DEAR BOB: I sold my principal residence and moved into my vacation home, which is now my permanent principal residence. However, I go to Florida four weeks each winter. During that time, I rent my home out for a little extra income. When I decide to sell, will that four-week annual rental period prevent me from claiming the house as my principal residence for the $250,000 tax-free exemption? –Dianna S.
DEAR DIANNA: No. Your short-term, four-week annual rental doesn’t prevent you from selling your principal residence and claiming your $250,000 tax-free exemption, as allowed by Internal Revenue Code 121.
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Of course, that presumes you own and occupy it as your primary home at least 24 of the last 60 months before the sale. Also, you cannot use IRC 121 more frequently than once every 24 months. For more details, please consult your tax adviser.
SHOULD LANDLORD COLLECT BIG DEPOSIT OR LAST MONTH’S RENT?
DEAR BOB: I am a new landlord who is receiving conflicting advice. I have been attending the monthly meetings of a local real estate investor’s club where I am learning about property management and having lots of fun meeting fellow landlords. But I am receiving conflicting advice. Some tell me I should collect the first and last month’s rent from a new tenant, plus a security deposit. But two old-time landlords told me they collect a big security deposit and the first month’s rent before the tenant moves in. Which is best? –Betsy S.
DEAR BETSY: State and local law determine any restrictions on collecting up-front security deposits and last month’s rent.
For example, where I live I am limited to collecting a security deposit that does not exceed two times the monthly rent. Frankly, I’ve never been able to get a new tenant to pay that large a security deposit anyway.
Even if collecting the first and last month’s rent at the time of renting a house or apartment is allowed where your property is located, I suggest you do not do that. The primary reason is rents will gradually increase over the years and if your tenant stays many years, when the tenant moves out you must then accept as full payment the already-paid low last month’s rent.
A better alternative is to collect a large up-front security deposit, plus the first month’s rent, before the tenant moves in. My experience is the larger the refundable security deposit, the greater the probability I will receive the rental back in excellent condition when the tenant moves out.
If the tenant only has a small deposit at risk, chances are the property won’t be in superb condition when the tenant vacates. Also, a security deposit can be used for any allowable purpose, such as repairing tenant damage or paying unpaid rent, whereas if you collect the last month’s rent in advance it can be used only for that purpose.
INSTALLMENT SALE OR TAX-DEFERRED EXCHANGE — WHICH IS BEST?
DEAR BOB: My elderly mother in her 60s owns some valuable land, which a developer wants to buy. He offered her an excellent price. However, the result will be a huge capital gains tax. A friend suggests an installment sale to spread out the tax over perhaps five or more years. But mother’s tax adviser suggests a tax-deferred exchange. Which is best? –Scott S.
DEAR SCOTT: Just for the record, a person in her 60s is not “elderly.” Both an installment sale and a tax-deferred exchange are good alternatives for your “senior citizen” mother.
It will probably take the developer several years to receive all his permit approvals so he will likely welcome an installment sale with perhaps a 10 percent or 20 percent cash down payment and your mother carrying back an 80 percent or 90 percent mortgage for five years or so. That will spread out your mother’s capital gain tax and give her some interest income.
But an Internal Revenue Code 1031 tax-deferred exchange for another investment property or perhaps a management-free tenancy-in-common (TIC), such as part ownership of a shopping center, office building or warehouse, could completely avoid any capital gains tax and offer potential future appreciation in market value and current tax benefits. Either is a good choice. For more details, your mother should consult her tax adviser.
The new Robert Bruss special report, “The 10 Key Questions Smart Home Buyers Ask to Avoid Getting Ripped Off,” is now available for $5 from Robert Bruss, 251 Park Road, Burlingame, CA 94010, or by credit card at 1-800-736-1736 or instant Internet delivery at www.BobBruss.com. Questions for this column are welcome at either address.
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