DEAR BOB: We have learned so much about real estate over many years from your articles. But now we need your advice. I am 72. My wife is 65. We have $160,000 in three-month T-bills. Should we use that money to pay off our approximately $100,000 mortgage at 5.7 percent interest with 28 years remaining at a $560 monthly payment? –Vinh H.
DEAR VINH: You have an excellent fixed mortgage interest rate. The only reason to pay it off early, presuming there is no prepayment penalty, is because you have more than enough cash than you will ever need.
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If you are retired and the $160,000 is a major portion of your retirement liquid cash, I suggest you do not pay off your superb mortgage. Re-borrowing in case of an emergency or investment opportunity could be very difficult or impossible if you have limited retirement income.
Considering your small $560 “petty cash” monthly mortgage payment, which approximately equals your 5 percent earnings on your $160,000, please don’t pay off your beautiful mortgage unless you have too much cash burning a hole in your pocket.
Just in case you foolishly disregard this advice and pay off that great loan, please do me a favor and immediately obtain a home equity line of credit (HELOC) at your bank or credit union for the maximum available (usually 75 percent of home market value). There is no cost until you write a check to borrow on your HELOC. The interest rate should be at the prime rate, or less. Then you will have easy access to cash for an emergency.
HOW TO AVOID TAX ON THE SALE OF A VACATION HOME
DEAR BOB: Over 20 years ago my wife and I bought an 11-acre vacation home in northern Michigan. We made several improvements and find that if we sell our property we will have a large capital gain. If we sell this property and reinvest the entire amount in another vacation property within a short time, will we still have a tax liability? –Paul M.
DEAR PAUL: Yes. There are no tax shelter opportunities for a second or vacation home that is not your principal residence.
The Internal Revenue Code 121 test is you must have owned and occupied the property as your principal residence at least 24 of the 60 months before its sale. Then you can qualify for up to $500,000 principal residence sale tax-free profits for a married couple filing jointly (up to $250,000 for a single home seller).
Your part-time second or vacation home cannot qualify for the Internal Revenue Code 1031 tax-deferred exchange rules unless both your old and new properties are rental or business properties. Because your vacation home is not rented to tenants, it can’t qualify for a tax-deferred exchange. For more details, please consult your tax adviser.
HUGE DIFFERENCE BETWEEN SEWER AND SEPTIC TANK
DEAR BOB: We recently purchased a home and learned after moving in it has a septic tank. The cost to clean it out is approximately $1,500. The buyer’s agent accepted the verbal representation from the seller’s listing agent that the home was on a public sewer system. On their disclosure statement, the sellers checked the box for “sewer system.” However, the MLS (multiple listing service) listing says there is a septic tank. The sellers now say they did not know there was a septic tank. Do you think the sellers are liable for misrepresentation damages? –Warner S.
DEAR WARNER: Yes. Virtually every homeowner knows if their residence is connected to a public sewer system or if it has a private septic tank, which must be pumped every year or two. That is a huge difference that affects the market value and desirability of a property.
If there is a public sewer to which the house can be connected, the sellers should be liable for the cost of making that connection. For full details, please consult a local real estate attorney.
DISHONEST MORTGAGE BROKER HAS BORROWER TIED UP
DEAR BOB: I am a first-time home buyer who is having trouble with my mortgage broker. With only two weeks left until the scheduled closing date, she just submitted my loan application to a lender. Although she assured me there would be no loan origination points, I finally received her good faith estimate of loan costs, which includes a loan fee of $8,369. She is getting a kickback from the lender for $2,109, plus charging me a $495 processing fee. I have personally known this mortgage broker for many years. Is that $8,369 loan fee unreasonable? What recourse do I have? –Amadeo A.
DEAR AMADEO: Face the facts. You are dealing with a very dishonest mortgage broker who is swindling you by leaving you with virtually no other mortgage finance alternative if your home purchase is to close on time in just two weeks.
Within three business days of your submitting your completed loan application, your mortgage broker was required to provide you with a written “good faith estimate” of your loan costs. Although she broke that rule, unfortunately there is virtually no penalty for her.
She is setting you up for a “take it or leave it” closing situation. Not only is she being very well compensated by that $2,109 “yield spread premium” paid to her by the lender for charging you a higher-than-market interest rate, but then she is asking you to pay an unexpected $8,369 loan fee for her horrible service to you.
Unfortunately, with the closing date fast approaching, you probably don’t have time to obtain a mortgage from another lender unless your seller will give you a written extension of your closing date.
It’s worth a try to negotiate with your dishonest mortgage broker to eliminate or reduce that outrageous unexpected $8,369 she wants to charge you. Thankfully, bad mortgage brokers like yours are the exception rather than the rule.
TWO HOUSES ON ONE LOT IS REALLY A DOUBLE SALE
DEAR BOB: We live on a property that has a three-bedroom house and a two-bedroom cottage. Each house has its own street address. But there is one tax assessor’s parcel number. To maximize our profit, we are thinking of selling the two houses as tenants in common. Can my husband and I qualify for that home sale tax exclusion of $500,000 when we sell our property? –Lee L.
DEAR LEE: You are making two separate sales. One is the sale of the home where you reside as your principal residence. The other is the rental unit sale.
My best advice is to forget your idea of attempting to sell to two buyers as tenants in common. That will greatly complicate the mortgage financing and discourage many prospective buyers. Instead, sell to one buyer as a two-unit property with an “owner’s residence.”
If you have owned and occupied one of the units as your principal residence at least 24 of the 60 months before its sale, you qualify for the Internal Revenue Code 121 tax exemption up to $500,000 if you file a joint tax return in the year of sale.
However, your profit from the sale of the rental unit will be subject to capital gains tax. Or, you can make an Internal Revenue Code 1031 tax-deferred exchange for your profit on the sale of that unit. To allocate the sales price between the two units, please consult your tax adviser.
CONFUSION ABOUT TAX-DEFERRED TRADES AND PERSONAL RESIDENCES
DEAR BOB: I took advantage of Internal Revenue Code 1031 to make a tax-deferred exchange to acquire a historic home as an investment property. I have owned it six years and plan to convert it back into my personal residence to live in for two years before selling. However, I was told that because I used IRC 1031 to acquire the property, I cannot use Internal Revenue Code 121 to claim the $250,000 or $500,000 principal residence sale tax exemption. Is this true? –Dan McF.
DEAR DAN: No. You received incorrect tax advice. Because you used IRC 1031 to acquire the investment property in a tax-deferred exchange, IRC 121 now requires you to own the property at least 60 months before becoming eligible for the $250,000 (single) or $500,000 (married) principal-residence tax exemption.
Of course, you must occupy the principal residence at least 24 of the 60 months before the sale. However, the depreciation you deducted during the rental period will be “recaptured” and taxed at the special 25 percent tax rate. For full details, please consult your tax adviser.
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