Q-My husband plans to retire in October or November. By then we hope to have sold our home, which we will list for sale in June after our son graduates from high school. We’ve owned our home about 30 years and expect to have a net profit of almost $200,000.
Our CPA advises us, since we are well over 55, we can use that $125,000 tax exemption you often discuss. But he says there’s no way to avoid paying tax on the additional $75,000 of profit. Or is there? Please help.
A-The answer to your question depends on your post-retirement plans. If you expect to buy another principal residence, perhaps a condo, then I can help. But if you will be renting and not buying a principal residence, then your CPA is correct that the $75,000 home sale profit exceeding your once-per-lifetime $125,000 exemption is a taxable capital gain.
Let me illustrate how buying a smaller replacement principal residence can avoid tax on that $75,000. To keep the numbers easy, let’s suppose you paid $25,000 for your home 30 years ago and it sells for a net adjusted sales price of $225,000. Presuming you didn’t add any capital improvements (which would increase your adjusted cost basis), your sale profit is $200,000, of which $125,000 qualifies for the “over 55 rule” tax exemption.
Subtracting your $125,000 “over 55 rule” exemption from the $225,000 net sales price (after paying sales expenses), your “revised adjusted sales price is $100,000 with a $75,000 remaining taxable profit.
To avoid paying tax on this $75,000 profit, in this example you can buy a replacement principal residence costing at least $100,000 (your revised adjusted sales price). Tax is thereby deferred on the $75,000 by using the “rollover residence replacement rule” of Internal Revenue Code 1034. This tax break is available to homesellers of any age who buy a replacement principal residence of equal or greater cost within 24 months before or after selling their old home.
By combining the “over 55 rule” and the “rollover residence replacement rule” you can avoid tax on more than $125,000 of home sale profits. Your CPA can give you further details.
Q-Several months ago, you explained something called a “Starker delayed exchange.” As I own an apartment building which I would like to sell, I perked up when I read your article.
But I asked my tax accountant (he’s not a CPA) and he had never heard of a Starker exchange. He looked it up in several tax reference books and the tax code but couldn’t find it.
My attorney, who doesn’t specialize in taxes or real estate, had not heard of it, either. Is this something new?
A-Starker delayed tax-deferred exchanges have been around since 1979 when T.J. Starker won his delayed exchange case against the IRS. In 1984, Internal Revenue Code 1031(a)(3) codified the Starker exchange rules (although you will not find the name Starker used in the tax code).
You’ll need a real estate or tax attorney to prepare your Starker exchange agreement.
The first step is to sell your apartment building. But be sure the sales proceeds are held by a third-party intermediary, such as a bank trust department, beyond your constructive receipt. Your second step is to take up to 45 days to designate the “like kind” property you want to acquire with those proceeds and 180 days to complete the acquisition.
Q-Our purchase contract to buy our home specified the kitchen appliances, wall-to-wall carpets, draperies and patio furniture were to be included in the sales price. The seller left everything except the beautiful custom-made living room draperies, which covered the three large picture windows. Instead, she left some cheap drapes she probably bought at K-Mart or Sears.
An interior decorator friend estimates replacing the original drapes will cost at least $3,000. The realty agent says he can’t locate the seller, although they are relatives. How can I force the seller to return the draperies?
A-Your situation shows why it’s so important for home buyers to re-inspect the residence the day before the sale closes to be certain the seller left everything specified in the sales contract.
Before the closing, the buyer has maximum leverage over the seller. After the sale closes, as you discovered, you have zero leverage.
Since the seller is difficult or impossible to locate, your best leverage is with the related real estate agent. He or she can best obtain the return of the draperies. A polite but firm letter from you or your attorney to the agent will probably bring results.
If not, Small Claims Court is the best place to settle this dispute, which the agent could have prevented.
Q-I am 76 and own 11 apartment buildings, which I manage. But I’m tired of “tenants and toilets.” However, I enjoy the benefits of real estate investment, especially the cash flow, since I have paid off all the mortgages. I’d love to sell my buildings and carry back mortgages but the capital gains taxes are too high.
At the monthly meetings of our local apartment owner’s association, I asked my fellow owners to recommend a property management company. About a year ago, I hired a certified property manager (CPM) who was highly recommended. He was a disaster by alienating my good long-term tenants, increasing vacancies and raising my expenses, mostly due to his 5 percent management fee. After six months, I fired him and took back management of my buildings.
How can I find a good property manager so I can have more time to play golf before I’m an old man?
A-In my opinion, the world’s most difficult job is being a professional property manager. Although you hired a CPM, as you discovered, that is no guarantee of top-quality property management.
The reason managing properties is the world’s toughest job is the professional manager is caught in the middle between tenants and landlords. The landlords want maximum net income. But the tenants want minimum rents and maximum services for their money. The property manager can’t keep everyone happy.
My suggestion is to gradually sell off your buildings, accepting minimal down payments from financially-sound buyers. Another alternative is lease-options.
If you carry back installment sale mortgages with interest only mortgages, you will owe only small capital gains taxes until the balloon payments come due in 10 to 30 years. By then, you’ll be a senile old man and won’t care.
Q-Each month our mortgage payment includes $58 for private mortgage insurance. The PMI enabled us to buy our home for just 5 percent down. But we have greatly improved our house and now the mortgage balance is only about 70 percent of its market value.
How can we get rid of this PMI? My letters to the loan company are ignored.
A-I suspect you may be including your letters asking for PMI removal with your monthly mortgage payment and those letters are not being forwarded to the right person.
Instead, phone your mortgage servicer. Ask who owns your mortgage. If you’re lucky, Fannie Mae or Freddie Mac own it. They have policies specifying when the loan-to-value ratio drops below 80 percent, as shown by an appraisal paid for by the borrower, the PMI can be dropped.
A few states have similar laws. Be persistent. Eventually you can get your PMI dropped, as it obviously is no longer needed to protect the lender against foreclosure loss.
Q-When we moved into our current home, almost five years ago, we deferred tax on the sale of our previous residence. Now that we’re selling our current home and will be buying another in our new city, can we defer our profit tax again? If so, is there any limit on the number of home sale tax deferrals?
A-There is no limit to the number of times you can use the “rollover residence replacement rule” of Internal Revenue Code 1034. However, it cannot be used more frequently than once every 24 months unless the home sale and replacement qualifies for the moving expense tax deduction involving a job location change.
If the new job is at least 50 miles farther away from your old home than was your old job location, then IRC 1034 can be used more than once every 24 months.
As you probably recall, the rollover residence replacement rule requires you to defer your profit tax when selling your principal residence if you buy a replacement home of equal or greater cost within 24 months before or after the sale. It’s that simple. Your tax adviser can give you further details.
Q-My only living relative is my sister, 56. I am 67 and not in very good health. I own my home and about 600 acres, now leased to a farmer. My sister will inherit everything.
A good friend suggests I add my sister to the title now in joint tenancy so the property won’t have to go through probate. Is this a good idea?
A-Please consult an estate planning attorney because there are advantages and disadvantages of the idea suggested. Joint tenancy with right of survivorship would simplify title transfer if you die before your sister does.
However, if you don’t die soon and should want to sell or refinance the property, your sister might not want to do so. Another alternative to consider is putting the property title into a revocable living trust.
Q-Why don’t you warn investors to check the ground condition before buying commercial property? Last year, I bought an abandoned supermarket that I wanted to make into four small stores to be leased out. I bought the property from an estate.
Shortly after purchase, I received a notice that the parking lot was a former gas station site which has toxic waste which must be cleaned up. Now I know why this was a bargain purchase price.
When I confronted the attorney for the estate, he claimed to have no knowledge of the problem. Cleaning up the hazardous toxic waste, which apparently had been dumped for many years, will cost thousands of dollars.
A-Thank you for sharing that experience so we won’t make the same mistake. Cleaning up a polluted property can often cost more than the property will be worth after the clean-up.
You might have legal recourse against the estate if you can prove there was knowledge of the toxic waste before selling the property to you. Please consult an attorney for further details.
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Please note: Real estate laws differ from place to place, so you should check local laws before making decisions on real estate problems. Letters should be addressed to Tribune Real Estate Features Service, P.O. Box 280038, San Francisco, Calif. 94128.
