DEAR BOB: In 1956 my parents purchased their house for $13,000. By a gift deed, title was transferred several years later to my sister who lived with our parents. My parents died in 1987 and 1988. My sister died in 2004. She had a revocable living trust. Proceeds from the sale of her house after her death were shared by her five surviving siblings, including me. Our lawyer says there is no capital gain tax because we automatically received a “stepped-up basis” for the inherited house. Please explain how that basis is determined – Tony J.
DEAR TONY: Your situation is a beautiful example of doing everything right. Usually, I receive letters about costly mistakes. It’s such a pleasure to read your letter.
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After your sister died in 2004, the five surviving siblings received title to her house at its current market value on the date of her death under the terms of her living trust. Thanks to her wise decision to hold title in her revocable living trust, there were no probate-court costs or delays.
The heirs apparently decided to sell the house soon after your sister’s death for a price that was about the same as its automatic “stepped-up basis” market value on the day she died.
Therefore, you had no profit difference between your stepped-up basis and the net sales price so no tax is due on the sale. The heirs get to enjoy their tax-free cash thanks to the stepped-up basis rule. More details are available from your tax adviser.
HOME FIRE REPLACEMENT COST DOESN’T INCREASE COST BASIS
DEAR BOB: You recently replied to a homeowner who bought a house for $200,000, tore it down, and built a new house costing $400,000 for construction. You said his basis is $600,000. My question is, when a house is totally destroyed by fire and the insurance company will pay me the full replacement cost, which is much higher than my original purchase price, will my basis cost for my new house be my original purchase price plus the cost of the new house? – Jen T.
DEAR JEN: No. Taxwise, a fire loss is an “involuntary conversion.” But tearing down an existing old house and building a new one is voluntary. The tax result is completely different.
When fire insurance pays to rebuild a burned house, the insurance payment is not taxable but it doesn’t add to the adjusted cost basis of the home. Of course, if you add additional cash to the insurance proceeds, perhaps to add on or upgrade the house, that additional investment will increase your adjusted cost basis. Your tax adviser can explain further.
DEEDING HOUSE TO CHILDREN CAN BE A COSTLY MISTAKE
DEAR BOB: In 1990, the title of my widowed mother’s home was transferred to her three children. After reading your articles, I now know that we should have instead set up a revocable living trust for her and kept the house in her name. Is there anything that can be done now, as our basis for the house is far below today’s market value? Would transferring title back to her make sense? She is now 82, enjoys her home, but with declining health we don’t know how long she will be able to live alone. If we need to sell the house to pay for her care, a big portion of the proceeds will be lost to taxes. Any ideas? – Barbara M.
DEAR BARBARA: Sorry. You can’t un-ring a bell. The costly mistake of deeding the house to the adult children was made in 1990. The current owners, as donees of a gift, are now stuck with the home’s low market value as of that date.
The three adult children could quit claim the house back to mom as a gift. But then she gets stuck with their low 1990 valuation.
However, if she then occupies and owns the house at least 24 of the 60 months before selling it, she could claim up to $250,000 tax-free profits under Internal Revenue Code 121. Please consult your tax adviser to discuss details.
CAN SEPARATED SPOUSE FORCE A HOME SALE?
DEAR BOB: I am 76, separated from my husband for five years, and I want to sell our mutually owned home. But my husband doesn’t want to sell. What are my choices? – Blossom G.
DEAR BLOSSOM: Unless you have a legal separation agreement with your husband that allows sale of the home, you will probably have to resort to a lawsuit to force a court-ordered home sale.
Because the home is co-owned, you will each then receive 50 percent of the sales proceeds. Such a court action is called a “partition lawsuit.” That means the judge can order the property sold with the sales proceeds split according to ownership shares. For full details, please consult a local real estate attorney.
WHAT IF SON DOESN’T PAY MOM ON HER MORTGAGE?
DEAR BOB: About two years ago, I decided to move out of my large house so I can live downtown in a nice apartment where all the action is. My son, then 24, and his live-in girl friend, talked me into selling my house to them for nothing down. Bad mistake! All went well for about a year while they were both working. They paid me $1,654 per month, which covered my apartment rent. Then the girl got pregnant. Next, they split up and she moved out. My son can’t afford to pay me the full mortgage payments and he is now about seven months behind. I’ve been able to pay my rent from savings, but I don’t know how long this can last. When the baby arrives, my son will have to pay child support. What should I do? – Angie W.
DEAR ANGIE: As a mortgage lender, you only have one legal remedy. It’s called foreclosure.
But foreclosure will ruin the credit of your son and his ex-girlfriend. Also, they will lose any equity they have acquired in your former residence.
At the foreclosure sale, you will either receive full payment (including arrearages) from the high bidder, or you will reacquire title to the house if there are no bidders.
Presuming they are both on the title (another bad mistake), you need to have a friendly talk to help them decide what to do.
The best alternative is for them to sell the house to obtain some cash from their equity. To make the sale attractive to a buyer and preserve your nice monthly mortgage income, you could agree to allow your mortgage to be assumed by a credit-worthy buyer. That way, everybody benefits.
AGE IS NOT A FACTOR IN OBTAINING A HOME MORTGAGE
DEAR BOB: My son, 22, has a great job with a major CPA firm earning $66,000 per year as assistant to a senior partner. He just graduated from college in June. When he passes his CPA tests, he has been promised a big pay raise. He interned for two summers with the same firm and his bosses say he has great potential. Already, he brought in several major new customers for the firm. But he wants to buy a condo rather than wasting money on apartment rent (he’s no dummy!). However, a mortgage broker friend couldn’t get him pre-approved because he is so young and doesn’t have any credit yet. Do lenders discriminate against young borrowers? – Thomas R.
DEAR THOMAS: Congratulations on raising a great son. It sounds like he is a fantastic “rainmaker” for his employer (that means he brings in profitable new clients).
By law, mortgage lenders cannot discriminate against borrowers by age, whether young or old. For example, when my parents were in their 70s, they obtained a 30-year mortgage to buy their retirement condo.
What matters most is your son’s FICO (Fair, Isaac and Co.) credit score. He can obtain it and his credit report at www.myfico.com. FICO scores don’t even consider age.
If your son doesn’t have a Visa, MasterCard and American Express card, he should obtain them. His employer can introduce him to a banker where the firm does business.
After a few months of on-time credit-card payments, he will be on his way to establishing a good FICO score. Personally, I recommend the airline credit cards, which reward spending with free trips.
IS $5,000 REVERSE MORTGAGE CLOSING COST TOO HIGH?
DEAR BOB: We inquired about a reverse mortgage but were “turned off” by the high closing costs over $5,000, plus $39 per month in fees, plus the interest and payment. It would take a lot of our home’s market value if we decide to sell. We read your weekend article first thing. What should we do? – Robert N.
DEAR ROBERT: Presuming you and your wife are both at least 62, if you (1) need a lump sum to pay a major expense, such as a new roof, new car or trip around the world; (2) would enjoy monthly lifetime income without any repayments; (3) want the security of a credit line (except in Texas); or any combination of these, a reverse mortgage is ideal.
But your letter puzzles me when you said the interest and payment bothers you. With a reverse mortgage, there is no repayment required until you either sell the home, move out for longer than 12 months, or die.
At that point, the principal and interest, plus those darn $39 monthly service fees, “mature” and must be paid, usually from the home sales proceeds.
As I’ve often said, when I’m about 85 or 90, I plan to get a reverse mortgage because I think they are a “good deal.” The older you are, the better the reverse mortgage benefits. Details are in my special report, “The Whole Truth About Reverse Mortgages 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 PDF delivery at www.bobbruss.com. Questions for this column are welcome at either address.
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