Buying a house is more expensive than ever. Home prices in California are 10% higher than a year ago and still increasing. As the Fed raises interest rates, the real estate market might cool off a bit, but prices won’t be dropping any time soon.
The rising cost of houses is a challenge on its own, but it also means homebuyers pay more in closing costs, which are a percentage of the total transaction. Considering these can range from 2 – 3%, that’s a hefty amount to add to a major transaction.
But what if there was a way to recoup some of those closing costs? Many real estate agents offer commission credits to entice homebuyers to work with them, sometimes amounting to thousands of dollars back once a deal closes. Let’s look at what commission credits are and how they can help you keep more of your hard-earned money.
What are commission credits?
Commission is a common part of selling a house. In general, the agent working with the seller will set a commission rate, usually between 5 and 6% of the final sale price. Typically, the seller’s agent will then agree to split the commission with the agent for the homebuyer. The two parties can split the commission as they see fit, but it’s frequently equal or nearly equal.
Commission credits enter the equation on the buyer’s side of the deal. The buyer’s real estate agent can offer their portion of the commission as a credit to the buyer. In theory, the agent can even offer a credit that exceeds their commission, but they’d have to pay out of pocket, so it’s rare.
In practice, it’s an agreement to help defray a buyer’s costs and entice them to use a particular real estate agent. While the agent sees less commission on the deal, it helps increase their volume of deals and their overall earnings.
How do commission credits work?
While the concept is fairly simple—home buyers receive a small credit or rebate once the deal closes—the execution varies. The scenario outlined above with the selling agent and buying agent coming to an agreement is fairly common, but there are a couple of other widely-used models:
- An agent negotiates a variable commission rate with the seller, depending upon how the final deal plays out. For example, if the selling agent recruits a buyer themself, without involving another real estate agent, they’ll reduce their commission, but then keep all of it since they worked both sides of the deal. They’re less apt to offer credits since the final commission amount is smaller, but they’re also more motivated to do the legwork to get a deal done.
- Many discount brokers will give their prospective buyers a blanket guarantee that they’ll receive a commission credit. The promise of money back can be enticing, but the downside is that these brokers tend to be less involved in the process. They may skip inspections and meetings, won’t assist with paperwork, and you’ll be on your own to navigate the process. You might not even see them until closing, if at all.
Are commission credits legal?
A real estate agent can’t legally pay a direct commission to an unlicensed person. However, agents can offer rebates, and there are several common ways they can structure commission credits for homebuyers:
- Credit towards closing costs on the transaction
- Covering some of the hidden costs of a home purchase like home inspections or moving services
- Gift certificates
Different states have slightly varying regulations for commission credits, but only ten states ban them outright: Alabama, Alaska, Iowa, Kansas, Louisiana, Mississippi, Missouri, Oklahoma, Oregon, and Tennessee.
What are the tax implications of commission credits?
Fortunately, the IRS has ruled that commission credits are not taxable income. Instead, they view the rebate as an adjustment to your home’s cost basis. Some real estate agents are unaware of this ruling and will issue a 1099-MISC to homebuyers who received a rebate. However, this doesn’t change the fact that it’s not taxable income. If you find yourself in this situation, contact the real estate agent and ask them to issue a corrected 1099-MISC.
While the rebate itself isn’t taxable, the adjustment to your home’s cost basis can have tax implications down the road. If you eventually sell the home, the profit can be subject to capital gains tax. Since your cost basis was lower than it would’ve otherwise been, taxes will also apply to the rebate amount. However, many sellers can avoid these taxes thanks to the home sale tax exclusion.
Finding the right real estate agent
Real estate agents are not a one-size-fits-all solution, and you shouldn’t settle when you’re choosing one. Buying a house is one of the biggest financial transactions you’ll make in life, and it’s imperative that you trust your agent to give you sound advice and help you navigate the process. A high commission credit is appealing, but if it results in a bad deal, you could be losing more than the credit is worth.
At The Mortgage Hub, we believe commission credits should be mutually beneficial. We have a network of vetted, knowledgeable agents who we count on to help our clients find the right home. These agents offer a set commission credit to our pre-qualified clients, as we’ve already helped you through the process of financially preparing for a mortgage.