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Author: TBosh Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 121341  
Subject: Interest Expense Date: 12/15/1998 1:39 PM
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Thanks for the help on the Roth IRA questions!! I definitely think the MF Tax Guide needs to go on my Xmas list!

I would also appreciate help with one more question (I promise just one more):


- A few days ago I refinanced the mortgage on a condominium that I own and rent out (ie business property). At the closing, I paid interest as part of the payoff on the old loan to the previous lender - and prepaid interest to the new lender from the date of closing to the end of this month - (12/11/98-12/31/98).

My question: Is any or all of this interest deductible as an expense against the rental income received in 1998?

( I understand that there are limitations on expense deductions based on income - but this scenario assumes that I am under the income ceiling)

thanks so much!!
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Author: TMFTaxes Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 7241 of 121341
Subject: Re: Interest Expense Date: 12/15/1998 8:46 PM
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[[Thanks for the help on the Roth IRA questions!! ]]

You are more than welcome. You might want to visit the Taxes FAQ area and read more about Roth IRAs in my series of posts on that very issue.

[[I definitely think the MF Tax Guide needs to go
on my Xmas list!]]

That would be great. And after you read the book, go to Amazon.com and leave a book review. You can see you name up in lights there!!!

[[ I would also appreciate help with one more question (I promise just one more):]]

One...two...five...the more the merrier (I guess...)

[[ - A few days ago I refinanced the mortgage on a condominium that I own and rent out (ie business
property). At the closing, I paid interest as part of the payoff on the old loan to the previous lender
- and prepaid interest to the new lender from the date of closing to the end of this month -
(12/11/98-12/31/98).]]

OK...but you didn't tell me if you pulled any money out of the deal. If you didn't, then you don't have a problem. But if you did take any cash out of the deal, you could have some issues to deal with. So let me know if you want to discuss those issues in more detail.

[[ My question: Is any or all of this interest deductible as an expense against the rental income
received in 1998?]]

Sure. Both the interest charged by the old lender and the interest charged by the new lender. Again, this assumes that you didin't pull any cash out of the deal, or get any cash that you used for other purposes.

[[ ( I understand that there are limitations on expense deductions based on income - but this scenario
assumes that I am under the income ceiling)]]

Right...rental property is treated as "passive" activities. So your AGI becomes an issue. But the interest expense is certainly deductible agains the rental income. But then you'll have to deal with the passive issues (and the exemption for residential real property) at that level.

If you would like additional information on the passive rules regarding residential rental property, please let me know.

TMF Taxes
Roy

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Author: TBosh Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 7250 of 121341
Subject: Re: Interest Expense Date: 12/16/1998 10:25 AM
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Thanks Roy for your help.

I didn't pull any money out of the deal. Also, I really would appreciate the additional info on passive rules for residential rental property. Is that covered in the book as well? Does the book discuss rental income/rental expenses?

Also - I did think of one more tax question on an unrelated topic .
I must be missing something because every year I hear the financial "experts" caution people from buying into a mutual fund at the end of the year right before the fund makes a capital gain distribution -due the taxes that will be owed on the distribution - . And every year when I hear this, I think to myself - isn't that a good thing? I mean - why not buy into something -get an immediate gain (when you weren't putting your money at any risk during the preceding months) - and so what you have to pay tax on the gain? -doesn't the capital gain distribution represent money you wouldn't have gotten otherwise? - or to put it another way - only if you had been in the fund all along? - and by buying at the end of year - you didn't have to be? I hope I haven't confused you.

After asking these questions I feel like only one of two things can happen:
(1) something that's obvious to everyone else in the world -but me- will be revealed
(2) or there'll be a chorus of "I've always wondered that too"

thanks again!

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Author: bliles One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 7257 of 121341
Subject: Re: Interest Expense Date: 12/16/1998 12:22 PM
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TBosh said:

I must be missing something because every year I hear the financial "experts" caution people from
buying into a mutual fund at the end of the year right before the fund makes a capital gain
distribution -due the taxes that will be owed on the distribution - . And every year when I hear this,
I think to myself - isn't that a good thing? I mean - why not buy into something -get an immediate
gain (when you weren't putting your money at any risk during the preceding months) - and so what
you have to pay tax on the gain? -doesn't the capital gain distribution represent money you
wouldn't have gotten otherwise? - or to put it another way - only if you had been in the fund all
along? - and by buying at the end of year - you didn't have to be?


Let's say you buy 100 shares of a mutual fund for $10 a share and they are about to pay a $2 a share distribution. You get $2 per share ($200) taxable distribution, re-invested. Your originally purchased shares drop to $8 a share. The re-investment will be at this price, so your additional shares number 25. At the end of the day, you have more shares (125), each priced lower($8), and you paid tax on some of it($200). Originally - 100 shares @ $10, no tax, = $1000
Finally - 125 shares @ $8, paying tax, = $1000-tax
You just bought the distribution.

Bob

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Author: TBosh Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 7258 of 121341
Subject: Re: Interest Expense Date: 12/16/1998 1:13 PM
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Thanks Bob for shedding some light on this situation. I guess I didn't realize that the originally purchased shares would drop after a capital gain distribution.

Maybe the real issue is that I need to become more familiar with the capital gains concept as it relates to mutual funds vs. individual stocks.

thanks again.

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Author: bliles One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 7259 of 121341
Subject: Re: Interest Expense Date: 12/16/1998 1:49 PM
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TBosh said:

Maybe the real issue is that I need to become more familiar with the capital gains concept as it
relates to mutual funds vs. individual stocks.


Someone once posted that individual stocks also dropped in price after a dividend, but the amount of the dividend is so small, and stock prices so volatile that it is not nearly as noticible. I figure that must be true, because I have never noticed the price drop anywhere except in mutual funds. Glad I could help.

Bob

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Author: TMFTaxes Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 7272 of 121341
Subject: Re: Interest Expense Date: 12/16/1998 7:42 PM
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[[Thanks Roy for your help.]]

My pleasure...

[[ I didn't pull any money out of the deal.]]

Perfect. Than you should have no problems.

[[ Also, I really would appreciate the additional info on
passive rules for residential rental property. Is that covered in the book as well? Does the book
discuss rental income/rental expenses?]]

The Motley Fool Investment Tax Guide doesn't really deal with real estate issues in any great detail (other than the gain exclusion on the sale of a personal residence). But we may cover real estate issues in the NEXT book.

As far as passive issues, go to the IRS web site and download/read IRS Publications 925 and 527. They will explain things in much greater detail.

[[ Also - I did think of one more tax question on an unrelated topic .]]

Okey Dokey....I'll let you off the hook...just this one time :-)

[[ I must be missing something because every year I hear the financial "experts" caution people from
buying into a mutual fund at the end of the year right before the fund makes a capital gain
distribution -due the taxes that will be owed on the distribution - . And every year when I hear this,
I think to myself - isn't that a good thing? I mean - why not buy into something -get an immediate
gain (when you weren't putting your money at any risk during the preceding months) - and so what
you have to pay tax on the gain? -doesn't the capital gain distribution represent money you
wouldn't have gotten otherwise? - or to put it another way - only if you had been in the fund all
along? - and by buying at the end of year - you didn't have to be? I hope I haven't confused you.]]

Believe me...it's a bad thing.

Here is a very brief and simple example...

You buy ABC Mutual fund on December 1. You buy 1,000 shares with a NAV at that time of $5/shares (we'll ignore the rip off sales fees and charges in this example...but please know that they are there).

On December 20th, the fund goes X-dividend with a payable date to holders of record on the 20th. (it really doesn't work this way...generally the x-dividend date is a few weeks before the "record" date...but this makes the example a bit easier to deal with). The dividend is $.50/share.

The next day, the fund value immediately drops to $4.50 per share to reflect the payment of the cash dividend.

You receive a dividend (either in cash or in shares...taxable either way) in the amount of $500, on which you'll pay taxes at your normal rate or LT capital gains rates (if these are capital gain distributions). Lets assume a regular distribution, and a tax rate of 28%. You'll see $140 in taxes go directly to good old Uncle Sammy.

So what do you now have for your $5,000 investment?

A mutual fund with a NAV of $4.50/share...or a total value of $4,500.

An after tax dividend in the form of cash in the amount of $360. That really stinks...at least in my opinion.

If you would have bought an individual stock, your full $5,000 investment would still be working, and you would not have "bought" a capital gain distribution, and would therefore have no taxes to pay.

That's basically it in a nutshell. Hope it makes a bit more sense now.

[[ After asking these questions I feel like only one of two things can happen:
(1) something that's obvious to everyone else in the world -but me- will be revealed
(2) or there'll be a chorus of "I've always wondered that too"]]

For the majority of readers who visit this folder, if they are really honest with themselves, it'll be #2. Trust me. So don't feel all alone on this one.

[[ thanks again!]]

Welcome...
TMF Taxes
Roy

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