How to Shelter Your Profits From Home Sale

QUESTION: We want to sell our large old home, where we have lived 28 years, and buy either a smaller house or perhaps a condo. Our problem is that we will have a profit of about $175,000, which is more than our $125,000 “over 55 rule” tax exemption. Is there any way we can shelter that remaining $50,000 profit from tax?

ANSWER: Yes. You can combine the “over 55 rule” $125,000 tax exemption with the “rollover residence replacement,” which is available to home sellers of any age.

To illustrate, suppose your home’s adjusted cost basis (purchase price plus any improvements) is $25,000, and you sell it for a net price of $200,000 and a $175,000 profit.

I’ll assume you meet the “over 55 rule” requirements of owning and living in the home any three of the five years before the sale, at least one co-owner spouse is 55 or older on the sale date and you or your spouse have not used this tax break before. Subtracting the $125,000 exemption from the $200,000 net sales price leaves a “revised adjusted sales price” of $75,000.

Then, if you buy a replacement principal residence costing at least $75,000 within 24 months before or after the sale, you can defer profit tax on your remaining $50,000 profit. Please consult your tax adviser for more details.

Could First Home Also Include Rental Units?

Q: My wife and I have about $25,000 for the down payment on our first home. We have looked at both single-family houses and small rental properties, such as duplexes, triplexes and fourplexes. If we bought rental property, we would live in one unit. Do you think such property should make a good first real estate investment?

A: My first real estate investment was a triplex where I lived in one unit and received income for the two rentals. This was a wonderful way to get started in realty investing because the rental income helped pay the expenses.

However, many owners do not like to live so close to their tenants. I was fortunate to have tenants who were mostly quiet and non-complaining, so we got along great. But, a troublesome tenant could drive the owner crazy because of the close proximity.

As for appreciation in market value, you will usually find single-family houses go up in market value faster than do small income properties. There is nothing wrong with investing in small rental properties as long as you are aware of their pros and cons.

Oral Sales Agreement Not Legally Binding

Q: My neighbor promised to sell me his house. We agreed on the price. We set up an appointment to meet at his lawyer’s office the next day. When I showed up, the attorney said the neighbor decided not to sell. I was very mad. A few days later the neighbor listed the house for sale with a real estate agent at a much higher price. The house has not sold in over three months, so I know it is overpriced. How can I enforce my agreement to buy the house at a fair price without a sales commission?

A: I regret to report verbal real estate agreements are not legally enforceable. In other words, your oral contract with your neighbor is worthless.

The Statute of Frauds requires virtually every agreement affecting real estate be in writing to be enforceable in court. There is a very good reason. The purpose of this law is to prevent misunderstandings.

Without a written agreement specifying the exact terms of the sale, there can be a misunderstanding by the buyer and seller. Until you have a written contract for the sale of real estate, nothing is enforceable.

How to Trade a Home for Income Property

Q: I want to trade my home, worth about $300,000, for a four-plex worth about $400,000. How can I accomplish this without paying tax on my profit of about $170,000?

A: That’s easy. Move out of your principal residence. Rent it to tenants, thereby converting it from your personal residence to investment property. Then make an IRC 1031 tax-deferred exchange for the four-plex. Ask your tax adviser to explain further.

What Happens When Lender Forecloses?

Q: My wife and I are thinking of selling our home and carrying back a second mortgage for the buyer. Our VA first mortgage is assumable. Frankly, we can use the extra interest income we will earn, as the rate is higher than we can get at a bank or S&L.; But our worry is what happens if the buyer doesn’t make the payments on the first mortgage?

A: If your borrower falls behind on the payments on the first mortgage, to protect your second mortgage, you should step in to make the first mortgage payments and then begin foreclosure on your second mortgage. Failure to pay the first mortgage is a default on the second mortgage.

If your second mortgage goes all the way to a foreclosure sale because the borrower doesn’t cure the default, and if there are no bidders at the foreclosure sale to pay off your loan, then you get the house back to resell for a second profit. Rather than fearing a default, you should look forward to it. Please consult a real estate attorney for further details.

Home-Equity Loan Computation Formula

Q: Recently, I received several letters from banks where I do not have accounts offering me home-equity loans for up to 80% of my home’s value, minus my mortgage balance. I figure my home is worth about $175,000 and my mortgage balance is around $53,000. How much of a home-equity loan can I get, and do you think I should take one even though I don’t have a use in mind for the money?

A: Eighty percent of your $175,000 home value is $140,000. Subtracting your $53,000 first mortgage results in an $87,000 maximum home-equity loan. Banks and S&Ls; are so eager to make these very safe and very profitable loans that they usually do not charge loan fees, appraisal fees or other charges except for title insurance.

However, be careful. I like the home-equity credit lines that give the borrower a checkbook. These loans don’t cost any interest until the borrower writes a check. Be wary of home-equity loans tied to the volatile prime rate, which is controlled by the banks. I prefer objective indexes such as the cost of funds index. The Treasury bill indexes are all right, but they can go up or down rapidly.

Can Vacation Home Serve as Replacement?

Q: We want to sell our city home and make a year-round full-time home out of our vacation home that we have owned for about five years. Our home should sell for at least $185,000. However, our vacation home only cost us $22,500, but we will add improvements costing about $50,000. Is there any way this situation will qualify for tax deferral on the over $70,000 profit from the sale of our home?

A: No. The roll-over residence replacement rule of IRC 1034 requires tax deferral when selling your principal residence and buying a replacement principal residence of equal or greater cost within 24 months. Since you purchased your vacation home more than two years ago, it is, therefore, ineligible. Another problem is the cost is much less, so there is no way it could qualify even if you met the time requirement.

Difference Between Brokers and Bankers

Q: In the past you have not been too kind to mortgage brokers. As a real estate broker I share your hostility toward some of them who make promises they know they cannot keep. I had just about given up trying to do business with these people until I discovered several mortgage bankers who make loans with their own funds or borrowed money and then sell the mortgages in the secondary mortgage market.

Both as a real estate agent and a borrower for my own properties, I have found there is a world of difference between mortgage bankers and the mortgage brokers who are middlemen between lenders and borrowers. Why don’t you mention mortgage bankers?

A: Shame on me for not emphasizing the difference between mortgage bankers and mortgage brokers.

In recent years, true mortgage bankers have been hard to find. Most so-called mortgage bankers who originate loans with their own funds usually try to sell their loans in the secondary mortgage market as fast as possible after origination, so they can minimize carrying costs.

But in recent years many S&Ls; have discovered they can act like mortgage bankers by originating loans, seasoning them for a year or two and then profitably selling them at the right time in the secondary mortgage market.

I have nothing against mortgage brokers, but I hesitate to recommend them because I get so many complaint letters about the tactics of a few who give the industry a bad name.

Why It Pays to List Home With Agent

Q: We are trying to sell our home ourselves to avoid paying the real estate sales commission. As we are in no hurry to sell, we don’t mind waiting and doing the work ourselves. However, we have had more than 20 serious buyers inspect our house, but none has made a purchase offer yet. I am a retired attorney, so I feel I can handle this sale, as the house is priced realistically. Any suggestions?

A: I wish you luck because you will need it. Selling a home without a professional realty agent is not easy. If you have had more than 20 serious prospects and have not been able to obtain a written offer, something is seriously wrong.

It is extremely difficult for a do-it-yourself home seller to be objective. That is why most people wind up listing their homes for sale with professional realty agents. Although I am a real estate broker, when I have a house to sell (unless I sell it to my tenant) I always list it with a real estate agent because I find their services well worth the commission.

I suggest you interview at least three local realty agents. Listen to their listing presentations, which should include written “comparative market analysis” forms showing you recent sales prices of similar nearby homes, asking prices of neighborhood homes (your competition), and each agent’s recommended sales prices for your home.

Be sure to ask lots of questions about the services, fees, references and anything else you want to know about each agent. But, before signing a listing, phone their references of previous sellers to inquire: “Were you satisfied with this agent and would you list with the same agent again?”

Short Listings Are Best for Home Sellers

Q: Thank you for sharing that letter some time ago where the lady listed her home for four months with a realty agent who only advertised the house twice and only held two open houses. After reading that letter in your column, when I put my house up for sale in January I listed it only for 30 days. I interviewed several realty agents and all said they wanted 90 days listings.

I told the one I liked best that I would renew her listing if she did a good job, but I didn’t want to be stuck with a long listing if she didn’t work hard. I was extremely pleased and I’m sure the agent worked so hard because she knew she only had a short time. It took about three weeks to get the first offer, but then things moved fast and the house was sold with no problems. Why don’t you recommend 30-day listings?

A: I have switched to 30-day listings, too. But every time I say real estate agents work hardest, smartest and fastest just before the listing is about to expire, you should see the nasty hate mail I get from hot-tempered real estate agents. They write long letters explaining why it takes at least 90 days to sell a home.

In a slow market, that is correct. But, even in a slow market a 30-day listing keeps the agent constantly hustling to keep the seller happy. If the listing expires with the home unsold, but the agent is doing a good job, the seller should then renew the listing for 30 additional days. However, if the agent is doing a poor job then the seller isn’t stuck for a long time with a lazy agent. Incidentally, a short listing is good for the realty agent, too, because when the home is sold quickly because of effective marketing, the agent gets the sales commission as soon as possible.

Signatures of All Sellers Are Required

Q: We are buying a home which is being sold because of a divorce. The husband has left town and the wife says she doesn’t know where he is. Before he left, the wife says he signed the purchase contract, but we and the realty agent think his signature is forged. We are ready to close the purchase, but the husband can’t be found to sign the deed. Our loan commitment expires soon and we don’t want to have to pay a higher interest rate. How can we buy this house without the husband’s signature?

A: Unless the wife has a power of attorney form signed by her ex-husband I don’t know any way to overcome the requirement that the husband sign the deed if his name is on the title. The ex-wife can bring a partition lawsuit to get a court order for the sale but such action will take time. I suggest you and the ex-wife consult a real estate attorney.

Duplex Sale Really 2 Tax Transactions

Q: In the next few months we plan to sell our two-family duplex. But, we are receiving conflicting advice on the tax consequences. When we had our income taxes prepared, the tax lady said we can defer our profit tax if we buy another duplex of equal or greater cost.

However, we don’t want to buy another duplex, as we are tired of living next door to tenants who can be a pain in the you-know-what. We want to take the money and buy a nice single-family home. How can we do this without paying a big tax on our profit which I estimate will be around $100,000?

A: For income tax purposes, your sale of the duplex where you live in one unit and the other is rented to tenants is the sale of two separate properties. The sale price must be allocated between the two units.

As for the profit from the sale of your personal residence portion, you can defer all your profit tax by buying a replacement principal residence of equal or greater cost within 24 months before or after the sale. This is the famous rollover residence replacement rule of IRC 1034.

But the profit from the sale of the rental unit will be taxable unless you make a tax-deferred exchange for another investment property that is not your personal residence. For example, you could take the money from the rental unit sale and trade for a rental house costing at least as much as the sales price of the rental portion of the duplex.

You also can make a Starker delayed exchange if you designate the replacement investment property within 45 days after the sale, complete the acquisition within 180 days and have the sales proceeds held by an intermediary in the meantime. For further details, please consult your tax adviser.

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.