DEAR BOB: About seven months ago, I had to evict deadbeat tenants from my rental house. He and his wife had been good tenants for more than six years. Then they suddenly started paying their rent late, and eventually they didn’t pay at all. I had no choice but to evict them (although I felt sorry for their two cute kids). In addition to the eviction order, the court awarded me a judgment for $1,836 unpaid rent and costs. My lawyer turned the judgment over to an excellent collection agency, but they have been unable to collect anything. Now they report the tenants can’t be found. How can I collect my judgment? Can I take a bad debt tax deduction? –Nathan R.
DEAR NATHAN: Be thankful you got the deadbeat tenants out of your rental property without too much rent loss. No, you cannot take a bad debt income tax deduction because you never received the lost rental income.
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As a landlord, I find it amazing how good tenants sometimes go bad, just like stale milk.
You can record an abstract of your judgment that will automatically attach to any real property the judgment debtors acquire in the counties where you record the judgment. Sorry, I don’t have any magic formula for collecting a former tenant’s worthless judgment.
IF YOU RENT YOUR HOME TOO LONG, YOU LOSE THE $250,000 TAX BREAK
DEAR BOB: I have owned and lived in my house for 11 years. If I decide to rent it to a family member, am I correct the capital gains won’t be taxed until after five years? My wife and I owe $75,000 on our $350,000 house. –Steve P.
DEAR STEVE: Your understanding is not quite correct. To qualify for up to $500,000 tax-free principal residence sale profits (up to $250,000 for a qualified single homeowner), Internal Revenue Code 121 says you must have owned and occupied your principal residence at least 24 of the 60 months before its sale. You appear to qualify.
The result is that you can rent the house to your family member for up to 36 months after you move out. If you don’t sell within 36 months after vacating, however, you lose your $500,000 tax-free principal residence sale exemption. The amount of your mortgage is irrelevant. For full details, please consult your tax adviser.
HOW TO CLAIM BOTH $250,000 HOME SALE EXEMPTION AND TAX-DEFERRED EXCHANGE
DEAR BOB: Several years ago, I bought a two-family duplex. I currently live in one side and rent out the other unit. Both halves have the same square footage. My Realtor informed me I can make a large profit when I sell. If I sell the property before the fifth year, and buy another duplex or triplex in a tax-deferred exchange, can I get a tax exemption on my owner-occupied unit? –Joseph C.
DEAR JOSEPH: Yes. You can benefit from both Internal Revenue Code 121 and 1031. For tax purposes, selling your duplex will be like two separate tax events.
Presuming you are a single owner of your principal residence half of the duplex, and have owned and occupied it at least 24 of the 60 months before its sale, you can use your Internal Revenue Code 121 tax exemption up to $250,000 (if you are married, your spouse can also claim up to $250,000 tax-exemption if she meets the occupancy test and you file a joint income tax return).
As for the rental half of the duplex, you can defer the capital gain tax on its sale by making an IRC 1031 tax-deferred trade for a qualifying “like-kind” rental or investment of equal or greater cost and equity.
You don’t have to acquire another duplex or triplex in that exchange. You could buy a qualifying single-family rental house, condo, apartment building, or warehouse that is not your personal residence.
Because you will probably make an IRC 1031(a)(3) “Starker exchange,” please consult your tax adviser now to arrange for a third-party accommodator to hold the sale proceeds. After the duplex sale closes, you then have 45 days to designate the replacement property and up to 180 days to complete title acquisition for the tax-deferred trade. I know this sounds complicated, but it really isn’t.
SNOWBIRD WANTS TO SELL CONDO AND BUY ANOTHER
DEAR BOB: I am a part-time Florida snowbird who wants to sell my condo and buy another. Your article last October, and several others, emphasize passing the 24-60 test. But how important are the home seller’s location of employment, location of the main home for family members, mailing address for bills, address on federal and state tax returns, driver’s license, car registration, voter registration, bank accounts and civic affiliations? –Roger G.
DEAR ROGER: It sounds like you have been studying this topic. All those criteria are very important if you own more than one residence. Those tests are listed in IRS literature and various tax books to help determine where your principal residence is located.
However, you omitted the primary test: where do you spend the most time each year?
Although you might meet the 24 out of last 60 months ownership and occupancy test of Internal Revenue Code 121 to qualify for up to $250,000 principal residence sale tax-free profits for your Florida condo, you could also meet the same test for another home. That’s when the criteria you listed become important if the IRS audits you.
The only court tax decision so far interpreting IRC 121 (the Guinan case) placed heavy emphasis on where the home sellers filed their income tax returns. If you have declared a Florida homestead and file your income tax returns in Florida, that is very strong evidence Florida is your primary residence. For full details, please consult your tax adviser.
ARE “NEGATIVE AM” MORTGAGES A GOOD OR BAD DEAL?
DEAR BOB: What do you think about “negative am” home loans? My husband and I keep hearing the radio ads and investigated. We want to refinance our home to take out tax-free cash to pay for a family room addition. Although my husband’s employment is stable, he is subject to transfer to another city. In fact, we expect a transfer within five years. Meanwhile, we badly need more home space for our two energetic kids. We love the community, especially the great schools. Only a corporate transfer promotion will get us to move. But a “negative am” mortgage will give us the lowest monthly payments. What do you advise? –Corla R.
DEAR CORLA: An adjustable-rate “negative amortization” mortgage means your monthly payment is fixed for six to 12 months (and sometimes longer), but the loan interest rate adjusts more often, usually monthly.
When the interest rate goes up, but your payment remains fixed, the unpaid interest is added to your principal balance. The result is you will probably owe more than your original mortgage balance.
That’s fine as long as homes in your community are appreciating in market value as fast as your mortgage “negative am.” However, if home values in your area don’t go up as fast as your mortgage balance increases, you might have a mortgage balance that exceeds your home’s market value when you decide to sell. Can you handle that?
WHAT DO YOU THINK ABOUT TANKLESS WATER HEATERS?
DEAR BOB: We are considering buying a brand-new house. The builder insists on installing tankless water heaters. We have never heard about them before. Do you recommend them? –Helen R.
DEAR HELEN: That question is way out of my real estate field. However, without recommending a particular brand, I have not heard anything negative about tankless water heaters, which deliver virtually instant hot water at modest cost.
At the recent Home Builders Show in Orlando, Fla., I heard nothing but praise for this product, which has been on the market for several years. The benefits are numerous and I haven’t heard any drawbacks except the initial cost, which is higher than for a traditional water heater.
WHY DOES REVERSE MORTGAGE REQUIRE MORTGAGE INSURANCE?
DEAR BOB: Last year I obtained a senior citizen reverse mortgage. It was one of the smartest things I ever did. Now I have extra monthly income, plus a credit line for an emergency. Instead of being “cash poor,” I am now “property rich” with plenty of cash.
My adult children weren’t thrilled. I think they were looking out for their inheritances.
However, FHA charges me a mortgage insurance premium. It’s a small amount, but do I need mortgage insurance when the loan balance is less than 50 percent of my home’s market value? –Agnes H.
DEAR AGNES: FHA mortgage insurance benefits your reverse mortgage lender, not you. In your situation, FHA mortgage insurance is a costly rip-off.
But all FHA mortgages require mortgage insurance to protect the lender and FHA reverse mortgages are not an exception. Sorry, there is no way to avoid unnecessary and costly FHA mortgage insurance on reverse mortgages.
The Robert Bruss special report, “The Whole Truth About Reverse Mortgages for Senior Citizen Homeowners,” is available for $5 from Robert Bruss, 251 Park Road, Burlingame, CA 94010 or by credit card at 1-800-736-1736 or instant Internet PDF delivery at www.bobbruss.com. Questions for this column are welcome at either address.
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