DEAR BOB: My mother-in-law was recently widowed at age 60. She is considering a move from her primary residence. She will owe capital gain tax on the sale and wishes to eliminate such tax. Could she move out of the home, rent it for a brief while, and then do an Internal Revenue Code 1031 tax-deferred exchange without incurring tax on the eventual sale? We are familiar with the Internal Revenue Code 121 use test for 24 of the 60 months before the sale, but how long must a home be rented before it qualifies for an IRC 1031 tax-deferred exchange? –Joe C.
DEAR JOE: Your mother-in-law should consult her tax adviser to determine her adjusted cost basis for her home. Depending on the state where the house is located, if her late husband held a full or partial title to the house, by inheritance she probably received a 50 percent or 100 percent new stepped-up basis to market value on the date of his death.
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The result could be she has little or no taxable capital gain if she decides to sell her primary home. Any capital gain can probably be avoided by the IRC 121 principal-residence-sale tax exemption up to $250,000 if she meets the last-24-out-of-60-month occupancy test before the sale.
It may not be necessary to rent the house to tenants and do an IRC 1031 tax-deferred exchange for another rental property of equal or greater cost and equity (unless that’s what she really wants to do of course). IRC 1031 has no minimum rental time, but most tax advisers suggest at least six to 12 months before exchanging.
QUITCLAIM DEED MIGHT BE VALID OR WORTHLESS
DEAR BOB: A probate attorney recently notified me that I inherited a vacant lot in a small town in Illinois. It seems my late uncle, who was very “strange,” had given the attorney a quitclaim deed with my name on it to be delivered only after my uncle’s death. The attorney warned me there are about $3,600 of unpaid property taxes on the lot, but other than that it is free and clear. I seem to recall you said something about deeds delivered after the owner’s death might be worthless. I’m thinking the lot must be worth more than the $3,600 property taxes I would have to pay. What should I do? –Betty W.
DEAR BETTY: That quitclaim deed might be perfectly valid. Or it could be worthless if there are other claims against that lot’s title or against your late uncle’s estate.
The general rule is a deed delivered after the grantor’s death is not valid. However, there is an exception if the deed was delivered to a trustee, such as that probate attorney, during the grantor’s lifetime.
You don’t have to accept the title and can renounce it if you don’t want the lot, subject to its unpaid property taxes and possible other liens.
I suggest you contact a title attorney or title company in the small town to see if the lot’s title is marketable and if you can obtain an owner’s title policy. If the quitclaim deed is valid, then you can decide if you want to accept or reject that lot.
NO $250,000 HOME-SALE TAX BREAK IF YOU ARE NOT ON THE TITLE
DEAR BOB: My daughter is selling her second home, which my primary residence. She has never lived in the house. Its sale will net her about $120,000. Can she buy another house of lesser value with the profits to give to me as a gift and pay tax on the remainder of her profit? She has never taken depreciation deductions on this house because she always reported the mortgage interest and property tax deduction on schedule A of her income taxes –Sandra P.
DEAR SANDRA: Your daughter should consult her personal tax adviser. From your description, since the house was not her primary residence, she will owe capital gain tax on the entire $120,000 profit. If she wants to give you a gift of part of that money, that will have no effect on her tax situation, as she still owes tax on her entire capital gain.
Since your name is not on the title, you are not entitled to a $250,000 principal-residence sale-tax exemption either.
If you were paying rent to your daughter and if she failed to report it on Schedule E of her tax returns, she may have a big tax problem for unreported rental income and for her failure to deduct depreciation on the rental house. The depreciation she should have claimed may be subject to the special 25 percent federal depreciation “recapture” tax rate.
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