DEAR BOB: My husband and I purchased a rental property some years ago. We only have seven years left on the mortgage payments. But we are pondering selling. How will we be affected by capital gains taxes? Can we reinvest the equity earned and avoid the tax? – Delmayne C.
DEAR DELMAYNE: Congratulations on your profitable rental property investment. You have probably enjoyed the depreciation tax shelter over many years.
Purchase Bob Bruss reports online.
But the only way to avoid capital gains tax on the sale of your rental property is to make an Internal Revenue Code 1031 tax-deferred exchange for another property to be held for investment or use in a trade or business.
The acquired property cannot be your personal residence. However, you can later convert it into your personal residence. Most tax advisers suggest waiting 6 to 12 months to show rental intent at the time of the trade. But IRC 1031 doesn’t specify any rule for minimum conversion time.
To qualify for a tax-deferred exchange, you must trade “equal or up” in both price and equity. That means you cannot take any cash (called “boot”) out of the exchange.
However, if you want to receive nontaxable cash from your equity, you can refinance either the old property well before the exchange or the new property after the exchange is completed.
In your situation, you can sell the old rental property, have the sales proceeds held by a qualified third-party accommodator (called an “intermediary”) beyond your constructive receipt, and then use that cash to buy the qualifying replacement property.
After selling your current rental property, you have 45 days to designate the replacement property and up to 180 days to complete the acquisition. This is called a “Starker exchange.” It is authorized by Internal Revenue Code 1031(a)(3). Full details are available from your tax adviser.
RISK OF AN ADJUSTABLE-RATE MORTGAGE REFINANCE
DEAR BOB: In 2002, we bought our condo. Our mortgage has a fixed interest rate of 5.25 percent. But we missed a great opportunity to refinance at 4.25 percent in March 2004. That simple action would have decreased our monthly payment by $200. I haven’t slept well since then. We need to lower our mortgage payment. But the only option seems to be an adjustable-rate mortgage (ARM) at 3.75. However, the lender warns the interest rate can change slightly from month to month. How risky is this? – Susana N.
DEAR SUSANA: Be happy! You have an excellent fixed-rate home loan at 5.25 percent, which cannot be matched in today’s financial market.
That ARM might sound good, but it is very risky because interest rates seem headed up.
If you do refinance with an ARM, be sure it has a slow-moving index, such as the lender’s cost of funds index. In my opinion, just to save $200 per month for a few months, it’s not worth the risk of giving up your great mortgage to switch to a high-risk ARM.
WHAT HAPPENS TO HOME AFTER REVERSE MORTGAGE BORROWER DIES?
DEAR BOB: I am a widower, age 78. I am quite comfortable with a military pension and social security. My home is debt free. But my health is declining and I am worried about potential future medical care. Last year, a friend obtained a reverse mortgage and used the money to buy a lifetime medical care policy. Just a few months ago, her health declined and she had to be moved into a fancy care facility. I’m worried that might happen to me. Although I am in excellent health for my age, if I get one of those reverse mortgages, what happens to my home after I die? Does the bank own it? – Raymond J.
DEAR RAYMOND: There are many misunderstandings about reverse mortgages for senior citizens. Your situation seems like a perfect situation for one of these superb tax-free mortgages.
You can select among lifetime monthly income payments, a lump sum (such as to pay for expenses such as a new roof or to by a lifetime care insurance policy), and a credit line (the most popular choice, but not available in Texas).
After you die, your home passes according to the terms of your will or living trust. Contrary to popular misbelief, the reverse mortgage lender does not own your house after you die.
When you pass on, after the reverse mortgage balance is paid off, the remaining equity goes to your heirs. More details are in my 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.
(For more information on Bob Bruss publications, visit his
Real Estate Center).
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