DEAR BOB: About five years ago, my wife and I were given a home in Florida. It is now worth about $800,000. We use it four months each winter. If we sell it, and buy another property worth the same amount, is there a capital gain tax to be paid? What is the best way to avoid paying capital gain tax on our sale profit? – Maxwell D.
DEAR MAXWELL: Your first step is to determine your adjusted cost basis. If the property was inherited, your stepped-up basis is the property’s fair market value on date of decedent’s death (or alternate date used by the estate). If the property was a gift, the bad news is your basis is the donor’s adjusted cost basis (probably very low).
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The cost of any capital improvements you added during ownership should be added to your original basis to arrive at your current “adjusted cost basis.”
Your second step is to determine the property’s approximate current market value, such as by a professional appraisal or by checking recent sales prices of comparable nearby homes.
If you sell that property today, your capital gain will be fully taxable. The reason is you don’t qualify for the Internal Revenue Code 121 principal residence sale tax exemption up to $250,000 (up to $500,000 for a qualified married couple filing jointly).
Neither is the property eligible for an Internal Revenue Code 1031 tax-deferred exchange because it is not held for investment or for use in a trade or business.
But you and your wife can qualify for up to $500,000 tax-free, principal-residence sale profits by making it your primary residence. To qualify, you must have owned and occupied it an “aggregate” two of the five years before its sale. For full details, please consult your tax adviser.
DON’T OVERIMPROVE HOME BEFORE SELLING
DEAR BOB: I am getting ready to sell my home. I am considering having the exterior painted. But it is an older home with old plumbing, which works well enough. However, it does need copper pipes to increase the water pressure. Is it worth investing in new copper pipes to increase the asking price? I can’t afford both the painting and the plumbing – Franklyn A.
DEAR FRANKLYN: Painting the exterior of your home (and the interior if you can afford it) will substantially increase the marketability of your home.
But installing copper pipes won’t increase the market value. Forget about installing new pipes.
Some prospective buyers might avoid buying your home when they, or their professional home inspector, discover the need for copper pipes.
My suggestion is to get written bids from two local plumbers for installing copper pipes. If your home doesn’t sell within 90 days after you list it for sale with a successful local realty agent, then you might consider discounting the asking price by the cost of the new plumbing.
INSURE HOME FOR REPLACEMENT COST
DEAR BOB: A few weeks ago you had an item about how much liability insurance to carry on a principal residence and investment properties. You said your insurance agent recommends $300,000 liability insurance on each property, and your auto, plus a $3 million umbrella liability policy. I carry $500,000 liability insurance on each property, and my cars, plus a $1 million umbrella policy. But what about the fire insurance coverage? How much hazard insurance should I carry? – Michael F.
DEAR MICHAEL: You might be able to save money and improve your coverage by dropping to $300,000 the liability coverage for each property and your cars, but adding a $2 million or $3 million umbrella liability policy.
But be sure to carry replacement cost insurance on each property.
Most insurance companies have stopped writing so-called guaranteed replacement cost policies. Instead, they now write replacement cost policies for their recommended replacement cost, plus up to 10 percent or 20 percent additional.
Make certain your hazard insurance policy includes building code upgrade coverage because rebuilding a home damaged in a fire usually requires complying with today’s tougher building codes. For full details, please consult two or three local insurance agents to discuss your coverage.
HOW IS PROPERTY VALUED FOR A STARKER TAX-DEFERRED EXCHANGE?
DEAR BOB: My question involves a rental house I inherited many years ago. It has dramatically increased over the years. I understand that no “booty” can be taken out of a trade. But what happens to the “value at death” portion of the value, which I feel should not be included in the price? The house I inherited was worth about $300,000. Today, it is worth around $700,000. Can I make a trade for a new property worth more than $300,000 without paying tax? Or do I have to trade for property worth more than $700,000? – Delray G.
DEAR DELRAY: Thanks for the compliments. I tell the truth and try not to harm anybody. But there are some real estate service providers who are less than honest and I don’t hesitate to expose them, when necessary.
To make an Internal Revenue Code 1031 tax-deferred exchange of your rental house, you must trade equal or up in both market value and equity without receiving any taxable “boot” (not “booty”) such as cash or net mortgage relief.
The $300,000 market value of the inherited rental house is irrelevant. To qualify for a tax-deferred exchange, you must trade for another rental or business property worth at least $700,000 in your situation. For full details, please consult your tax adviser.
GET YOUR NAME ON THE TITLE IF YOU WANT TAX DEDUCTIONS
DEAR BOB: Our adult son has decided to go into a different profession. My husband and I have agreed to assist him financially. We will be paying his condo mortgage payments. Can we claim our son’s mortgage interest as a tax deduction on our income-tax returns by showing our cancelled checks for the mortgage payments? – Rose S.
DEAR ROSE: To qualify for the tax deductions of the actual mortgage interest (and property taxes) you pay on your son’s condo, you must be legally obligated to make those payments. That means you must be on the title.
Your son can easily add you to his title by signing and recording a quit claim deed, granting you an interest in the condo. The deed should also specify how title is to be held, such as joint tenancy with right of survivorship. For more details, please consult a real estate attorney in the state where the condo is located.
DIVORCE ATTORNEY WARNS OF MORTGAGE PITFALLS
DEAR BOB: Thank you for that item a few weeks ago about the ex-husband whose ex-wife defaulted on their mortgage on the house she got in the divorce, thus ruining his credit and now there’s nothing he can do. You courageously said, “Your divorce lawyer messed up.”
When one ex-spouse gets the house and is supposed to refinance to get the other ex-spouse’s name off the mortgage obligation, as a divorce attorney I insist this be done before the divorce is final. If it isn’t, my experience has been the spouse living in the house usually fails to refinance and, if the mortgage payments are late, the other ex-spouse incurs credit problems. I’m going to give copies of your article to my clients and their attorneys – Clint W.
DEAR CLINT: Thanks for your compliment. I also received a letter from a Virginia “family law attorney” (that sounds better than divorce lawyer) who suggests the mortgage refinance requirement be part of the divorce judgment. She said, at least in Virginia, if the ex-spouse living in the house fails to refinance, that ex-spouse can then be held in contempt of court. But I like your suggestion better.
DOES NEW CONDO BUYER NEED TITLE INSURANCE?
DEAR BOB: Next month I will be closing on the purchase of a brand-new condo. I am paying cash so no mortgage is involved. The builder suggests I should buy title insurance, at a cost of about $2,200. But I’m thinking, because the condo is new and I’m paying cash, there can’t be any title problems. Is title insurance in my situation a waste of money? – Agnes H.
DEAR AGNES: You need an owner’s title insurance policy far more than most home buyers. There are so many potential title risks in your situation I can’t list them all.
For example, if the builder failed to pay a sub-contractor, that sub-contractor can file a mechanics’ lien on your new condo and, if he doesn’t get paid, foreclose on your condo. Or there might be forged signatures on the title documents (the biggest cause of title losses). Or the builder’s original title to the property might be defective.
Please don’t be stupid. Always insist on receiving an owner’s title insurance policy when acquiring title to any property, especially a brand-new condominium.
The new Robert Bruss special report, “Pros and Cons of Flipping Houses and Investment Properties for Fast Cash Flow Profits,” is now 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.bobbbruss.com. Questions for this column are welcome at either address.
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