Q-I am 74 and have trouble managing my 18-unit apartment building. As the owner, I’ve found I have to manage the resident manager. But this is getting more difficult for me. I’d like to sell the building but I need the cash flow from the rents. If I sell and carry back a mortgage, my income won’t be as much as I now earn from the rents.
I have a cash buyer, but if I sell for cash I will have a tremendous capital gains tax to pay. Any ideas?
A-A Starker delayed tax-deferred exchange can solve your problem. You can sell your apartment building for cash, have the sales proceeds held beyond your constructive receipt by a third-party intermediary, such as a bank trust department, and then invest the funds in a managed “like kind” property.
Internal Revenue Code 1031(a)(3) gives the rules, such as identifying the property to be acquired within 45 days and completing the acquisition within 180 days.
To illustrate how Starker exchanges work, some friends recently sold a rental house they owned and had the sales proceeds held beyond their constructive receipt by a bank trust department. A few weeks later, they used these funds to complete the Starker exchange by buying an interest in a restaurant building which is managed by a syndication firm.
Each quarter they receive a check which produces about a 9 percent yield on their invested dollars. You could make a similar Starker exchange for a property which is much less management-intense than your apartment building. Ask your tax adviser for details.
Q-I only have about 10 percent cash for a down payment. A Realtor found me a nice townhouse where I can get a new 80 percent first mortgage and the seller will carry back a 10 percent second mortgage. But the seller wants the second mortgage due in two years. Do you think that’s too soon?
A-Yes. You will probably have great difficulty refinancing that second mortgage in just two years to pay off its balloon payment. A better alternative is to ask the seller to carry back the second mortgage for 10 years.
If the seller won’t do that, I recommend getting a 90 percent first mortgage. Yes, I realize you will then have to pay PMI (private mortgage insurance), but paying PMI is better than having a short-fuse balloon payment coming due in just two years.
Q-With mortgage interest rates such a bargain, my wife and I have decided to buy a home. We got pre-approved for a mortgage, but the maximum mortgage payments are far higher than we are now paying for rent.
How do lenders calculate the mortgage payments borrowers can afford to pay?
A-Each lender has different loan qualification criteria. But most lenders won’t approve a home loan which requires more than 28 to 33 percent of gross family income for monthly payments. However, a few lenders allow this percentage to go as high as 40 percent if the borrower doesn’t have any installment debts.
Don’t worry. Most home buyers stretch their budgets to buy a home. As your income increases in future years, your mortgage payments will become easier to make each month. Also, don’t forget you can reduce your income tax withholding because the mortgage interest will save you tax dollars.
Q-I own a house where I live; I can sell it for about $250,000 cash. However, if I sell I will have to pay tax on about $200,000 profit. I am not yet 55 and I don’t plan to buy another house.
Since I need income, I would like to somehow trade my house for either apartments or a commercial building which will produce rents. My CPA says there’s no way I can do this because my house is my personal residence and the apartment or commercial building is income property. What should I do?
A-Your CPA is correct that you cannot make a tax-deferred exchange of your personal residence for income property.
However, you can convert your home into income property by moving out and renting it to tenants. Then you can make a “like kind” Internal Revenue Code 1031 tax-deferred exchange for an apartment or commercial building.
The unanswered question, however, is how long after you begin renting your house to tenants can you make a tax-deferred exchange? The answer is, nobody knows for sure because the tax code and regulations don’t discuss this subject. But most tax advisors suggest renting your former personal residence at least six to 12 months before making a tax-deferred exchange. Ask your tax adviser for more details.
Q-My husband and I plan to take a two-month cruise. But a friend told me if we are gone from our home over 30 days our fire insurance policy is cancelled. Is this true? If so, what can we do to avoid this problem?
A-Many homeowner’s insurance policies specify certain coverages lapse if the residence is vacant more than 30 days. However, your fire insurance policy is not cancelled under those circumstances.
Coverages which may lapse if your home is vacant more than 30 days pertain to preventable losses, such as damage from broken pipes and vandalism. Check with your insurance agent to learn what you can do to keep all your coverages effective. For example, if a friend comes in to check the house daily or weekly that may be sufficient.
Q-I took the necessary real estate courses and passed my real estate license exam. Now I’m debating if I want to give up my dead-end salaried job, which pays well. I’m worried it may take me six months or longer to start earning real estate sales commissions.
Any ideas on how I can start earning quick income if I decide to become a realty saleswoman?
A-Be sure to read the excellent new book, “Up and Running in 30 Days,” by Carla Cross, available at local bookstores and public libraries. It shows how to quickly start earning realty sales commissions.
But one method of earning quick income in real estate not explained in that book is to become a “rental lady.” That means you work in the rental department of a realty brokerage and specialize in renting houses and apartments. As soon as the tenant moves in, you get paid your rental commission. This means you can be receiving rental commissions within a week or two.
Later on, you may wish to switch to listing and selling homes. If you treated the tenants well, when you notify them you are real estate sales they will probably come back to purchase a home from you. Renting houses and apartments is the quickest way I know to start earning income with your new real estate license.
Q-Is there any way I can estimate what my after-tax mortgage interest rate will be?
A-Yes. (1) Subtract your income tax rate, such as 28 percent, from 100 percent to arrive at your after-tax rate. (2) Multiply that rate by your mortgage’s interest rate. The result is your after-tax mortgage interest rate.
To illustrate, suppose you have an 8 percent interest rate mortgage and you are in the 28 percent income tax bracket. Subtracting 28 percent from 100 percent is 72 percent. Multiplying 8 percent by 72 percent is 5.76 percent, your after-tax mortgage interest rate.
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Robert Bruss’ report “The 10 Key Questions to Ask Before Selling Your Home” is available for $4 from Tribune Media Services, 435 N. Michigan Ave., Room 1408, Chicago, Ill. 60611.
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 Media Services, 435 N. Michigan Ave., Suite 1400, Chicago, Ill. 60611.
