Retirement requires smart tax move

DEAR BENNY: My aunt is 76 years old and lives in her home. She also owns a detached rental property nearby. Her primary residence has been the same property for more than 10 years. She would like to move into a retirement community this year, but to afford this new lifestyle she would have to sell one of her properties soon. Would it be more cost-effective from a tax perspective to sell her primary residence or her rental property? Are there any tax benefits to selling rental property vs. one's primary residence?

I have heard about a one-time tax exemption on the proceeds of selling one's primary residence, but I do not understand the rules of this exemption. I was thinking it would be better to sell the rental property first to avoid inconveniencing my aunt's daily routines, and later convert the primary residence into rental property after she moves. She could wait to sell one of the houses until the housing market improves in a few years. However, I would not want her to lose a tax exemption or tax benefit by making the wrong decision. --Arlene

DEAR ARLENE: If you aunt is married and files a joint tax return with her spouse, she can exclude up to $500,000 of any gain (profit) that she will make in the house. If she is not married -- or files a separate tax return -- she can exclude only up to $250,000 of gain.

In order to take advantage of this gain exclusion, there are two tests: (1) ownership -- you must be on title; and (2) use -- you have to have lived in (used) the property for two out of the five years before it is sold.

In your aunt's case, she currently meets both tests: She owns the property and has lived there for a long time. However, if she rents it out and cannot sell within three years from the date she moved out, she will lose that tax benefit.

You (or your aunt) should consult a tax advisor, who will prepare an analysis of the pros and cons of selling each house. Everyone's financial situation is different, so I can provide only general advice.

I suspect that your aunt has an accountant who has been preparing her tax returns each and every year. He/she should be able to quickly project the tax consequences regarding each house.

DEAR BENNY: My husband and I refinanced our condo in December 2007 with the existing mortgage company. In addition to the refinance, the lender opened a $250,000 home equity line of credit for us, although we never requested this, were not aware of it, and certainly never signed documents agreeing to it.

We are planning to refinance another property this month and are concerned about the impact that a $250K line of credit (although not at all used) may have on our credit reports. I have contacted the lender three times over the last 30 days to close this account, since we never signed papers for it, but am running into a wall, with someone always acknowledging that they don't have signed documents and promising that they'll "research it" and asking me to call back in seven days.

What is my recourse if the lender will not resolve this and close the account? Isn't it illegal for them to open this account without our agreement? --Angelique

DEAR ANGELIQUE: I am at a loss to understand how the lender put a HELOC loan ("home equity line of credit") on your home without your knowledge. I suspect that when you went to closing (escrow) you signed a bunch of papers, and one of them may have been that HELOC. While you may not have been advised of this, if you look at all of the loan documents, you will probably see the HELOC papers.

Regardless, have you confirmed with the second refinance lender that the HELOC will, in fact, be a problem regarding your credit standing? Although lenders are much more strict and conservative nowadays, if you explain that you did not ask or want that HELOC -- and that you have not used it -- your new lender may be willing to make you that refinance loan. The HELOC lender will have to subordinate to the new first trust.

If not, I suggest you contact your local consumer affairs office, as well as the banking commissioner in your state. You may also consider sending a complaint to the Federal Reserve Board in Washington, D.C. Send your lender copies of all your correspondence. That often gets their attention. ...CONTINUED

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