Virtually all affordable housing programs, including those using assistance from the Department of Housing & Urban Development (HUD) and the Rural Housing Service (RHS), as well as Low-Income Housing Tax Credit (LIHTC) projects, must determine actual or potential income from assets when projecting the income of applicants and residents. The rules governing how to do this are contained in HUD Handbook 4350.3. One of the more complex assets to deal with when projecting income is real estate.
In many – if not most cases – real estate owned by a member of an assisted family will be considered an asset. In this article, I will outline the circumstances under which real estate is not an asset and will explain how to determine income from real estate when it is an asset.
When is real estate not an asset to a family?
The decision as to whether to treat real estate as an asset depends on family circumstances. The net income derived from an applicant’s real estate holdings will either be considered business income or income from an asset. If the resident’s main business is real estate, income from the rental of real estate is considered business income, and since the real estate is an asset of an active business, it should not be considered an asset to the household.
To consider real estate as the primary business of the individual, income from real estate should generate most of the income for the person. While relatively rare in affordable housing, the presence of residents whose main business is real estate is not unheard of. And, in such cases, the net income from the business will be counted as household income.
The best documentation of such business income is IRS Schedule E (Form 1040). This form is used to report income (or loss) from rental real estate.
When is the real estate an asset to the family?
If real estate is not the main business of an applicant or household, then the real estate is considered an asset. If the property is rented, the net income from rent is considered asset income. To determine the value of the property, subtract amounts owed on the property, as well as a reasonable cost of sale, from its market value.
For example, assume an applicant owns a single-family home that is rented. The market value of the home is $250,000, and the applicant owes $105,000 on the mortgage. Assume a cost of sale of $20,000. Cash value is determined by subtracting the cost of sale from the market value, and then subtracting the balance on the mortgage. So, the calculation is $250,000 minus $20,000 minus $105,000 = $125,000 cash value.
In order to determine income from the asset, the rental income must be verified. Once the gross rent is verified, you may deduct any verifiable operating expenses, such as mortgage interest payments, taxes, insurance, and maintenance. The resulting net income is considered asset income.
Verification of Cash Value
To determine cash value, the fair market value must first be determined. The fair market value (FMV) is the amount that another person would pay to acquire the property in an open-market transaction. There are several ways to verify market value, including (1) tax assessments {in some states}; (2) online real estate listing; (3) an estimate from a qualified broker; or (4) a bona fide sales contract. Once the market value has been determined, a verification of any outstanding mortgage balance is required. Then, the process outlined above for determining cash value is followed.
Verification of Rental Income
A variety of documents may be used to verify rental income. These include a current lease, recent rent checks, or the latest IRS Schedule E (Supplemental Income and Loss).
HOTMA and Real Estate
HUD’s Final Rule relating to the implementation of The Housing Opportunity Through Modernization Act (HOTMA) is now in effect. The final rule did not change how the cash value and income from real estate is determined. But HOTMA did establish new household asset limitations preventing households that own real property “suitable for occupancy,” or assets over $100,000, from receiving HUD rental assistance. However, housing providers may establish exceptions and have a great deal of discretion in enforcing the new limits on current residents. It is also important to note that these limitations apply to HUD programs only – not RHS or LIHTC.