QUESTION: The cooperative where I live recently circulated a memo advising all of us that several of the owners are interested in converting the co-op to a condominium. I like the idea because I'd prefer to have more control over changes I want to make to my apartment and I've never liked the feeling that the co-op "allows" me to occupy something I paid for. But is this going to wind up costing all of us a lot of money? I am concerned that the value of the apartment as a condo will be considerably larger than it is as a co-op and that I will owe a huge tax bill on the difference.--L. L.
ANSWER: You can rest easy. If you are fortunate enough to see the value of your apartment increase, tax on the gain can be postponed and probably will never have to be paid.
That's because the tax code treats the stock held by the tenant-owner in a cooperative as ownership in a principal residence. And when the owner of a home or other principal residence sells that home and uses any gain from the sale to buy another principal residence within two years (in other words, the purchase price of the new home must be at least as much as the adjusted sales price of the old home), he is permitted to postpone paying the tax on all of the gain from the sale.
You and the other co-op tenants qualify for postponing the gain you anticipate because the conversion will be treated the same as if you had sold one principal residence and immediately bought another.
Why might the tax gain on this bill be forever forgiven instead of just postponed? Because once in every taxpayer's lifetime he or she is allowed to exclude from gross income up to $125,000 of gain on the sale of a principal home. (The rules are that you can't elect to take that option until you are at least 55 years old and you must have owned and lived in the property sold or exchanged as your principal home for at least three of the five years immediately before the sale.)
So if the collective gains on principal residences that you buy and sell over the years don't exceed $125,000, you will never pay the tax. You just keep postponing payment of the tax (and subtracting the untaxed gain from the cost of your new home, giving you a lower basis in the new home) until you choose to take the one-time exclusion.
Q: I have been reading about various ways to pay for my children's college education and at the same time plan my estate. Several times, I have come across the term "short-term spousal remainder trust." But I can't find a good explanation of what it is. Can you help?--O. S.
A: This is a trust designed for married couples looking for a way to do three things simultaneously: provide income to a relative for a specific purpose--most commonly providing a child with college education money--and save on their income taxes and on their estate taxes. Such trusts are usually set up for less than 10 years--parents using one to help pay college expenses will often set it up for just four or five years so they have no obligation to continue providing the child with trust income once the child is finished with college. The income from the trust is taxed at the child's lower income tax rates, which is where the income tax savings come in.
And when the trust ends, the trust principal is paid over to your spouse, which is where the possible estate tax savings occur because the trust property is removed from your taxable estate free of any estate tax liability.
That shift occurs regardless of whether you die while the trust is still running or after it ends. For that reason, you may want to think twice about such a plan if there is a possibility of marital discord. In such cases, you might want to consider instead a so-called reversionary interest trust, under which the property in the trust is automatically returned to your estate when the trust expires.
Since there is a laundry list of rules you have to follow in setting up and carrying out the terms of these trusts, be sure to seek advice from a lawyer or other financial consultant before proceeding.