Learn about the key considerations to make when converting real estate assets to cash including the fair market value of property.In Part 1 of our Tenant Real Estate post titled Verifying Fair Market Value, we discussed several ways to obtain the Fair Market Value of a property. In part 2, we will finish with converting the asset to cash (cash value).
The Cash Value of an asset is the market value less reasonable expenses that would be incurred in selling or converting the asset to cash. Some examples of reasonable expenses are Mortgage Principal, Broker Fees, Closing Costs and Commissions. These costs are added up and deducted from the Fair Market Value of the property. The balance is what is listed on your Tenant Income Certification (TIC).
Market Value $400,000
Mortgage Principal -$100,000
Broker Fees -$2,000
Closing Costs -$3,000
Cash Value $283,000 (Amount listed on Tenant Income Certification)
What about other types of situations such as foreclosures or multiple owners? Read on to find out.
To determine if the Property is considered an Asset or Income, the following apply:
- If the person is renting a property out as an investment which is not the person’s main business, the cash value of the property would be considered an Asset and any income would be counted as the asset’s income.
- If the person has a business in renting real estate, it would then be considered Business Income and the real estate would not be considered an Asset. HUD states, “do not count it as both an asset and business income.”
- If a family member or friend is living in the property and paying the mortgage/has taken over the mortgage payments, this is still considered income from the rental property and is counted even if it is not being directly paid to the real estate owner. The real estate would be counted as an asset and the income from the asset would be counted as asset income. If the rental property is currently listed for sale but has not yet been sold, the rental income should be counted for a full 12 months as there is no guarantee the property will sell prior to the anticipated MI date.
- If rent is being received on the property, the net rent would be considered the income from the asset. Net rent is the amount after which any verifiable operating expenses as listed on IRS Schedule E Supplemental Income and Loss are deducted.
Examples of Allowable Operating expenses on Real estate are:
- Auto and travel for rental property
- Cleaning and maintenance
- Legal and other professional fees
- Management fees
- Mortgage interest paid to banks, etc.
Applicant/Tenant must provide documentation to verify expenses.
EXAMPLE: Applicant owns a house that is being rented and produces an annual income $20,000. Applicant provides documentation verifying annual expenses which are taxes of $2,000, insurance of $1,000, maintenance of $500, mortgage payments of $12,000 and mortgage interest of $150.00. What is the annual net rental income?
$16,350 is the net rental income. Remember, mortgage payments are not counted towards expenses, only the mortgage interest.
As with any asset, the higher of the imputed income or the actual income would be the asset income listed on the TIC. If the net rental income is $5,000 per year and the imputed income comes to $5,800 per year, the imputed amount of $5,800 would be reflected on the TIC as (imputed) asset income.
Verification of Rental Income
The HUD 4350.3 REV-I Appendix 6-C, M states the following provide suggested information to verify with a third-party and acceptable forms of verification:
- IRS Form 1040 with Schedule E (Rental Income).
- Copies of latest rent checks, leases, or utility bills.
- Documentation of applicant’s/tenant’s income and expenses in renting the property (tax statements, insurance premiums, receipts for reasonable maintenance and utilities, bank statements or amortization schedules showing monthly interest expense).
- Lessee’s written statement identifying monthly payments due the applicant and applicant’s affidavit as to net income realized. A sample of statements the applicant/tenant will have to provide can be found here: PHFA Income from Real Estate Verification
Suggestion: If an applicant owns a rental property and it’s currently listed for sale, it is always best to err on the side of caution. Since there is no way to predict when the property will sell, the rental income should be counted for the full 12 months. The applicant should supply their tax returns for the past 2 years and a copy of the lease.
Documentation of the Foreclosure must be provided by the owner. There is a process that the lender must go through when putting a home into foreclosure. A variety of legal notices must be filed with the county recorder. Those notices are public record. In addition, most people will receive some type of pre-foreclosure notice, like a breach letter or notice of intent to foreclose. These documents from the owner will need to be provided for verification of the foreclosure.
If the house has been foreclosed on, in most cases, the asset value on a foreclosed home would be zero. The owner usually does not receive proceeds from a foreclosed sale. However, if they do, these proceeds would be considered an asset. The property would no longer be owned by the person so any proceeds received would be listed on the TIC as they are now held, possibly in a bank account.
If the real estate is in foreclosure but has not yet been officially closed on, the foreclosed property must be counted as an asset until the final foreclosure documents are provided, the house is sold at auction or the title has been transferred to a new owner, generally the bank. NOTE: The cash value of the asset may be zero if the homeowner owes more on the mortgage than the home is worth, and verification is still required to determine such.
Is it a disposed of asset? No, the foreclosed property would not be considered an asset disposed of for less than Fair Market Value because it is usually not given away by owner choice. The HUD Handbook 4350.3, REV-1, Chg 4 specifically states that assets disposed of for less than fair market value as the result of a foreclosure, bankruptcy, divorce or separation agreement are not counted as assets because these are involuntary dispositions.
When the mortgage balance on the real estate is more than what the home is worth and you need to sell, the transaction in which you will sell your property is called a short sale. You need your lender’s approval to do a short sale because they’ll be accepting less than they’re owed at closing. There are many reasons homeowners opt for a short sale, but one of the most common is to avoid going into foreclosure. A short sale will often not have a profit for the seller since the amount owed on the home is more than what it will sell/has sold for. Therefore, it will not be considered an asset. However, as in Foreclosure above, if the real estate has been listed as a short sale but has not yet been officially closed on, the property must be counted as an asset until the final settlement documents are received. Also, as with Foreclosures the Short Sale property would not be considered an asset disposed of for less than Fair Market Value because it is usually not given away by owner choice.
If the real estate has multiple owners outside of the household, meaning the asset is not owned 100% by the applicant/tenant, the value of the asset as well as any income from the asset must be divided amongst the owners. Ownership can be verified by mortgage statements, tax bills, deed, etc.
“Creating and maintaining affordable housing communities is a complex task. Numerous state and federal requirements must be followed – both during development and for years thereafter. We clarify LIHTC, Federal HOME, HUD, and certification requirements you must follow to remain compliant. For more information on these services be sure to visit our Property Compliance page and don’t hesitate to contact us. The information presented in this post is intended solely for informational purposes and should not be construed as consulting advice from McKonly & Asbury, LLP.”