DEAR BOB: Please clarify. You often mention a married couple filing a joint income tax return can claim up to $500,000 principal-residence-sale tax-free profits, thanks to Internal Revenue Code 121. But what about two unmarried co-owners of a home who each meet the 24-out-of-last-60-months ownership and occupancy tests? Both are on the title. Can each claim a $250,000 exemption or do they have to split the exemption? –Mary O.
DEAR MARY: There is no limit to the number of co-owners who can claim the IRC 121 principal-residence-sale tax exemption up to $250,000 each. Theoretically, you could have three, four, five or six home sellers who each can claim up to $250,000 tax-free principal-residence sale profits if they each meet the 24-out-of-last-60-months ownership and occupancy tests in the same home.
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The IRC 121 tests are applied individually to each co-owner so they need not have owned and occupied the residence at the same time. But each must be on the title for the required time.
This is slightly different than for a married couple where title to the principal residence can be held in the name of one spouse alone, as is quite common. However, for a married couple filing jointly to claim up to $500,000 principal-residence-sale tax exemption, each spouse must meet the 24-out-of-last-60-months occupancy test. Full details are available from your tax adviser.
INMATE FINDS LOOPHOLE TO AVOID TAX ON INHERITED PROPERTY
DEAR BOB: As you can see from my letter, I am currently a prison inmate. But I will be released next month. My father passed away in March 2004. His estate was just probated. I received $93,000 for my share from the sale of his house. But I was told I will have to pay capital gains tax on $107,000. My brother bought the house from me and my two sisters. How much capital gain tax will I have to pay? Are there any loopholes? –Lonnie P.
DEAR LONNIE: That’s a nice check you have waiting for you when you are released next month. Use it very wisely to get a “fresh start,” perhaps by investing in real estate, and avoid future mistakes.
Yes, there is a major “loophole” that many heirs overlook. When you inherited a share of the house (plus perhaps other assets) from your late father, you received those assets with a new “stepped-up basis” to market value on the date of his death.
You and your siblings should hire a professional appraiser to determine that 2004 market value because it is very important. The estate administrator might have had an appraisal made. If so, you can use that valuation.
Your taxable capital gain is only the increased value after the date-of-death “stepped-up basis.”
For example, suppose your individual stepped-up basis valuation share of the house was $75,000. Because you received $93,000, that means your capital gain share increased in value during the three years after the death by $18,000.
This $18,000 amount is taxable in this example at a maximum federal tax rate of 15 percent, plus any state tax. I have no idea where that $107,000 number originated. For full details, please consult your tax adviser.
TITLE INSURANCE ARBITRATION WAS A RIP-OFF
DEAR BOB: We had a very bad experience with our owner’s title insurance policy. Several months after we bought our home it was discovered we did not have clear title. The title company admitted they made a mistake and offered to pay a percent of the insurance claim. They wanted to go to arbitration. The arbitrator ruled we suffered no loss because the property went up in market value after our purchase. We were ordered to pay the title insurance company more than $8,000. It seems the arbitrator was clearly on the title insurer’s side. Do we have any recourse? –Neal C.
DEAR NEAL: Your situation shows the pitfalls of agreeing to arbitration because there is no right of court appeal from an arbitrator’s decision. In the future, if you foolishly agree to arbitration (perhaps involving a small amount), please remember the arbitrator probably works for your opponent frequently and is likely not to rule in your favor.
Contact the state insurance commissioner to file a complaint against that no-good title insurer who failed to pay a legitimate claim without hassle. After you bought your owner’s title insurance policy, you should never have to pay a dollar to protect your property title rights.
CAN HOMEOWNER ASSOCIATION PROHIBIT OUTDOOR CLOTHES DRYING?
DEAR BOB: I recently moved into a condominium where the homeowner association rules prohibit residents from air drying their laundry outside their units. Not only is air drying a great electricity savings, but we live in a patio home where few people see our clothes drying. Do we have any protection under energy conservation laws? –Norbert M.
DEAR NORBERT: Welcome to the mini-democracy world of condominiums and homeowner association rules. I am not aware of any state or federal law entitling you to air dry your clothes in violation of homeowner association rules.
Of course, if everyone hung their laundry out on their balconies and patios, your condo complex would soon look like a Hong Kong high-rise slum where everyone air dries their clothes.
If the homeowner association should decide to enforce the rule against you by levying a fine, you then would have the opportunity to contest the fine in local court.
PRE-DEATH PROPERTY GIFT COULD BE EXPENSIVE FOR DONEE
DEAR BOB: My wife and I own two rental properties acquired in an Internal Revenue Code 1031 tax-deferred exchange. One is a rental home. The other is a two-family rental duplex. We have owned each about seven years. Since we are getting up in years, we would like to transfer these properties to our children. If we do that, will we have to pay tax now or when they sell the properties? –Roland L.
DEAR ROLAND: Because the gifts will exceed the $12,000 annual gift exemption per donor per donee, you and your wife will have to file federal gift tax returns. However, no gift tax will be due if your total lifetime non-exempt gifts are less than $1 million each.
By making these lifetime property gifts, your adult children will be burdened by taking over your presumably low adjusted cost basis. When they eventually sell these properties, they will owe large capital gain taxes.
A better alternative is to let your adult children inherit the properties after you both pass on. Then they will receive them with a new “stepped-up basis” to market value on the date of death. For full details, please consult your tax adviser.
WHY JOINT TENANCY ISN’T AS GOOD AS A LIVING TRUST
DEAR BOB: You often suggest properties be held in a revocable living trust to avoid probate. We are an unmarried couple in our late 60s and own two properties together as joint tenants with right of survivorship. In our situation, should we set up a revocable living trust? –Dean T.
DEAR DEAN: The primary purpose of a revocable living trust and a joint tenancy is to avoid probate when one co-owner dies.
However, living trusts offer a major additional advantage if one co-owner becomes incapacitated, such as due to Alzheimer’s disease or a severe stroke. Then the successor trustee can manage the trust assets, even selling them if necessary. That advantage is not available with joint tenancy. For more details, please consult an attorney specializing in living trusts.
NO STEPPED-UP BASIS IF SPOUSE DIDN’T INHERIT ANYTHING
DEAR BOB: My wife died in 2006. We lived together in our house for 31 years. Although title was in my name alone, do I get a new stepped-up basis to market value? –Herb W.
DEAR HERB: No. The reason is you didn’t inherit anything. To be entitled to a stepped-up basis to market value on the date of death, you have to inherit the asset.
Now I hope you understand why I recommend married spouses hold their assets in both names, preferably in a living trust. For full details, please consult a local probate attorney.
CAN A REVERSE MORTGAGE BE REFINANCED?
DEAR BOB: My wife and I took out a reverse mortgage about four years ago. It provides us with extra monthly income so we can live very comfortably. Before that, we often could barely pay expenses without dipping into our meager savings. Recently, our reverse-mortgage company asked if we would like to “refinance” our reverse mortgage because our home has gone up in market value by about $125,000. However, we would have to pay the up-front fees all over again. Is this a good idea? We are now 83 and 77. –John and Ida W.
DEAR JOHN AND IDA: The answer depends how long you want to stay in your home. If your answer is at least five years, then it might be wise to refinance your reverse mortgage to increase your borrowing power since your home has appreciated in market value.
More reverse-mortgage details are in my new special report, “Everything You Need to Know About Reverse Mortgage Pros and Cons for Senior Citizen Homeowners,” available for $5 from Robert Bruss, 251 Park Road, Burlingame, Calif., 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.
(For more information on Bob Bruss publications, visit his
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