DEAR BOB: My wife and I are avid readers of your educational articles, especially because we own four properties in three states. Following your suggestion, we put their titles into a living trust so our heirs won’t be burdened with probates in several states. But my question is about that Internal Revenue Code 121 principal residence sale tax break. We plan to sell our New York condo this year and live in our other principal residence year-round. However, we have rented the condo for about two years. It was formerly our full-time year-round primary residence. Our tenant now wants to buy it and we’re glad to sell it to her. But our CPA says we can’t have two principal residences at the same time so we would owe tax on our condo sale capital gain. Please tell us he is wrong – Chris C.
DEAR CHRIS: Your CPA is wrong. I am shocked he can keep his CPA designation without understanding the ultra-important but very simple Internal Revenue Code 121. If I were you, I would find a new tax adviser because that CPA is giving you costly bad advice.
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You say the New York condo was your full-time year-round primary residence until two years ago. That means you qualify for the IRC 121 principal residence sale tax exemption up to $250,000 (up to $500,000 for a married couple filing jointly). Contrary to what the CPA told you, the property need not be your principal residence at the time of sale.
To qualify, you must have owned and occupied the principal residence at least an “aggregate” two of the five years before its sale. The good news is you clearly still qualify although at the present time the New York condo is no longer your primary residence.
However, the bad news is the depreciation you deducted during the last two rental years will be “recaptured” upon sale and taxed by Uncle Sam at a special 25 percent federal tax rate. But that’s a small price to pay for receiving the balance of your condo sale profit up to $500,000 tax-free. For more details, please consult your new tax adviser.
DON’T RELY ON A WILL UNTIL THE TESTATOR DIES
DEAR BOB: I am concerned about my mother, age 50, who has befriended a male neighbor in his 70s. She recently revealed to me that she has been paying his home mortgage for more than two years. He signed the deed over to her and made a handwritten will leaving her the house. This whole situation makes me very nervous. What should I do? – Maynard R.
DEAR MAYNARD: At this moment, there’s nothing you can do (unless there is evidence the neighbor is taking advantage of your mother). If he gave her a valid deed to the house, she should record it now.
The legal reason is if the deed, presuming it is valid, was delivered on condition it not be recorded until after the neighbor’s death, that is a conditional delivery which is incomplete. The neighbor’s relatives could contest the deed if your mother records it after his death.
As for the will, presuming it is valid, it means nothing until after the testator dies. The neighbor might have given that will to your mother to make her feel secure.
But the very next day, he could write another valid will leaving his assets to his relatives, a mistress, or perhaps a charity. The latest will would prevail over the earlier will. Your mother should consult a local probate attorney to discuss her situation.
TAX-DEFERRED REVERSE EXCHANGE OF INVESTMENT PROPERTY
DEAR BOB: My son, currently in Iraq, owns rental properties in California and Maryland. He has no problems with the management. But he recently read there is a “reverse exchange” method where he can buy a rental property and then sell one he already owns, thereby making the sale tax-deferred. Is this true? – Madeline B.
DEAR MADELINE: You have a very smart son. In October 2000, the IRS Internal Revenue Bulletin 2000-40 and Revenue Procedure 2000-37 (available at the IRS Web site www.irs.gov) approved so-called reverse tax-deferred exchanges.
In a reverse exchange, the qualifying replacement property is acquired before selling the old “like kind” investment property. However, it must be acquired in the name of a third-party intermediary accommodator, not in your son’s name. The acquired property must meet the usual IRC 1031 exchange rules, such as a trade equal or up in both value and equity.
Your son can’t take title in his own name until after he sells his current rental property. He should consult his tax adviser. More details are in my special report, “How to Exchange Your Way to Tax-Deferred Real Estate Wealth”, available for $4 from Robert Bruss, 251 Park Road, Burlingame, CA 94010 or by credit card at 1-800-736-1736 or instant Internet download at www.bobbruss.com.
GIFT TAX RULES EXPLAINED
DEAR BOB: In a recent article you advised inheriting a house is better than receiving it as a gift before death because the heir gets a new stepped-up basis to market value on the date of death. However, wouldn’t gifting a house before death also involve a federal gift tax for the value exceeding the annual $11,000 gift tax exemption for each donee? – Billy H.
DEAR BILLY: Not necessarily. There is much confusion about the federal gift tax. You are correct that a donor can give away up to $11,000 per donee each year without any gift tax. That would mean a married couple can give up to $22,000 per donee tax-free each year.
However, when more than $11,000 is given by a donor to a donee in one year, a federal gift tax return is required. But a gift tax might not be due. If the donor has not given away more than $1 million during his or her lifetime to individuals, excluding charitable gifts, no federal gift tax will be due.
The cumulative amount of reportable individual lifetime gifts (excluding charitable gifts and annual gifts up to $11,000) will be excluded upon the donor’s death from his or her current $1.5 million federal estate tax exemption. For full details, please consult your tax adviser.
“GUN CLUB” NOISE IS A PUBLIC NUISANCE
DEAR BOB: I read with great interest that item about the barking dogs in the kennel adjoining a condo complex. We have a similar problem. When we moved into our house two years ago, I was horrified to learn the loud noise I first thought was a neighbor’s nail gun was a local gun club range that is near our home. My neighbors say the gun club has been there forever and there’s nothing we can do about it. I was told by the town council the gun club noise is “grandfathered” so they can shoot whenever they want and there is nothing we can do about it. The surrounding area is entirely residential. Most of the people shooting there, ruining our peace and quiet, are from out of the area. Can we do anything? – Holly K.
DEAR HOLLY: The situation you describe is a public nuisance because it affects many people. Ideally, it should be abated by the city or county attorney.
However, if that official refuses to act, there are provisions for citizens to bring legal actions, such as by filing Small Claims Court damage lawsuits against the gun club.
Just because a public nuisance has existed many years does not make it legal. The loud noise is an invasion of your private property, which can be abated or compensated. You and your neighbors should consult a local real estate attorney who is familiar with the law of nuisance and who is willing to take your challenging case.
REVERSE MORTGAGE CAN SOLVE SUDDEN NEED FOR CASH
DEAR BOB: After reading several of your columns about reverse mortgages, about three years ago I took out a FHA(HECM) reverse mortgage. Until now, I’ve been very satisfied with the lifetime monthly payments I receive. However, now I have a sudden need for cash. I had to spend about a month in a convalescent home after I slipped and injured my back. But I’m doing fine now and am back in my house. Then I discovered my roof is leaking and needs replacement at a cost of around $15,000. As I only have about $5,000 in the bank, can I take out a home equity loan? – Evelyn T.
DEAR EVELYN: No. A home equity lender won’t approve a loan behind your reverse mortgage. The reason is your reverse mortgage balance grows every month and a home equity loan would be too dangerous for its lender.
However, depending on the details of your reverse mortgage, you can request a lump sum advance. But that will reduce the amount of the monthly payments you receive. An alternative is to refinance your reverse mortgage if your home equity has grown since you obtained that mortgage four years ago.
More information is in my brand new special report “Secrets of Tax-Free Reverse Mortgage Income for Senior Citizen Homeowners” available for $4 from Robert Bruss, 251 Park Road, Burlingame, CA 94010 or by credit card at 1-800-736-1736 or instant Internet download at www.bobbruss.com. Questions for this column are welcome at either address.
Real Estate Center).