QUESTION: In January, 1986, we sold our home at a profit of about $22,000. Ten months later, we bought a slightly more expensive home and deferred our profit tax, using that "rollover residence replacement rule" you often discuss. This second house was a run-down house, which my husband fixed up beautifully. However, we didn't like the schools for our children and sold this second house in July, 1987, for a net profit of about $36,000.
In August, 1987, we bought a slightly more expensive home in a better school district. We reported the sale of our second home and deferred the profit tax on our income tax returns. However, the IRS recently contacted us and said we owe tax on the $36,000 profit, plus a penalty from the sale of the second house. The auditor says we can only avoid home sale profit tax once every 24 months. But I thought you said there was no limit to the number of times this tax break can be used. Please clarify.
ANSWER: I regret to report both the IRS auditor and I are correct. The "rollover residence replacement rule" of Internal Revenue Code 1034 is one of the biggest taxpayer benefits. As you know, this rule allows home sellers to defer their profit tax when selling their principal residence if a replacement home of equal or greater cost is bought and occupied within 24 months before or after the sale.
There is no limit to the number of times this tax break can be used. But to prevent home sellers from getting greedy, it cannot be used more frequently than once every 24 months.
But there is one exception that allows more frequent use. If the principal residence sale and purchase of a replacement home involves a job location change that qualifies for the moving expense tax deduction, then IRC 1034 can be used more frequently than once every 24 months. Please consult your tax adviser for complete details.
How Realty Agents Split Commissions
Q: I am considering getting into real estate sales. Please explain how realty agents split sales commissions. When we bought our home there were two agents, one for us and one for the seller. How did they split the commission which, as I recall, was about $10,000?
A: Suppose you paid $170,000 for your home and the seller paid a typical 6% sales commission of $10,200. Usually the listing agent and the selling agent split the sales commission 50-50. That means the listing firm got $5,100 and the selling brokerage got $5,100.
However, each sales agent usually then must split his share with the real estate broker who provides the office, pays the overhead and supervises the salespeople. Although commission splits vary in each brokerage office, until an agent reaches a substantial earnings level, the split is usually 50-50. That means the listing agent in our example receives $2,550 and the selling agent receives $2,550, with the two brokers receiving $2,550 each.
As you can see, by the time the $10,200 commission in our example is split four ways, each recipient receives only about 25% of the gross commission. Of course, this is before taxes and expenses. If you want to make a handsome income, you will need to make several sales each month. Best wishes for success.
Is House Better Deal Than a Mobile Home?
Q: My son and his new bride want to buy either a mobile home or a small house. They can afford a down payment on a modest mobile home, but I am not excited about their living in a crowded mobile-home park. I am willing to help them with the down payment if they decide to buy a home. Do you think a mobile home or a house is a better investment?
A: A sound, well-located house is almost always a far better investment than a mobile home. The reason is single-family houses usually appreciate, but mobile homes either depreciate like your car or hold their value steady. However, some mobile homes appreciate in value if located in a top-quality mobile-home park.
Congratulations on being willing to help with the down payment, so your son and daughter-in-law can buy a house. I think you and they will be much happier than if they buy a mobile home.
Seller Outsmarted by a 'Nice Couple'
Q: My husband wanted to save the real estate sales commission, so I agreed to "for sale by owner." The first weekend a nice young couple made us an offer which we thought was very fair and close to our asking price. We should have known something was wrong when they offered to provide the printed sales contract forms. It turns out the man is a lawyer and his wife is a legal secretary.
But the next week I was talking with my neighbors and we learned other neighborhood homes have sold for up to $12,000 more than we got. So, my husband called the couple and told them the deal was off. They weren't very nice about it. A few days later we were served with papers for a specific performance lawsuit and the title to our house was messed up with something called a "lis pendens." We hired a lawyer and he says we signed a valid contract and the fact we sold too cheap is not a defense. What should we do?