Q–Thank you for your recent explanations of how the 1997 Tax Act benefits qualified home sellers with the $250,000/$500,000 exemptions. But I haven’t seen anything written about how the new tax law applies to those of us who operate our businesses from our homes. I use the family room of our six-room house for my office. For the last four years, I have been taking depreciation deductions on it. If we sell our home at a net profit of $300,000, how does my office affect taxes?
A–The new exemption of $250,000 per qualified person does not include the profit from the “business area” of your home. When you sell your home, the depreciation you’ve deducted for the office area will be recaptured. That means taxed.
For example, suppose you have deducted $20,000 depreciation for your home office area of your residence. That $20,000 will be taxed at the new 25 percent tax rate for depreciation recapture. Thus, in this example, you would owe $5,000 depreciation recapture tax. In addition, you would owe tax on the sale profit attributable to the business area of your residence at the new 20 percent capital gain tax rate. Please consult your tax advisor for details.
Q–In 1993, we sold our home and carried back the first mortgage for our buyer. We love the extra retirement income and think the safe yield at 8.5 percent is excellent. Our biggest worry is that the buyers will refinance and pay off our mortgage. Each Christmas, the buyers mail us 12 postdated checks and all we have to do is remember to deposit one in our bank on the first of each month. Each year our CPA calculates how much tax we owe on the mortgage payments we received. The interest is taxed as ordinary income and our profit was taxed at 28 percent as a capital gain. Since the 1997 Tax Act reduced the capital gain tax rate to 20 percent, can we benefit from this tax reduction?
A–Yes. Installment sale payments received after May 6, 1997 qualify for the new, lower 20 percent capital gain tax rate. Of course, the interest remains taxable as ordinary income at 28 percent.
The capital return portion of each payment received remains tax-free. Calculating the tax on your installment sale payments received in 1997 won’t be easy, at two different rates, but I’m sure your CPA will be able to do the job.
Q–I’ve owned a condo about two years in a badly mismanaged complex. The homeowners association is suing the developer for shoddy construction. Several homeowners are suing the association for failure to fix the leaky roof. I want to sell. My Realtor has found a buyer who still wants to buy despite the lawsuits. However, no mortgage lender will make her a loan until the lawsuits are resolved. That could take years. Meanwhile, I want to sell my condo. What should I do?
A–Your situation shows what can happen when condo associations become mired in litigation, which is not infrequent.
To avoid losing your buyer, lease your condo to her with an option to buy. Since she won’t be getting the ownership tax deductions for mortgage interest and property tax payments, give her a generous rent credit of at least 50 percent toward the option purchase price when the litigation is settled. A local real estate attorney can prepare a lease-option.
Q–During a storm last April, the city storm drains backed up, flooding our front lawn and garage. It was a mess. We had fixed up our garage as a family room for our four kids. It was ruined. Our homeowner’s insurance company refused to pay for the approximately $12,000 damage. The city refused to pay either. We didn’t have any flood insurance since we’re not in a flood-prone area. A neighbor says we can deduct our loss on our income tax returns. True?
A–Possibly. Your situation sounds like a “sudden, unusual or unexpected” casualty loss deduction. However, such loss is deductible only on the amount exceeding 10 percent of your adjusted gross income, plus $100 per loss event.
To illustrate, suppose your family adjusted gross income is $50,000. That means the first $5,100 of your casualty loss is not deductible. But the remaining $6,900 loss qualifies.
Be sure to document your loss amount carefully, such as with photos, appraisals, repair costs and other evidence. Casualty losses are a favorite IRS audit area because claimants tend to exaggerate. Ask your tax advisor for further details.
Q–I recently bought a nice condo for my elderly mother. It’s about four blocks from our house, so we can keep an eye on her but still give her independence. She will probably walk over to our house for Sunday dinners. She lives on Social Security and a small pension, so I’m not going to charge her any rent. Since I took out a mortgage on the condo and will also have to pay the property taxes, can I deduct these expenses on my tax returns?
A–Yes. Mortgage interest and property taxes are always tax deductible, even on a nonprofit family rental. However, you cannot depreciate the below-market-rent condo. The monthly condo fee will not be tax deductible, either. Your tax advisor can give you full details.
Q–We were amazed when our Realtor brought us a practically full-price purchase offer within a week after we listed our home. We accepted. But the offer contained a contingency clause for a professional inspection. The inspector’s report says the roof needs to be replaced. However, we have had no problems with leaks, although I admit the roof looks poor. The buyer wants us to give him a $7,500 roofing credit. Do we have to do so?
A–No. Most home purchase inspection contingency clauses specify that the report is subject to the buyer’s approval. If the buyer doesn’t approve of the report, the sale is canceled.
———-
PLEASE NOTE: Real estate laws vary from place to place. Be sure to check the laws of your state and municipality before making decisions on real estate matters.
Write to Robert Bruss at Tribune Media Services, 435 N. Michigan Ave., Chicago, Ill. 60611.
