DEAR BENNY: I hold a $175,000 second trust on a house I sold five years ago. It has been payable "interest only" monthly at 5 percent. It comes due early next year and although I need the principal I have a feeling the debtor will want an extension of the loan. How much can I increase the interest and yet avoid it being usurious. I do not know how much of a first mortgage he has.
Also if he offers to pay it off but at a discount, how much should I discount it? I sold him the house for $475,000, but it is probably worth only $350,000 at present. –Doug
DEAR DOUG: Different states have different usury laws, so you should ask your attorney for the laws in your state. But clearly, whatever the usury laws are, I don’t think you want to increase the rate too much or you will scare off your borrower. More importantly, you want to make sure that he is able to make his monthly payments; the last thing you want is to have him default on your loan.
As to what discount you should offer him should he want to pay you off in full, there really is no set formula. Let him make the first offer, and then if that’s not acceptable, you can counter. There may be some back-and-forth negotiation until you finally reach agreement.
But don’t be too greedy; his house is upside down and unless he has an incentive to pay off his second mortgage, he may just let the property to go foreclosure. If that happens, and the first lender forecloses, your trust will be wiped out. You can still sue on the promissory note he signed, but that could be expensive and litigation is always uncertain.
DEAR BENNY: Is the definition of "capital improvement" something that increases the actual value of the house, even if it may not trigger change in taxes, or must it be taxable?
If the first, is there a dollar figure that could be considered a "floor"? When we bought our house we discovered many unsafe issues, such as no railings on steps leading down from the deck and, notably, unsafe steps exiting the house into garage. We built a landing with better, safer stairs at the dangerous exit; the cost was $400. The railings cost $100. Our corrections have made our house safer, but they didn’t lead to a rise in taxes and they will not lead to an increase in sales price. Are additions directed to safety considered repairs or capital improvements? –Phyllis
DEAR PHYLLIS: The line between repairs and improvements is fuzzy. The court cases that have analyzed this issue are all over the place, with judges deciding the exact same work going in opposite directions.
If your property is a rental, then in most cases you want to call the work a repair. Repairs can be deducted as rental expenses in the year that you pay them, thereby reducing your rental income.
If this is your principal residence, however, while you obviously want to keep your house in good repair, the money you spend on ordinary maintenance provides no taxable benefits for you.
Improvements, on the other hand, may be very valuable to you when you sell your house, since they increase the tax basis in your house. The higher the basis, the less tax you have to pay. …CONTINUED
Readers will question this and tell me, "But I am eligible for the up to $250,000 or $300,000 exclusion of gain, so why is this important?" The answer is simple: There are still homeowners in this country who bought their house a long time ago, and their profit (i.e., gain) will exceed the amount of their exclusions. Thus, the more improvements you can demonstrate, the higher your basis will be.
Any work you do to your house that adds to its value, prolongs its useful life or adapts it to new uses (such as "going green") will be considered an improvement and can be added to the tax basis of your property.
Let’s look at your situation: For safety purposes, you corrected your stairs and your railings. As this not only resolves a safety issue but prolongs the useful life of your property, I would consider it an improvement.
The Internal Revenue Service (in Publication 527 entitled "Residential Rental Property") has a helpful discussion of what constitutes a "repair" and what constitutes an "improvement." The thinking process of the IRS for rental properties would be the same for your principal residence.
The IRS publication contains a list of "examples of improvements," but cautions, "work you do (or have done) on your home that does not add much to either the value or the life of the property, but rather keeps the property in good condition, is considered a repair, not an improvement."
So, it’s fuzzy at best. But here’s the IRS test: "An improvement adds to the value of the property, prolongs its useful life, or adopts it to new uses."
However, if this is the only work you will do to your house, and if you can take the exclusion, I wouldn’t bother listing this work on any of your tax returns. The amount is small, so why take a chance with the IRS?
DEAR BENNY: My mother passed away and left the house in her will equally to my sister and me. According to the will, I have the first option to buy her out. I would like to do so and it would be the first time I would be buying a house. My purchasing the home would settle the estate.
However, I am confused. Because I would "have" half of a house, will a mortgage company consider my half as equity in the home and won’t require 20 percent down? –Holly
DEAR HOLLY: I have encountered this issue several times, and all I can tell you is that lenders are confused and really don’t know how to handle this. Clearly, you have half of the equity in the house, so (assuming you can qualify for a loan) you should not have any problems. Lenders like to make loans where there is a lot of equity in the house; the risk of foreclosure is greatly reduced under those circumstances. …CONTINUED
Some lenders are willing to treat this as a purchase, while other lenders may want to call this a refinance loan. Talk with several lenders, and get rate and term quotes so that you can get the best possible deal. I do not believe you should have any problems getting a loan.
DEAR BENNY: I plan to buy a brand-new house at a community for active individuals 55 and over. I contacted a sales consultant who represents the builder.
My questions are: Do I need to hire a real estate buyer’s agent to represent me when I am going to buy a new house? Do I need a professional home inspector? Do I need a real estate lawyer? –Katherine
DEAR KATHERINE: I don’t believe you need a buyer’s broker to assist you, but I do strongly recommend that you retain a real estate lawyer and ask him/her to review your contract before you sign it.
From my experience, many new-home sales contracts are one-sided in favor of the builder. I often joke that if there is anything in the contract that protects the buyer, it’s because the seller’s attorney forgot to take it out of the contract.
You must understand all of the terms and conditions of that contract. Do you have to use the seller’s attorney (or title or escrow company) when you go to settlement? Do you have to use the seller’s lender or can you shop around?
Are the appliances that will convey with the house clearly defined? Too often, a builder will merely state, for example, that the washer and dryer will be "top of the line." What does that mean? There should be specific models listed in your sales contract.
Do you need a home inspector? My answer is yes, even though many builders will balk at this. From my experience over the years, when my clients who were purchasing new homes used an inspector, often many problems were found during construction.
In fact, one builder told me that but for the inspection (which found defective installation of some water pipes), the builder would have had to spend a lot more money correcting the problem after the house was finished. Because the inspector discovered the problem early, the builder saved a lot of time and money.
Tell the builder that you want a home inspector — at your expense — to periodically inspect the house during construction. Hopefully, the builder will agree since it may be beneficial to the builder in the long run.
Benny L. Kass is a practicing attorney in Washington, D.C., and Maryland. No legal relationship is created by this column. Questions for this column can be submitted to email@example.com.
What’s your opinion? Leave your comments below or send a letter to the editor. To contact the writer, click the byline at the top of the story.