DEAR BOB: My townhouse is worth about $300,000. My mortgage balance is around $46,000. I believe I can buy a small house for under $200,000 in Arizona. Does it make sense to buy the new house with no mortgage? What if I find that house before I sell my current home? – Judith E.

DEAR JUDITH: If you commit to buying a $200,000 house in Arizona for all-cash before selling your current home, you might be in financial hot water unless you have $200,000 spare cash.

Purchase Bob Bruss reports online.

Instead, I suggest you include a mortgage contingency clause in your purchase offer for a 75 percent or 80 percent mortgage just in case your townhouse doesn’t sell as quickly as you anticipate and for as much money.

More important, I recommend you don’t commit to paying all-cash for a home in a new area where you are not currently living. It just isn’t smart to put all your eggs in one basket, especially if you are unfamiliar with the community.

Maybe you won’t like the famous Arizona “dry heat” summers. Worse, suppose the zero-mortgage home you buy has lots of unexpected defects, but most of your nestegg is tied up in that “lemon house.”

However, after you have lived in your Arizona house for a few years and all is well, then paying off your mortgage would be a smart idea to save interest. For this reason, be sure the mortgage you obtain does not have a prepayment penalty.

HOW PRE-1997 DEPRECIATION GETS TAXED

DEAR BOB: In a recent article you said rental property depreciation deducted by an investor after May 6, 1997, is taxed upon property sale at a special federal depreciation recapture tax rate of 25 percent. My question is what happens to the depreciation I deducted before May 6, 1997? Is it taxed? I bought my rental property in June 1975 and sold it in August 2000 – Manuel DeL.

DEAR MANUEL: Hopefully you reported the property sale correctly on your 2000 income tax returns because the three years to amend your tax returns has elapsed.

Depreciation you deducted before May 6, 1997 (when the 1997 Tax Act became effective) is taxed as part of your capital gain sale profit.

If you sold your investment property today, this “old depreciation” would be taxed at a maximum 15 percent federal tax rate for capital gains. Only the depreciation deduction after May 6, 1997, is “recaptured” and taxed at the special 25 percent federal “recapture” capital gains tax rate.

The only way to avoid this higher “recapture” tax is to die while owning your rental property. Death is the ultimate tax shelter of all. For full details, please consult your tax adviser.

SORRY, NO TAX-DEFERRED EXCHANGES FOR R.E.I.T. STOCK

DEAR BOB: My husband and I want to sell our single-family rental house. But the federal and state taxes will be enormous since we’ve owned the house over 30 years. Would it be possible to “exchange” the property for shares in a mutual fund REIT (real estate investment trust)? Our accountant says it can be done, but through a special arrangement called a “CIT.” Do you agree? – Alice G.

DEAR ALICE: I regret to inform you that it is not possible to make an Internal Revenue Code 1031 tax-deferred exchange of your rental house for REIT stock. The reason is that is an “unlike kind” trade of real property for personal property.

I have no clue what a CIT is so I can’t comment on that alternative.

However, you can made a Starker delayed tax-deferred IRC 1031(a)(3) exchange of your rental house for a TIC (tenancy in common) interest in a qualified investment property.

For example, about 10 years ago my retired friends Andy and Dory sold their California rental house and made a Starker tax-deferred exchange for a TIC interest in an Applebee’s Restaurant in Kentucky. Every month they receive a nice check for their profit share. Needless to say, they are very happy.

The new Robert Bruss special report, “How the New Tax-Deferred Realty Exchange Rules Can Make You Wealthy,” 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.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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