DEAR BENNY: My husband and I built a townhouse in 1983 for $33,000. We lived there for a few years and then rented it out for 17 years, taking all the tax advantages such as depreciation, etc.

In 2003 we sold it for $90,000, and did a like-kind exchange with a house that my husband built. That house has been rented for the past six years and now has a market value of $190,000. We have no liens on the home and would like to sell it and put the money towards our dream home.

If we moved into the home and lived there for two years, would we have to pay capital gains taxes when we sell the home?

DEAR BENNY: My husband and I built a townhouse in 1983 for $33,000. We lived there for a few years and then rented it out for 17 years, taking all the tax advantages such as depreciation, etc.

In 2003 we sold it for $90,000, and did a like-kind exchange with a house that my husband built. That house has been rented for the past six years and now has a market value of $190,000. We have no liens on the home and would like to sell it and put the money towards our dream home.

If we moved into the home and lived there for two years, would we have to pay capital gains taxes when we sell the home?

We’ve asked our certified public accountant (CPA) and she said we would have to pay capital gains because we took depreciation on the properties. We also asked a friend who worked for the Internal Revenue Service and he said as long as we lived in the home for at least two out of the last five years before we sold the home, we would not have to pay capital gains tax. Who is correct? –Jeanne

DEAR JEANNE: I believe your CPA is correct. Any depreciation that you took after May 6, 1997, will be taxed. And based on a new 2008 tax law, the gain must be allocated between the rental and the personal use starting after Dec. 31, 2008. The portion of the gain allocated to the rental period will be taxed.

I would always follow the advice of your paid accountant, rather than that of a friend, even if he or she works for the IRS.

DEAR BENNY: I live in New York and my 80-year-old mother lives in Florida. We are both on the deed to my home, which was purchased in 1994. She wants to give me the house outright, and wants her name off of the deed. What is the easiest way and how should we go about it? –Tom

DEAR TOM: The process of transferring title from your mother to you is easy; however, the tax complications may not be so easy.

You, and preferably an attorney, can make sure who owns the property by conducting a title search. If it is clear that you and your mother own the house, the lawyer can simply prepare a deed conveying the property from her to you. There may be some technicalities in New York that I don’t know about. And, generally, because this is a transfer between mother and son, again — depending on New York law — you may not have to pay any recordation or transfer tax but only a nominal fee to record the deed.

But discuss the situation first with your lawyer and/or a tax advisor. My answer below may not apply in community property states out west, such as California or Oregon. …CONTINUED

Let’s say you and your mother bought the house back in 1994 for $100,000. Her basis for tax purposes is $50,000 and yours is the same. Let’s ignore for this example any improvements you have made over the years.

Now, let’s further assume the house is worth $500,000. When your mother gives you her half of the house, you pick up her basis for tax purposes. This means that your basis will now be $100,000. If you ultimately sell it say for $600,000, you will have made a profit of $500,000 (for this discussion I am ignoring commissions and other closing costs).

If you are married and have lived in the property for two out of the five years before it is sold, you can exclude for tax purposes all of that profit (i.e., the $500,000). But if you are not married — or have not met the two-out-of-five-year occupancy test, you may have to pay a lot of capital gains tax.

Talk with your professional advisors before you go down this path. It may be better for your mother to sell you her half, and you can pay her a monthly or yearly amount for the sales price.

DEAR BENNY: My husband and I just signed documents to refinance our home. The entire process was long and frustrating. The appraisal was done a month ago, but the lender never notified us that the appraisal value was lower than what we needed to refinance. We found this out almost one month afterwards and only after we called to ask how things were going. The communication with the lender was extremely poor, but that wasn’t the biggest problem.

The lower appraisal value meant we had to pay down the loan by $20,000 in order to refinance. Our house has three bedrooms, and four of the six sales comps were two-bedroom houses. Adjustments were made only for the overall square footage, not for the number of bedrooms.

We felt the amount was inaccurate for our area and asked the lender to have the appraisal reviewed. I gave the lender additional comps and the same appraiser replied with a second report with no change in value. There were numerical discrepancies between both reports. One comp ended up with a higher value, as the first report omitted to make any adjustments. I contacted both the lender and appraiser by e-mail and did not receive a response to these errors.

In the past few weeks a house in our neighborhood of similar size and lot has sold for more than $100,000 above what our house was valued at. I looked at the open house and this house had only one bathroom and a single garage compared to our two bathrooms and double garage. In order for that house to sell, it would have had to appraise at the amount offered.

I’ve read all sorts of stories about low appraisals happening, but these appraisals affect homeowners from refinancing and buying a home. Have we been wronged and is there anything we can do? If an appraisal is so important to the loan process, it should at the least be correct and not contain errors. –Maileen

DEAR MAILEEN: I can’t agree with you more. Although appraisals are not an exact science, they are crucial to the selling, buying and refinancing process. …CONTINUED

But the appraisal process has been dramatically changed in the past year. As a result of a compromise agreement between the New York Attorney General and the major mortgage secondary lenders such as Fannie Mae and Freddie Mac, mortgage lenders have much less impact on how appraisals should come in.

Most lenders are now required to follow what is known as the "Home Valuation Code of Conduct." Perhaps the most significant part of this new code is that mortgage lenders cannot select an appraiser. The lender must contact an appraisal company who will assign an independent appraiser to prepare the valuation report.

What do you do if you are not satisfied with the appraisal? Eventually, an Independent Valuation Protection Institute will be established that will have the authority to review all such complaints. However, that entity has yet to be created.

So in the meantime, if you get no satisfaction after talking with your lender, you can complain to Freddie or Fannie. The Federal Housing Administration (FHA) has not adopted the code, so if your loan is backed by FHA, complain directly to the local FHA office in your area.

These new procedures have created major problems for the lending community and for homebuyers and homeowners. However, the underlying concept is important: Appraisals should be totally independent and not based on what a mortgage lender would like to hear so that he can make any loan — no matter how bad it may be.

DEAR BENNY: We own a commercial condo building that we bought in 1985. If we sell it now, not only do we have to pay capital gains tax, but also recapture all of the depreciation we have taken on it over the years. It is still used in our business, but it is pretty much totally depreciated, so almost all of the sales price would be subject to recapture as far as I understand. Will a 1031 Starker exchange help us in any way if we decide to sell this location? The only reason we would consider selling it is that the parking situation there is getting more and more crowded, but we don’t have to sell. What is your advice? –Caleb

DEAR CALEB: Yes, a Section 1031 exchange (also known as a Starker exchange) should be considered if you really want to get rid of that property. You would have to carefully follow the rules, because they are strict.

For example, when you sell that property, you cannot have any access to the sales proceeds. They have to be put in escrow to be used only to buy the new property. The replacement property must be identified within 45 days from the date you sold the relinquished property, and you must take title to the new property within 180 days from the date of the earlier sale.

Keep in mind that a 1031 exchange does not mean that you avoid paying any capital gains tax. Your tax basis from the relinquished property becomes the tax basis of the replacement property. Thus, you only defer, not avoid, paying the tax.

This is complicated and you must talk with a tax attorney who understands the process.

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 benny@inman.com.

***

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