The rapid rise in real estate values over the past five years has created as much confusion as it has profits. Bottom Line! Personal asked Bob Bruss, real estate attorney and nationally syndicated columnist, to answer the thorniest questions he gets from home owners and real estate investors...
DOWNSIZING
I made a $375,000 profit on the sale of my four-bedroom house in Pennsylvania. I’m planning to retire to a brand-new two-bedroom condominium in a warmer climate. I have the ability to pay cash, but would it be better for me to take a mortgage?
I would advise against tying up a big chunk of your nest egg in an all-cash deal. What if you decide that you don’t like the area? Or you aren’t satisfied with the new condo? You might not have enough available cash to explore other options if your money is tied up in the new condo.
My suggestion: Make enough of a down payment—usually 20%—to get the best mortgage terms. Be sure that the mortgage has no prepayment penalties. If everything is working out fine after a year or two, then pay off the mortgage if you wish.
CAPITAL APPRECIATION AND TAXES
My wife and I own a rental property that is worth about $200,000. We want to sell it and split the proceeds between our two children so that they can make down payments on their own homes. How do we minimize or avoid capital gains taxes?
Unfortunately, the property you’re
selling is an investment, so you don’t qualify for any principal residence tax exemption. Profits from the sale are subject to a 25% depreciation recapture tax, a 15% capital gains tax and state income tax.
My suggestion: Instead of selling the property, refinance it. By doing that, you still can give the money to your children for their down payments, but your tenants will continue to make the mortgage payments for you.
You and your wife are allowed to give away $11,000 each annually tax-free ($22,000 to each child) without being required to file a gift tax return with the IRS. You and your wife won’t owe gift tax unless either of your total life time gifts exceeds $1 million.
My house has more than quadrupled in value, but I bought it before I got married and only my name is on the title. If my wife and I sell the house now, are we both entitled to the capital gains tax exemption on the profit?
Yes. If you and your wife both occupied the house as your principal residence for at least two of the past five years, you each avoid taxes on $250,000 of home-sale profits. The law does not require that the title to the home be held in both your names so long as you are married and file a joint income tax return in the year of the sale.
Example: Say you bought your home for $155,000 and sell it for $675,000. Your total appreciation is $520,000, but with $500,000 in exemptions, only $20,000 of your profits would be taxed (at the federal capital gains tax rate of 15%). If you made capital improvements to the house or paid a sales commission to a real estate agent when you sold, you can add that to your cost basis (the price you paid for the house) and further reduce your tax liability
Other tax loopholes: Military and foreign-service personnel who decide to sell a house due to an assignment qualify more easily for the full ($250,000/$500,000) tax exemption. The seller must have lived in the home for two out of the last 10 years instead of two out of the last five years. Divorced couples who sell jointly owned residential property can take a $500,000 exemption as long as one of them has lived in the house for two of the past five years.
REAL ESTATE VS. BONDS
A decade ago, my wife and I invested in a single-family rental house in San Mateo, California. We still would like to receive monthly income, but we’re approaching retirement and no longer want to deal with tenants and managing the property. We’re considering selling the house and investing in bonds. Is this a smart move?
If you don’t need a lump sum right away, it might be wiser to do a tax- deferred exchange under Section 1031 of the Internal Revenue Code.
How it works: You can swap your property for another real estate—based investment of equal or greater cost and equity. This is called a Starker exchange. IRS rules are highly complex and have strict time limits, so you will need to consult a knowledgeable adviser
Currently, a very popular Starker exchange involves reinvesting in shares of tenancy-in-common (TIC) funds. Like real estate investment trusts (REITs), TIC funds include properties that developers typically buy and manage, such as office buildings or shopping centers. These funds deliver annual returns of 5% to 8% to investors.
Careful: TICs should be treated as long-term investments. Unlike REITs, which are publicly traded, they lack liquidity and can take time to resell.
Also, hundreds of TIC promoters that have no track records have been cropping up. Make sure you stick with a reputable company that has been in business for a decade or more. Rules are tricky, so consult a real estate tax specialist.
INHERITANCES
My mother is quite elderly and says she would like to sign over the deed to her house as a gift to me while she still is alive. Is this reasonable from a tax perspective?
Absolutely not. It’s much better to inherit real estate than to receive it as a gift before a loved one’s death.
Reason: If it is a gift, the cost basis when you sell the house will be what your mother originally paid for it. You’ll wind up owing substantial capital gains taxes. With inherited property, you get a new “stepped-up” cost basis, which is the market value of the house on the date of your mother’s death.
Related issue: I see many sick or elderly parents add their children’s names to the titles of their homes and properties. This is known as a joint tenancy with right of survivorship. When one joint tenant dies, the surviving joint tenant gets that person’s half. This step is meant to streamline the inheritance process since the property avoids pro bate, but there is a downside. If a child runs into financial problems, any law suits, judgments or liens against him/her could be attached to the property even while the parent is living there.
A better alternative is to hold the title in a revocable living trust and make the children the beneficiaries. This protects the property and lets the parent maintain control but still allows conveyance without probate upon his death.
MORTGAGE PAYMENTS
I recently was approached by a company that offered to set up a bi weekly mortgage-payment program for me. The company charges sever al hundred dollars but claims that the program would save me thousands in interest costs and let me build equity in my home faster. Is this true?
Yes, but you can set up your own accelerated payment program and avoid the fees. Simply take your monthly principal and interest payment and divide it by 12. Add that figure to your regular monthly mortgage payment. Make it clear on your check that the extra amount is for “principal reduction.”
The annual extra principal payments don’t trigger any prepayment penalty. To calculate how much you might save, go to www.reduce-my-mortgage.com/calculate.htm.
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