own it outright. I've paid cash for my last 2 houses, but then again I bought relatively modest homes. Realtors think I'm crazy since I could "afford" much bigger homes if I put what I paid for my house down on a bigger, more expensive house and took out a mortgage. Effectively I pay 0% interest and on a personal level the current downturn in the housing sector or stock market does not effect me as much as others who are over-extended.

YMMV

[berettafan]

if you 'borrow' from your retirement accts you will pay income tax at a rate of XX%.

next issue is a time value calculation. run an amort. schedule on the $300k borrowed from a bank (net of tax effect) and then run one on the lost income from your investment accounts (w/ tax effect included ie you're taking out MORE than $300k to get $300k as you'll be paying income tax).

this is the direction your CPA should take when you talk with him/her about this.

knee jerk reaction is that it wouldn't be wise to borrow from retirement funds earning a good return (you said up to 22%) to avoid a 7.x% mortgage with a bank.

[tabs]

Use the Banks money to buy the property. Another solution is to use alittle of your own money and a little of the banks money to buy the property.

Keep your cash/liquidity in hand especially if mortgage interest rates are sub 6%.

BTW: I have been thinking about having a summer home in Sierra Nevadas or Klamath Mountains while maintaining NV residency.

[fingpilot]

Thanks guys, as always.

This would actually be a second residence. The manufactured home would be on a permanent foundation, making it real estate. Surprisingly, when I was researching financing, there was a difference in interest rates on the home price until it 'became' real estate. The rate on the land changed as soon as it was 'developed'. Both went down once completed. The usual way to accomplish this was with a 'bridge loan'. I would use the retirement funds to secure the loan if that was the way I went.



Dueller: I goofed on the age, yes, it is 59 1/2. Your analysis of the borrowing against retirement funds was how it went. I did run the numbers, and it was as you said. Could make an argument to go either way.

When everything was said and done, cashing into the entire project is the quickest, easiest, and most headache-free way to go. The loss of the retirement income from the decreased retierement fund was more than offset by the less worry. The remaining funds still provided enough interest to live on.

berettafan: Agreed.

Tabs.... That WAS my original thinking. But as you can see, I was concerned about the numbers, and the banks bull. Everything said, it would be wonderful to not have to have any payments and still be 'retired'. Is why I'll cash in.


Thanks everyone! I'll post pics as the project progresses.

[Moneyguy1]

Long term annual percentage your investments are making vs. interest rate on the mortgage.

Also, just for grins and giggles. Interest deduction on a mortgage yields a percentage return on your taxes. SImple and stupid example: (Just for ease): Assume a 20% tax bracket: 20% of your interest paid is returned. Assume no mortgage (cash): You would have the equivalent of all of the interest you paid as spendable income. Which is better? 20% of something or 80% of something? Kinda a fun experiment in costing out futue value of money.

Dueller and Beretta make some excellent points. A visit to a CPA is in order. Worth the cost in the long run.

[berettafan]

keep in mind you have a standard deduction of $10k or whatever it is so THAT much of your mtg. interest, etc. gives you no benefit.