QUESTION: We have a problem I haven't seen in your column before. Due to illness and unemployment, we must sell our home to pay overdue bills and avoid foreclosure. Our home should sell for at least $175,000 and we only owe about $92,432, so we will receive enough cash from the sale to pay our bills and have enough left over for a down payment on another house.
But we are receiving conflicting information from the IRS and a tax preparer as to our tax situation. We called the IRS and were told we must reinvest all our cash from the sale into another house of equal or greater cost if we are to avoid tax on our profit. But our tax preparer says all we need to do to avoid tax is buy a house costing at least as much as the net sales price of our current home. Who is right?
ANSWER: Your tax preparer is right. The IRS is wrong. The government's own surveys show the IRS gives out incorrect information to at least 30% of the callers.
The roll-over residence replacement rule requires total profit tax deferral when you sell your home and buy a replacement principal residence of equal or greater cost within 24 months before or after the sale.
However, contrary to the information you obtained from the IRS, Internal Revenue Code 1034 does not require you to reinvest all your sale proceeds into your replacement home. If you wish, you can sell your old home for cash, spend it as you wish and defer your profit tax by buying a replacement home for nothing down (such as with a VA mortgage) if its cost equals or exceeds your old home's net (adjusted) sales price.
It Is Better to Inherit Than Receive by Gift
Q: I am 72 and am thinking I should give my real estate away now to my three adult children to get it out of my estate. But my wife is opposed to the idea. Our net equity is about $2 million. Our children are very devoted to us and they would continue to give us the net rental income from these properties. We are comfortably well off. Do you think we should divide up our properties now while we are still in good health?
A: No. With careful estate planning, you and your wife can exclude at least $1.2 million of assets from federal estate tax. Giving your properties away now would hurt your children, because they will take over your low basis in the properties. However, if they inherit the properties they will receive a new basis, stepped-up to market value on the date the last spouse dies.
More Advantageous to Invest as Partnership
Q: Three of us want to buy land as an investment and include a buy-out agreement in case one of us wants to sell the property. Also, we want to specify what happens if one investor can't pay his share of the property expenses, such as property taxes. We contemplate a 10-year holding period. One investor wants a tenancy in common but my lawyer suggests holding title in partnership. Which do you think is best?
A: The big advantage of holding title in a partnership is the partnership agreement can provide for many contingencies such as a buy-out agreement among the partners. A major disadvantage of a tenancy in common is one or more unhappy co-owners could bring a partition lawsuit to either force the division of the property or its sale. In my opinion, partnership ownership is much more flexible than holding title as tenants in common.
When Is the Best Time to Refinance Property?
Q: I have about $70,000 equity in my house. My fixed-interest rate is 10.25%, so I wouldn't save interest by refinancing now. However, I could use the extra cash for an investment. When do you think I should refinance?
A: I don't see any reason for you to refinance your existing mortgage because today's fixed-interest rate is about what you are now paying. A better alternative might be to add a home-equity credit line mortgage.
Although the interest rate will be a little higher than 10.25%, the credit line flexibility allows you to pay interest only on the money you actually borrow. The money can be borrowed and paid back at your convenience. Home-equity credit lines are very advantageous. Shop around for the best deal among banks and S&Ls.
Small Down Payment on a Home Is Not New
Q: In reply to a reader who criticized you for suggesting home buyers make a small down payment you said, "Uncle Sam makes me do it." Then you explained the 1987 Tax Act makes it smart for home buyers to make the smallest possible down payment and obtain the largest available mortgage. My question is, before this tax law change, how much down payment did you advise home buyers to make?
A: Last week I had occasion to review some of my old columns. Way back in the dark ages of June 1977, in answer to a question, I replied: "Always invest as little cash as possible when buying property. Get the biggest mortgage you can afford." That advice hasn't changed, but now I can blame it on Uncle Sam's tax law.
Finding Apartment Loan Is Not Easy