Q–My wife and I are discussing selling our large home, which is getting too expensive and time-consuming to maintain. I’m 74 and she’s 72. Our main concern is taxes on our profit of close to $200,000. We’re not counting on President Clinton’s tax abatement getting through Congress this year.
Other than that $125,000 “old folks” tax exemption, is there any way we can avoid tax if we sell our home?
A–Yes. I agree there is no guarantee Congress will pass the proposed $250,000 per person ($500,000 per couple) home sale tax exemption. Currently, there are three basic ways principal residence sellers can avoid tax on their sale profits:
1. The “over 55 rule” $125,000 home sale tax exemption. Since you and your spouse are well over 55, presuming you haven’t used this tax break before and have owned and lived in your principal residence at least three of the five years before its sale, up to $125,000 of your sale profit will be tax exempt.
2. The rollover residence replacement rule. This tax deferral rule applies to home sellers of any age. They must defer their profit tax if they sell their principal residence and buy a replacement home of equal or greater cost within 24 months before or after the sale.
You can combine this tax rule with the $125,000 exemption to shelter all your profit from tax. For example, suppose your home sells for a net price of $300,000 after sales expenses. Subtracting the $125,000 “over 55 rule” exemption leaves a $175,000 “revised adjusted sales price.” Just buy a replacement home costing at least $175,000 in this example to exempt $125,000 of your sale profit from tax and defer tax on the $75,000 profit.
3. Installment sale. You can use the “over 55 rule” $125,000 exemption and spread out tax on the remainder of your profit by making an installment sale. This means you must carry back a first or second mortgage for your home buyer. An added advantage is a quick, easy sale for top dollar, since you offer easy financing.
Ask your tax adviser to explain further about these three home sale tax avoidance methods.
Q–I have my eye on buying some rural acreage for future development. The parcel that interests me is 46 acres. It has been for sale several years at a very reasonable price.
I talked with my banker about a 75 percent mortgage loan, but he says banks don’t like mortgages on vacant land. I got the same answer from four other banks. How can I finance my investment in this potentially valuable land?
A–Financing the purchase of vacant land is virtually impossible, unless you’re an experienced developer with a success record. Mortgage lenders know the default rate on land is very high. Reselling land after foreclosure is extremely difficult.
Virtually the only way to finance land purchases is for the seller to carry back the mortgage for at least 10 years. By then you should be able to develop the land. If the seller won’t finance your purchase, maybe you shouldn’t buy.
Please remember my frequent advice to avoid buying real estate you won’t use within six months of purchase.
Q–The apartment building where I live was recently sold. Should I be concerned about my $550 security deposit? The new owner hasn’t said anything to the 22 tenants about our deposits. Should we do anything to get credit for our deposits?
A–Yes. To prevent errors and misunderstandings, immediately after an apartment building sale is an excellent time to verify your security deposit with the new owner.
When you pay your rent, attach a short letter asking the new owner to verify in writing that your $550 security deposit was transferred. Usually, the tenants are asked to sign estoppel letters confirming the terms of their lease and the security deposit. Since this apparently wasn’t done, you should verify your deposit now to prevent a future problem.
Q–I want to sell my home and exchange it for a small apartment building. But my CPA has never heard of a Starker tax-deferred exchange for a simple situation like this. He says it can’t be done.
Where can I find someone who can show me how to do a Starker exchange?
A–I am shocked your CPA has never heard of a Starker delayed tax-deferred exchange. He or she should read Internal Revenue Code 1031(a)(3).
However, it doesn’t apply to your situation because your personal residence is not eligible. Starker delayed exchanges are only available for property held for investment or use in a trade or business.
But you can make your home comply by moving out and renting it to tenants. It then becomes investment or business property, eligible for a tax-deferred exchange. Then you can sell it, have the sales proceeds held beyond your constructive receipt by a third-party intermediary such as a bank trust department, and use those proceeds to acquire the apartment building you want.
After the rental home sale closes, you have 45 days to designate the investment or business property you want, and 180 days to complete the acquisition. I’m sending you my report “How to Profit from Starker Tax-Deferred Exchanges.” Readers can obtain a copy for $4 sent to Robert Bruss, 251 Park Road, Burlingame, Calif. 94010.
Q–My mother is dying. She wants to give her her house. But I recall your saying it’s better to inherit property than receive it as a gift. Why?
A–When you inherit real estate, you receive it with a cost basis of its market value on the date of the decedent’s death. If you receive it as a gift, you take over the donor’s usually much lower adjusted cost basis.
The higher your cost basis, the better. To illustrate, suppose your mother’s cost basis for her home is $25,000, but it is worth $100,000 when she dies. If you inherit the house and sell it for $100,000, you owe no capital gain tax since you have no profit. But if you receive that house as a gift while your mother is alive, you take over her $25,000 cost basis. Should you decide to sell it for $100,000, you’ll have a $75,000 taxable capital gain. Ask your tax adviser to explain further.
To avoid probate, ask your mother to put title to her house and other major assets into a living trust. While she is alive she can still manage her assets normally. But when she dies, under the terms of the living trust, the assets can go to you without probate costs or delays. An attorney can usually set up a living trust for $500 to $1,000 unless it is very complicated.
Q–I recently got an unexpected job offer outside the United States. At the same time, my newly purchased home is about ready to close. I am thinking about selling the house or renting it to tenants.
Is it a good idea to lease the house rather than selling it? If I rent, how can I find a reliable realty agent to rent and manage it? How much rent should I charge? Who will pay the mortgage?
A–I presume you’ve decided to accept the foreign job offer. Selling your newly purchased home could be a costly mistake. It will cost at least a 6 percent sales commission, plus other sales expenses.
Of course, if you don’t plan to return to the area, ask if you can pay the seller a few thousand dollars to cancel your purchase. That might be a very wise expenditure.
Although I do not recommend long-distance home rentals, if you go through with the purchase you don’t have any viable alternative. While you’re renting the house, at least you’ll get some tax shelter from depreciation tax deduction.
Many larger residential real estate sales offices have rental departments, which will find you a reliable tenant and collect the monthly rent. If you wish, they can pay the mortgage from the rent collected. However, you’ll be better off paying the mortgage yourself, so you’re sure it gets paid on time.
By the way, the mortgage lender might give you a little trouble if you are discovered not to be living in the house. Presumably, you have an owner-occupant loan at the best loan terms. If asked, just explain you received an unexpected out-of-town job offer, but you plan to return to live in the house (if you do).
