Real-Estate Sleight of Hand

Itzhak Ben-David is a Ph.D. candidate in finance at the University of Chicago’s Graduate School of Business. (Levitt is one of his dissertation advisors.) While pursuing his original research idea — the degree to which housing prices efficiently incorporate anticipated tax increases — Ben-David stumbled upon a slightly juicier topic: a real-estate sleight of hand known as the “cashback transaction,” in which the seller gives the buyer a clandestine rebate that the lending bank never finds out about.

Yes, it’s illegal.

Our current New York Times Magazine column is about Ben-David’s research. Here is his paper on the subject. Not only is the subject matter interesting, but the detective work he employed — a sort of mashup of the methodologies in the Levitt/Syverson real-estate paper and the Duggan/Levitt sumo paper — is really impressive.

As always with our N.Y. Times columns, we’ve posted some complementary research materials on the subject.

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  1. Bruce Hayden says:

    I was impressed with the methodology. Very ingenious.

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  2. Bruce Hayden says:

    I was impressed with the methodology. Very ingenious.

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  3. sygyzy says:

    @#7 – Spam much?

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  4. sygyzy says:

    @#7 – Spam much?

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  5. cab says:

    Since the original research idea had to do with taxes, I am curious to know to what extent the buyers and sellers involved in these transactions consider the tax implications. By engaging in a cashback transaction, the buyer would have a higher basis for property taxes and a larger mortgage balance for interest and closing costs. The seller would also have a larger investment gain on which taxes would be owed (though, a 1031-exchange could at least defer the seller’s additional liability).

    If all these factors are considered, this means that a seller shouldn’t be willing to give the entire overage back to the buyer, in order to reserve for her additional tax liabilities (e.g. at 15% LT cap gains, she should require 17.65% more than the cashback amount to the buyer). In addition, the buyer is not getting the full benefit of the cash she received, since she must pay taxes, interest and loan closing costs on this additional “purchase price”.

    If the buyer and seller both properly consider these factors, I am curious how often the reduced interest rate the buyer gets on the mortgage for putting 10% down outweighs the larger mortgage balance, increased closing costs and property taxes for the transaction to make economic sense.

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  6. cab says:

    Since the original research idea had to do with taxes, I am curious to know to what extent the buyers and sellers involved in these transactions consider the tax implications. By engaging in a cashback transaction, the buyer would have a higher basis for property taxes and a larger mortgage balance for interest and closing costs. The seller would also have a larger investment gain on which taxes would be owed (though, a 1031-exchange could at least defer the seller’s additional liability).

    If all these factors are considered, this means that a seller shouldn’t be willing to give the entire overage back to the buyer, in order to reserve for her additional tax liabilities (e.g. at 15% LT cap gains, she should require 17.65% more than the cashback amount to the buyer). In addition, the buyer is not getting the full benefit of the cash she received, since she must pay taxes, interest and loan closing costs on this additional “purchase price”.

    If the buyer and seller both properly consider these factors, I am curious how often the reduced interest rate the buyer gets on the mortgage for putting 10% down outweighs the larger mortgage balance, increased closing costs and property taxes for the transaction to make economic sense.

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  7. If the lender knows about it (i.e. its on the HUD1) AND 6% or less, it is legal. Most lenders won’t agree to more than 3%, which is typical closing costs (so buyer does not get cash back, but gets their closing costs paid), and the home has to appraise for the higher value. When the market was appreciating these deals (legal and illegal) were common, now that home prices are depreciating lenders and forcing appraisers to be much more conservative and this practice will go away, at least until the pendulum swings back

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  8. If the lender knows about it (i.e. its on the HUD1) AND 6% or less, it is legal. Most lenders won’t agree to more than 3%, which is typical closing costs (so buyer does not get cash back, but gets their closing costs paid), and the home has to appraise for the higher value. When the market was appreciating these deals (legal and illegal) were common, now that home prices are depreciating lenders and forcing appraisers to be much more conservative and this practice will go away, at least until the pendulum swings back

    Thumb up 0 Thumb down 0