QUESTION: We want to sell our large old home, where we have lived 28 years, and buy either a smaller house or perhaps a condo. Our problem is that we will have a profit of about $175,000, which is more than our $125,000 "over 55 rule" tax exemption. Is there any way we can shelter that remaining $50,000 profit from tax?
ANSWER: Yes. You can combine the "over 55 rule" $125,000 tax exemption with the "rollover residence replacement," which is available to home sellers of any age.
To illustrate, suppose your home's adjusted cost basis (purchase price plus any improvements) is $25,000, and you sell it for a net price of $200,000 and a $175,000 profit.
I'll assume you meet the "over 55 rule" requirements of owning and living in the home any three of the five years before the sale, at least one co-owner spouse is 55 or older on the sale date and you or your spouse have not used this tax break before. Subtracting the $125,000 exemption from the $200,000 net sales price leaves a "revised adjusted sales price" of $75,000.
Then, if you buy a replacement principal residence costing at least $75,000 within 24 months before or after the sale, you can defer profit tax on your remaining $50,000 profit. Please consult your tax adviser for more details.
Could First Home Also Include Rental Units?
Q: My wife and I have about $25,000 for the down payment on our first home. We have looked at both single-family houses and small rental properties, such as duplexes, triplexes and fourplexes. If we bought rental property, we would live in one unit. Do you think such property should make a good first real estate investment?
A: My first real estate investment was a triplex where I lived in one unit and received income for the two rentals. This was a wonderful way to get started in realty investing because the rental income helped pay the expenses.
However, many owners do not like to live so close to their tenants. I was fortunate to have tenants who were mostly quiet and non-complaining, so we got along great. But, a troublesome tenant could drive the owner crazy because of the close proximity.
As for appreciation in market value, you will usually find single-family houses go up in market value faster than do small income properties. There is nothing wrong with investing in small rental properties as long as you are aware of their pros and cons.
Oral Sales Agreement Not Legally Binding
Q: My neighbor promised to sell me his house. We agreed on the price. We set up an appointment to meet at his lawyer's office the next day. When I showed up, the attorney said the neighbor decided not to sell. I was very mad. A few days later the neighbor listed the house for sale with a real estate agent at a much higher price. The house has not sold in over three months, so I know it is overpriced. How can I enforce my agreement to buy the house at a fair price without a sales commission?
A: I regret to report verbal real estate agreements are not legally enforceable. In other words, your oral contract with your neighbor is worthless.
The Statute of Frauds requires virtually every agreement affecting real estate be in writing to be enforceable in court. There is a very good reason. The purpose of this law is to prevent misunderstandings.
Without a written agreement specifying the exact terms of the sale, there can be a misunderstanding by the buyer and seller. Until you have a written contract for the sale of real estate, nothing is enforceable.
How to Trade a Home for Income Property
Q: I want to trade my home, worth about $300,000, for a four-plex worth about $400,000. How can I accomplish this without paying tax on my profit of about $170,000?
A: That's easy. Move out of your principal residence. Rent it to tenants, thereby converting it from your personal residence to investment property. Then make an IRC 1031 tax-deferred exchange for the four-plex. Ask your tax adviser to explain further.
What Happens When Lender Forecloses?
Q: My wife and I are thinking of selling our home and carrying back a second mortgage for the buyer. Our VA first mortgage is assumable. Frankly, we can use the extra interest income we will earn, as the rate is higher than we can get at a bank or S&L. But our worry is what happens if the buyer doesn't make the payments on the first mortgage?
A: If your borrower falls behind on the payments on the first mortgage, to protect your second mortgage, you should step in to make the first mortgage payments and then begin foreclosure on your second mortgage. Failure to pay the first mortgage is a default on the second mortgage.
If your second mortgage goes all the way to a foreclosure sale because the borrower doesn't cure the default, and if there are no bidders at the foreclosure sale to pay off your loan, then you get the house back to resell for a second profit. Rather than fearing a default, you should look forward to it. Please consult a real estate attorney for further details.
Home-Equity Loan Computation Formula