Most of these giveaways give the winner the option of taking the house or taking a cash prize. For example, HGTV’s “Dream Home Giveaway” offers the winner the option of taking the $2 million home plus $500,000 cash ($2.5 million total taxable prize) or taking $1.3 million in cash. Is the cash option better? Maybe:
- If you take the home, you’ll pay tax on a $2.5 million prize = $875,000 total tax owed.
- If you take the home and sell it to pay the tax, you may owe even more taxes because of capital gains. (A sale for $2.1 million = $910,000 in tax owed, but would leave $1.69 million cash in hand after the taxes are paid.)
- If you take the $1.3 million in cash, the tax owed would be $455,000, leaving $845,000 cash in hand after taxes are paid.
There are two other possibilities: borrowing to pay the taxes, or renting the house out.
Home Equity Line of Credit
A $375,000 line of credit, at 5.99% for 15 years, equals a payment of about $3,160/month. That’s nearly $38,000/year. Yes, you’d pay off your income tax obligation but you’d still have to find $38,000/year to pay the line of credit. (Part or all of the line of credit interest may be deductible, depending on the amount of personal use of the property.)
The HGTV home is in Park City, Utah — home of the Sundance Film Festival. You could no doubt rent the home for a premium price during the festival. You could also rent it throughout the year as a mountain getaway. You would probably be able to get enough rental income to cover the line of credit and the tens of thousands of dollars in other expenses associated with the property (such as property taxes, utilities and maintenance).
IMPORTANT NOTE: AFTER THIS ARTICLE WAS PUBLISHED, I LEARNED THAT THERE ARE LOCAL COVENANTS THAT PROHIBIT THE TYPE OF RENTAL I PROPOSE HERE, THUS SHOOTING DOWN MY IDEA. I NOW SAY, TAKE THE MONEY AND RUN! SEE PART 4 OF THE SERIES. (JASON 1/26/12)
A combination of renting and using a line of credit might be a good strategy. You could rent the house, even part of the year, to cover all the expenses associated with the property. The tax implications would vary depending on your income (rental losses may or may not be deductible depending on your income), how much you use the house for personal purposes, and if the average rental period is 7 days or less per tenant. (This is why it’s best to proceed with caution and seek professional tax help!) See the “Important Note” above and Part 4 of this series. This strategy is likely not possible due to covenants.
Tomorrow I’ll blog about what I would do if I won a home in a giveaway.