DEAR BOB: What is your opinion on my pulling out as much equity as possible from my home by taking out a negative-amortization mortgage in order to have retirement income 10 years from now? I am 65 but still work, have good income and a good FICO (Fair Isaac Corp.) credit score. My son says “no.” What do you think? –Carmen S.
DEAR CARMEN: I think you have a very smart son. Why in the world would you take out a negative-amortization mortgage where you will owe more than you borrowed? That makes no sense.
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If that mortgage costs you at least 6 percent interest in today’s mortgage market, where can you invest that money to earn 6 percent after-tax with safety?
You will probably be better off obtaining a reverse mortgage, which will give you a choice of a lump sum, lifetime monthly income, a credit line or any combination of those choices. That’s a far wiser alternative than obtaining a negative-amortization mortgage.
MAJOR MISTAKE GIVING VACATION CABIN TO CHILDREN
DEAR BOB: My wife recently sold a lakefront cabin that she owned with her two siblings. It was gift deeded to them by their mother in 1991. There was no money exchanged. In 1991, it had an assessed tax value of $47,240. It sold for $269,000 this year. How do the sellers arrive at the fair market value in 1991 to calculate their basis for capital gains tax? –William M.
DEAR WILLIAM: It was a major mistake for your mother-in-law to give the cabin to her three children in 1991. Because it was a gift, the donees took over the donor’s presumably very low adjusted cost basis (probably lower than that 1991 assessed value of $47,240).
If they had instead inherited the cabin, they would have received it with a new stepped-up basis of market value on the date of the mother’s death. For this reason, I often say it is usually better to inherit property than receive it as a pre-death gift.
The difference between the mother’s adjusted cost basis and the $269,000 sales price is the taxable capital gain for the three co-owner sellers.
The good news is the maximum federal long-term capital gains tax rate is currently only 15 percent. Depending on the state where the cabin is located, there might also be a state capital gains tax due. For details, your wife and her siblings should consult their tax adviser.
DIVORCE IS AN “UNFORSEEN CIRCUMSTANCE” FOR HOME SALE
DEAR BOB: My wife and I were divorced in early 2007. We had owned and lived in our home for about 12 months before selling it. We were very lucky and earned a net profit of about $111,000. However, my tax adviser says we owe capital gains tax because we didn’t own and live in our home for 24 of the last 60 months before the sale. Do you agree? –Daniel F.
DEAR DANIEL: No. Get a new tax adviser. Internal Revenue Code 121 provides three specific partial exceptions to the 24-month-minimum, principal-residence ownership and occupancy rule. These home-sale exceptions are health reasons, change of employment location qualifying for the moving expense tax deduction, and “unforeseen circumstances.”
The IRS Regulations for IRC 121 include divorce as an unforeseen circumstance. Based on your 12 months of ownership and occupancy, that means you and your ex-wife qualify for 50 percent of the full $500,000 principal-residence-sale exemption (12/24ths), or $250,000. Your $111,000 capital gain is well below this exempt amount so it appears your profit is fully tax exempt.
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