IRS Limits How Often You Can Sell Your Home--Once Every 2 Years
QUESTION: We bought our first home in May, 1986. Then we sold it in June, 1987, and bought a larger home in the same month. Now we can sell our present home at a nice profit, so we can buy a better home. However, the realty agent says we should wait to sell until June, 1989, if we want to avoid tax on our sale. Is this correct? - Jule R.
ANSWER: Yes. The “rollover residence replacement rule” of Internal Revenue Code 1034 can be used over and over again without limit if you buy a replacement principal residence of equal or greater cost within 24 months before or after the sale.
However, this tax break cannot be used more often than once overy 24 months, unless the home sale qualifies for the moving expense deduction which involves a new job location at least 35 miles farther away from your old home than was your old job site.
Ambitious homeowners who know how, can start out with a modest home, such as a cottage, and pyramid their equity up to a mansion without paying profit tax along the way just by using IRC 1034 to avoid tax.
Please notice the law says nothing about mortgage balances. All that matters is your old home’s net sale price (called “adjusted sales price” in tax language) and your replacement home’s adjusted cost basis, including most closing costs. Of course, you must meet that inflexible 24-month replacement deadline (but a few time extensions apply, such as for military service or if you move overseas).
In everyday, non-tax talk, your new home must cost at least as much as your old home’s net sales price. But if you want to take out some tax-free cash from the transaction, you can sell your old home for cash, buy your new home for zero down, such as with a VA mortgage, spend the cash you received from the sale, and live happily ever after.
This most generous of tax benefits can be used by home sellers of any age who dispose of one home and buy another of equal or greater cost. However, there are pitfalls to expect and avoid, such as:
1-If your principal residence is one unit in an apartment building you own, the profit tax deferral only ato the value of your personal residence apartment, not to the sale profit on the entire building.
2-If you haven’t purchased your replacement home by the time your 1988 tax return is due on April 15, you can still defer your profit tax if you plan to buy a replacement residence within 24 months after the sale. Just report the sale in IRS form 2119 and indicate you plan to buy a qualifying principal residence. However, if you fail to purchase the replacement home then you owe tax on your sale profit, plus interest.
3-If you buy a less expensive replacement home, you’ll owe tax on your profit up to the difference in the two prices. To illustrate, suppose your old home sells for $100,000 net (adjusted) sales price with a $30,000 sale profit. However, your replacement home costs only $90,000. That means you owe tax on the $10,000 price difference, but tax on the remaining $20,000 profit is deferred. But if you add $10,000 of capital improvements, such as landscaping or a room addition, to your new home within the 24-month replacement period to bring its adjusted cost basis over $100,000, then you owe no profit tax.
4-If the location of your old or replacement home is outside the United States you can still use IRC 1034 to defer tax since the law does not require either home to be within the United States.
5-If one or both of the homes is not the taxpayer’s principal residence, IRC 1034 does not apply. Vacation or second homes are not eligible for the residence replacement rule. For example, selling your city home and moving to your previously owned vacation home won’t quality.
In summary, the rollover residence replacement rule is the most important tax break for most taxpayers. Although IRC 1034 is simple and easy to understand, consultation with a tax adviser is suggested to make certain your personal situation qualifies for tax deferral.
Go Ahead and Make that Low-Ball Offer
QUESTION: You told another reader not to be afraid to make a low purchase offer on a house, and if the realty agent refused to deliver it to the seller, to report the matter to the state real estate commissioner. That is exactly what I had to threaten to a snotty real estate agent who was holding a Sunday open house. Her asking price for the house was $189,500, but I knew homes in the area had been selling for only about $150,000.
My wife and I liked the house, and the schools in the area are excellent. When I said we wanted to offer $150,000 the agent refused to take our offer. Then I recalled your article and said we would report her to the real estate commissioner who would probably revoke her license for failing to represent the seller honestly. Reluctantly, she prepared our offer. The next day she called to say she was shocked, but the seller made a counteroffer at $155,000. We accepted the counteroffer. Thanks to you, last week we moved into our new home.
ANSWER: Real estate agents get mad at me when I admonish them not to try to think for their buyers and sellers. But your situation shows why agents can’t possibly know which offers will prove acceptable.
For example, I sold my condo for $10,000 less than the asking price. My realty agent was shocked when I accepted the buyer’s first offer. She said she was sure the buyer would pay more. But I was thrilled to get an all-cash offer, which gave me an obscene profit and enabled me to buy a larger home from the same agent. Although I probably left at least $5,000 on the table, I was happy, the buyer was happy and the realty agent earned a full sales commission.
Interest on Lot Only Partially Deductable
Q: About five years ago, my husband and I bought a lot in Florida, where we plan to build our retirement home. We just received the annual statement from the developer-lender stating we paid $3,032 interest on our mortgage in 1988. I understand the new tax law allows us to deduct mortgage interest on only our home plus a second home. Does the interest on our lot where we plan to build a second home qualify?
A: No. The 1986 Tax Reform Act clearly allows you to deduct mortgage interest only on your personal residence plus a second home. It says nothing about a lot on which you hope to build a retirement home. Therefore, only 40% of your 1988 interest paid on that vacant lot is tax deductible as itemized personal interest. Consult your tax adviser for details.
How Long Does Home Sale Tax Deferral Last?
Q: With our 1987 federal income tax returns we filed IRS form 2119, reporting the sale of our residence and purchase of a replacement home to defer the tax. How many years does this tax deferral last?
A: The “residence replacement rule” tax deferral of Internal Revenue Code section 1034 lasts as long as you own your current home. If you sell it without buying another qualifying replacement home of equal or greater cost, then you will have to pay the deferred tax. However, if you should die while owning your current home, Uncle Sam will forgive the deferred tax. Isn’t he nice? Consult your tax adviser for further details.
After You Sell, It’s Too Late to Avoid Tax
Q: Recently I read your article about tax-deferred exchanges. The part about Starker delayed exchanges especially interested me. In late January, I sold my fourplex and earned about $135,000 net profit. If I reinvest that money within 45 days, can I defer my profit tax?
A: No. It’s too late. To make a Starker delayed exchange, you make a sale of “like kind” investment or business property. But the sales proceeds must be held by a third-party intermediary, such as an attorney or bank trust department. You then have 45 days from the sale closing to designate the property to be acquired. The purchase must be completed within 180 days. Further details are in my special report, “Current Tax-Deferred Exchange Developments and Starker Delayed Exchanges,” available for $3.50 from NewspaperBooks, Box 4386, Orlando, Fla. 32802.
Don’t Fret About Tax on Inherited Property
Q: Within a month I will be receiving title to a house I inherited from my uncle. As it is located about 50 miles from my home, I plan to sell it. Since I am over 55, how can I qualify for that $125,000 residence sale tax exemption on this inherited house which should sell for about $175,000?
A: Don’t worry, be happy, as the song says. When you inherit property, your cost basis is the market value on the day of the owner’s death. Presumably, that value was close to the current market value. To illustrate, if the estate valued the house at $170,000 and you sell it for a net sales price, after expenses, of $175,000, you have only a $5,000 taxable profit.
Since you have not owned and lived in the house as your principal residence for at least three of the five years before the sale, you can’t qualify for the $125,000 “over 55 rule” tax exemption. But you need not be concerned because your profit and tax will be minimal. Consult your tax adviser.
Owner-Seller Should Arrange Financing
Q: I know you don’t recommend thatsellers try to sell their home without a professional realty agent, but my husband insists on trying. Our home has been for sale for about three weeks and we are enjoying the experience. However, we are encountering mostly first-time home buyers who know less about home selling than we do. We have several interested prospects but they aren’t sure if they can get a mortgage. How can we handle this problem?
A: If you had a professional realty agent you would learn one of the agent’s primary duties is to arrange mortgage financing for buyers. Since you have no agent, it becomes your job to find a mortgage, because most buyers won’t know how to get a loan themselves.
Benefits of Converting Home to a Rental
Q: We are buying a larger home but are undecided if we should sell our old home or keep it as a rental. One problem is, if we keep it as a rental we will need to refinance it so we can pull some tax-free equity out to use for our down payment on our new home. What do you advise?
A: You can never own too much real estate. If you will be living in the same vicinity as your old home, then I recommend you keep it as a rental. Your description indicates the home has been appreciating nicely in market value. That is likely to continue unless you foresee adverse local economic conditions.
Of course, you must report the rental income on Schedule E of your income tax returns. But you will be able to deduct the mortgage interest and the property taxes on your old home, plus expenses for insurance and repairs. In addition, you will be able to deduct depreciation for the lower of your adjusted cost basis, or the home’s market value on the day it is converted to rental status. You can deduct up to $25,000 of losses from rental properties, called “passive loss activity,” against your ordinary income, such as job salary, interest and dividends.
However, if you will have a large negative cash flow, meaning the expenses are higher than the rental income, then renting your old home might not be a good idea. But if your current home is appreciating rapidly in market value, then, if you can afford a negative cash flow, you would be wise to keep the house because you will be profiting over the long term.
Will ‘As Is’ Clause Protect Home Seller?
Q: We are selling a home that we have owned for about 12 years. But it has been rented to tenants for the last five years. As we now live about 100 miles away, we haven’t been inside the house during that time. The tenants say it doesn’t need any repairs. What is the best way we can protect ourselves against liability to the buyer, in case something goes wrong with the house shortly after purchase? I have seen several homes advertised for sale “as is.” Will that protect us?
A: For protection, you should disclose in writing any defects in the house of which you are aware to the buyer. Some states, such as California, have state-mandated disclosure forms, which must be given to the buyer. This is a good idea which I hope spreads to all states.
However, since you may not be aware of all the defects, after disclosing what you know about the house, you then can sell it “as is.” An “as is” home sale means the seller and realty agent make no warranties or representations and will not be responsible for any repairs that might be necessary. While an “as is” sale is good for the seller, it raises red flags for the buyer who wonders what the seller may know but isn’t telling. Home sellers should not use “as is” sales unless they do not know the house’s condition and want to protect themselves from possible future liability to the buyer. Please consult a real estate attorney for further details.
Can Lender Sell Home Mortgage Without OK
Q: Just two months ago, we refinanced our home loan. We have only made one loan payment, but last week we received a letter from a savings bank in Texas that our loan has been sold to them and that we must send our payments there. When I called the local S&L; where we got our loan, the clerk said she didn’t know anything about this but she can’t find our loan on her computer. What should we do?
A: I share your frustration because the same thing has happened to me. You thought you would be doing business with a local lender and then you find out the loan was sold to an out-of-town lender whose 800-phone number is always busy. Unfortunately, there isn’t anything you can do about this but learn to live with it. Mortgage loan servicing is a multibillion dollar business and your loan is now part of that huge industry.
Letters and comments to Robert J. Bruss, a San Francisco-area lawyer, author and real estate broker, may be sent to the real estate section, Los Angeles Times, Times Mirror Square, Los Angeles 90053.
