Q–I plan to sell my home in a few months and consulted my tax advisor about how to avoid taxes. She says I have an “excess mortgage” of about $40,000 which will become taxable when I sell. I’ve never heard of such a thing before, have you?
A–Yes. An excess mortgage occurs when a home or other property is refinanced for more than its adjusted cost basis. For example, suppose you bought your home for $50,000 but it appreciated in market value to $100,000 during your ownership without any capital improvements.
A few years ago you refinanced for $75,000. The $25,000 loan balance exceeding your $50,000 adjusted cost basis is called an “excess mortgage.” It has no tax significance until you sell your home. Then it becomes part of your taxable profit.
To avoid paying tax on your excess mortgage, just buy a replacement principal residence costing at least as much as your net sales price.
Using this example further, if you net $90,000 after paying the sales commission and transfer costs, by purchasing a replacement principal residence costing at least $90,000 within 24 months before or after the sale, you can avoid paying tax on your excess mortgage. I’m shocked your tax advisor didn’t explain.
Q–Thanks for sending me your lease-option report. I thought I couldn’t afford to buy a home, but now I realize I can. I am 26, earn about $45,000 gross per year, but have only around $3,500 in a savings account. What price range should I be looking for in a house or townhouse? How can I find a lease-option? The Realtors here have never heard of them. How much of a rent credit should I expect?
A–As a general rule, most home buyers can afford to purchase a residence costing about three times their annual family gross income. That puts you in the $135,000 price range.
Everywhere I travel I hear, “You can’t do lease-options here.” That’s just not true. The problem is most Realtors don’t like lease-options because they only get a partial commission up front and must wait for the majority of their commission until the buyer exercises the purchase option.
I suggest you run a newspaper classified ad for 30 days under “Houses Wanted” such as: “Executive wants two-year lease-option on three-bedroom home. Phone Katy 555-5555.” You’ll only get a few phone calls but all you need is one. Incidentally, my lease-option report is available for $4 from Tribune Media Services, 435 N. Michigan Ave., Chicago, Ill. 60611.
Q–In a few weeks we will close on the purchase of our first home. The mortgage company asked if we want an “escrow impound account” for our property taxes and fire insurance. Is this a good idea?
A–No. Presuming you are a highly disciplined, fine, upstanding person, you can pay your property taxes and fire insurance premiums directly. However, never be late.
But VA, FHA or PMI (private mortgage insurance) home borrowers are required to have escrow impound accounts. The big drawback is mortgage servicers often over-collect from the borrowers. If they under-collect, they frequently threaten dire consequences if borrowers don’t pay the deficit instantly.
In other words, mortgage escrow impound accounts are trouble for borrowers whose loan servicers are less than honest. If you can avoid such an account, do so.
Q–I have about $100,000 which I recently received as a bonus from my previous employer for a suggestion I made before I retired due to injury. My wife and I have plenty of income for a very comfortable retirement. but I don’t want to just sit around doing nothing.
A friend invests in second mortgages through a mortgage broker. He says I should do so too. What do you think of loaning money secured by mortgages?
A–Congratulations on not wanting to just sit around doing nothing after you retired. Most people who retire do nothing and die within a few years (probably from boredom).
Second mortgages can be excellent, very profitable mortgages for retirees. I recall my Uncle Harvey, who died a few years ago at age 89. The last time I saw him before he died we talked about his second mortgage investment portfolio. After his visit, he was going over to look at a house on which he was considering making a mortgage loan.
However, rather than making “hard money” cash loans to borrowers, I suggest you instead buy existing second mortgages at a discount. The yield is often higher, such loans are usually “seasoned” so you know the borrower’s payment record, and there is much less paperwork. These are called “discounted mortgages” because you can buy them for less than their loan balance.
The high yield, typically 15 to 20 percent, comes from the interest rate the borrower pays plus the discount. The best discounted mortgage book to study is Jimmy Napier’s excellent “Invest in Debt,” available only by mail for $15 from Jim Napier Inc., P.O. Box 858, Chipley, FL 32428. I think you will enjoy buying discounted mortgages far better than making loans.
Q–This summer we plan to sell our vacation home as the upkeep is too much work for my wife. I am in a wheelchair and can’t help very much.
But we have a nice problem. As we bought the place for only about $4,500 many years ago, and it should sell for around $90,000, we will owe a huge profit tax. Because we are both well over 65, is there any way we can avoid paying tax on our sale profit?
A–No. Neither the famous “over 55 rule” $125,000 home sale tax exemption nor the “rollover residence replacement rule” apply because your vacation home is not your principal residence.
If you rent your vacation home to tenants before selling it, thereby converting it into rental property, you could defer tax by making an Internal Revenue Code 1031 tax-deferred exchange for other investment or rental property. However, that’s probably not what you want to do.
Presuming you own the vacation home free and clear, if I were in your situation I would sell it for a small down payment and carry back an “interest only” mortgage. By making an installment sale with minimal receipt of profit, your tax will be minimized. Please consult your tax advisor for details.
Q–Due to my husband’s military transfer overseas, we are selling our home. Our net profit should be about $45,000. Is there any way we can avoid paying tax on our profit, as we can’t buy a replacement home within 24 months because we don’t know where he will be transferred after several years overseas?
A–Yes. There is a special home sale tax deferral for military personnel stationed overseas. File IRS Form 2119 when you sell your home and indicate on it you plan to buy a qualifying replacement principal residence upon return from overseas military duty. Your tax advisor can give you complete details.
Q–Our home is listed for sale with an excellent Realtor. He’s only 22 but is very enthusiastic and energetic about getting our home sold.
So far, we’ve received two purchase offers from cooperating agents. Both were low, so we counteroffered but couldn’t reach an agreement on price.
However, my question involves the contingency clauses. One offer contained a professional inspection clause and a financing clause. As I read them over, I didn’t see any time limit. Is it customary to have a time limit?
A–Yes. Purchase offer contingency clauses should always have a time limit. The professional inspection contingency should allow a short time, such as five business days. But the financing contingency needs a longer time for the mortgage approval, such as 15 business days.
These escape clauses, sometimes called a “free look” or weasel clauses, effectively take your home off the market.
From your viewpoint, you want the time limits as short as possible so you’ll know if the buyer will complete the purchase or not. Your attorney can give you further details.
———-
The Robert Bruss report “How Senior Citizens (and Their Adult Children) Should Shop for a Reverse Mortgage” is available for $4 from Tribune Media Services, 435 N. Michigan Ave., Chicago, Ill. 60611.
Please note: Real estate laws differ from place to place, and laws of your area should be checked before making decisions on real estate problems. Letters should be addressed to Tribune Real Estate Features Service, 435 N. Michigan Ave., Suite 1400, Chicago, Ill. 60611.
