Rule Limits Profit Rollover From Sale of Home to Once in 24 Months

QUESTION: In January, 1986, we sold our home at a profit of about $22,000. Ten months later, we bought a slightly more expensive home and deferred our profit tax, using that "rollover residence replacement rule" you often discuss. This second house was a run-down house, which my husband fixed up beautifully. However, we didn't like the schools for our children and sold this second house in July, 1987, for a net profit of about $36,000.

In August, 1987, we bought a slightly more expensive home in a better school district. We reported the sale of our second home and deferred the profit tax on our income tax returns. However, the IRS recently contacted us and said we owe tax on the $36,000 profit, plus a penalty from the sale of the second house. The auditor says we can only avoid home sale profit tax once every 24 months. But I thought you said there was no limit to the number of times this tax break can be used. Please clarify.

ANSWER: I regret to report both the IRS auditor and I are correct. The "rollover residence replacement rule" of Internal Revenue Code 1034 is one of the biggest taxpayer benefits. As you know, this rule allows home sellers to defer their profit tax when selling their principal residence if a replacement home of equal or greater cost is bought and occupied within 24 months before or after the sale.

There is no limit to the number of times this tax break can be used. But to prevent home sellers from getting greedy, it cannot be used more frequently than once every 24 months.

But there is one exception that allows more frequent use. If the principal residence sale and purchase of a replacement home involves a job location change that qualifies for the moving expense tax deduction, then IRC 1034 can be used more frequently than once every 24 months. Please consult your tax adviser for complete details.

How Realty Agents Split Commissions

Q: I am considering getting into real estate sales. Please explain how realty agents split sales commissions. When we bought our home there were two agents, one for us and one for the seller. How did they split the commission which, as I recall, was about $10,000?

A: Suppose you paid $170,000 for your home and the seller paid a typical 6% sales commission of $10,200. Usually the listing agent and the selling agent split the sales commission 50-50. That means the listing firm got $5,100 and the selling brokerage got $5,100.

However, each sales agent usually then must split his share with the real estate broker who provides the office, pays the overhead and supervises the salespeople. Although commission splits vary in each brokerage office, until an agent reaches a substantial earnings level, the split is usually 50-50. That means the listing agent in our example receives $2,550 and the selling agent receives $2,550, with the two brokers receiving $2,550 each.

As you can see, by the time the $10,200 commission in our example is split four ways, each recipient receives only about 25% of the gross commission. Of course, this is before taxes and expenses. If you want to make a handsome income, you will need to make several sales each month. Best wishes for success.

Is House Better Deal Than a Mobile Home?

Q: My son and his new bride want to buy either a mobile home or a small house. They can afford a down payment on a modest mobile home, but I am not excited about their living in a crowded mobile-home park. I am willing to help them with the down payment if they decide to buy a home. Do you think a mobile home or a house is a better investment?

A: A sound, well-located house is almost always a far better investment than a mobile home. The reason is single-family houses usually appreciate, but mobile homes either depreciate like your car or hold their value steady. However, some mobile homes appreciate in value if located in a top-quality mobile-home park.

Congratulations on being willing to help with the down payment, so your son and daughter-in-law can buy a house. I think you and they will be much happier than if they buy a mobile home.

Seller Outsmarted by a 'Nice Couple'

Q: My husband wanted to save the real estate sales commission, so I agreed to "for sale by owner." The first weekend a nice young couple made us an offer which we thought was very fair and close to our asking price. We should have known something was wrong when they offered to provide the printed sales contract forms. It turns out the man is a lawyer and his wife is a legal secretary.

But the next week I was talking with my neighbors and we learned other neighborhood homes have sold for up to $12,000 more than we got. So, my husband called the couple and told them the deal was off. They weren't very nice about it. A few days later we were served with papers for a specific performance lawsuit and the title to our house was messed up with something called a "lis pendens." We hired a lawyer and he says we signed a valid contract and the fact we sold too cheap is not a defense. What should we do?

A: Now you know why I advise against home sellers trying to sell their home without a professional real estate agent. Your situation is a classic example of a do-it-yourself home seller who sold too cheap and now is regretting it.

In the absence of fraud, duress or other grounds to rescind the sale, I suggest you go ahead and sell the house to that "nice young couple" who outsmarted you and your husband. Although you got less than you could have received, since you saved the sales commission, you probably came out about even.

Pair Want to Know Tax on Sale Profits

Q: I will be getting married next month. My new husband and I plan to sell our current homes, both one-bedroom condos, and buy a nice house. He expects to make about a $12,000 profit and my net profit should be about $20,000. How can we avoid paying tax on our profits?

A: Internal Revenue Code 75-238 says you can defer your profit tax if the purchase price of your new, jointly-owned principal residence exceeds the total of the net (adjusted) sales prices of your former principal residences.

To qualify, your replacement principal residence must be purchased within 24 months after the sale of each of your old principal residences. I suggest you sell your condos first before buying the replacement home. Then you will know how much cash you have available for the new home.

How to Buy Home If You Have Bad Credit

Q: I earn about $80,000 per year, but had some serious credit problems about a year ago. However, I want to buy a home. Several mortgage lenders have told me I can't qualify for a new mortgage. What about some other method?

A: Of course you can buy a home, even with bad credit. You can buy with an assumable VA or FHA loan, for example, which require no credit check. If necessary, the seller can carry back a second mortgage to fill any finance gap. Work with a creative realty agent who can show you how to buy a home even with your poor credit.

How to Squeeze the Equity Out of Home

Q: I was watching one of those late-night TV real estate shows where the promoter said if I buy his tapes I will learn how to use the equity in my home as the down payment on investment property and it will cost me only about $10. Please explain how this technique works.

A: All you need is a typewriter and some mortgage forms. Just type a promissory note and mortgage secured by your residence and offer it as all or part of your down payment on the investment property you want to acquire.

The nice thing about using this technique is you get to write the terms, subject to acceptance by the seller, of course. The $10 is for the recording fee.

Can't Force a Seller to Extend Mortgage

Q: After searching many months for a home we can buy for a low down payment, our realty agent found a home with an assumable VA mortgage where the seller will carry back a large second mortgage. We offered the full asking price and the seller accepted immediately. But our problem is the seller will only carry the second mortgage for five years.

In evaluating our total monthly payments we realize they will be rather steep. We asked the agent about getting a 10-year second mortgage either from the seller or from a bank. But the agent says the seller won't carry the second loan for more than five years. What should we do?

A: If the seller won't agree, you can't force him to accept a 10-year mortgage. Neither can you go to another lender, such as a bank, because the seller is counting on receiving the interest income from your second mortgage. The seller is probably also planning on delaying the tax on his profit, thanks to your installment sale.

But consider the benefits of your situation. Thousands of home buyers would love to be in your position. Buying a home with a low cash down payment by assuming an existing mortgage and getting the seller to finance the balance of the sales price is an almost perfect way to buy a home.

Give it a try. It sounds like you have a case of buyer's remorse. After you move in, if you find out you absolutely cannot afford to make the monthly mortgage payments, you can sell the house and let the buyer take over your payments. To keep this possibility open, be sure that second mortgage from the seller is assumable.

Location Important in Choosing Home

Q: My husband and I are debating whether to buy a fairly new home in a not-so-good, distant suburb or a more expensive but smaller and older one in a much better neighborhood. Our friends tell us to buy the better located home. What do you suggest?

A: Presuming you can afford both homes, listen to your smart friends and buy the smaller but better located home. Top location is very important if you want a home which is likely to appreciate in market value.

However, I am assuming both homes are in equally good school districts. If there is any significant difference, then please be aware poor-quality schools restrict home market value appreciation because good families usually don't want to move where schools are not the best.

Aunt's Unrecorded Deed May Be Valid

Q: My aunt died recently and I was named executor in her will. When I opened her safe deposit box I found the deed to her house. However, it appears to never have been recorded. I believe she and my late uncle bought the house about 1950. As I am her only heir, what should I do?

A: That unrecorded deed may be perfectly valid if it was delivered unconditionally and presuming that your aunt inherited your late uncle's interest in the house. Consult a real estate attorney or title insurance company for further details. To be sure you receive marketable title, I suggest you purchase an owner's title insurance policy.

Pay Off Credit Cards Before Trading Homes

Q: One and a half years ago we bought a new four-bedroom home in a new subdivision. We paid $96,000 with $1 down on a VA home loan. Judging by recent neighborhood home sales we could now get $120,000 for our house. But our problem is we are seriously over our heads in debt. We have two car payments and have foolishly built up a $30,000 credit card debt.

Although we earn about $70,000 per year, we are living paycheck to paycheck. More than anything, we want to eliminate that $30,000 debt. But, we also want to somehow get into a bigger home. Should we sell our home and use part of our profit to pay down our debt and then buy a larger home of equal or greater cost? Or should we get a home-equity loan?

A: Congratulations on your wise $1 investment in your home. The 34,000% return is probably the best investment you will ever make.

But I don't envy you trying to pay off $30,000 at 18% or higher interest. You are wise to concentrate on getting rid of that debt.

However, selling your present home and buying a larger one doesn't appear to be a viable option, because most of the cash received will be needed for the sales commission, down payment on the new home, and your monthly mortgage payments will increase. There won't be much cash left to pay down your $30,000 debt. Fortunately, your four-bedroom home should be plenty large enough for a few more years.

Neither is a home-equity loan a feasible solution. Most home-equity lenders will not loan more than 80% of the home's market value. Eighty percent of your home's $120,000 market value is $96,000, which is pretty close to your current mortgage balance. Forget the home-equity loan idea.

My suggestion is to pay off your credit card debt as fast as possible. With $70,000 annual income you should be able to pay $1,000 to $2,000 monthly. Since annual interest costs you at least $5,400, with annual $12,000 to $24,000 payments you will be fast paying down your debt. After paying off the credit cards, then you can think about buying a larger home.

Get Title Insurance in Buying From Friend

Q: A friend wants to sell me some rural land on which I can build a vacation home. He only needs $17,000 cash, which is far below market value. Although this friend says there is no mortgage, how can I be sure? He is not the most honest person I know.

A: Obtaining an owner's title insurance policy is especially important when buying real estate from friends and relatives. The slight cost will be worthwhile because the title company will search the title to be sure there are no mortgages, liens or encumbrances. Your friend may be truthfully telling you there is no mortgage, but perhaps he forgot to tell you about his IRS income tax lien, which has attached to the property.

How to Sell Vacation Home Without Taxes

Q: This summer I want to sell my vacation home. The profit will be about $50,000. How can I avoid paying tax on this profit?

A: Unfortunately, your vacation home cannot qualify for either the IRC 121 $125,000 "over-55 rule" home sale tax exemption or the "rollover residence replacement rule" of IRC 1034 because it is not your principal residence.

However, your vacation home can qualify for an IRC 1031 tax-deferred exchange if, before the sale, you move out and rent the vacation home to tenants. Then it becomes investment or income property, which can be exchanged for other such "like kind" property. However, it cannot be traded for a personal residence.

Don't Sell Your Home Unless You Must

Q: I am 68, a widow, and own my home worth about $150,000 free and clear. My problem is I need money to live on. I have looked into those reverse mortgage plans but don't feel comfortable with the idea. Also, I don't want to sell the house as I would miss the garden and the wonderful neighbors. Any ideas?

A: Don't sell your home until you are ready. One solution is to take in a renter to increase your monthly income. The companionship would probably be good for you, too.

Recourses in Case of Racial Discrimination

Q: My wife is Chinese and I am black. We want to buy a home. Last weekend we went to a new subdivision, which just opened. The saleswoman was very courteous but also very tough. When we said we wanted to buy she made us fill out a long complicated mortgage application form. On the purchase contract she wrote: "Contingent on mortgage lender's approval within five days."

The mortgage company phoned to say we didn't qualify because I have only been on my job about six months. However, this is a much better job than I had before and it is in the same field. Also, my wife had some credit problems five years ago, before we got married. Since then our credit has been excellent. We have plenty of income. Do you think we are victims of illegal discrimination?

A: Yes. The builder's lender is raising issues that normally would not cause loan rejection. Lenders can and should discriminate against prospective borrowers who have inadequate income or bad credit.

But it appears that builder doesn't want you living in that new subdivision. Job changes, especially involving improvement in income in the same field, are not valid grounds for rejection of a mortgage application. Your wife's credit problem five years ago, before marriage, also is not a valid reason for loan rejection.

If you want the loan arranged by the builder, I suggest you talk to a vice president representing the lender. Make it clear that you know your legal rights and won't hesitate to pursue the matter unless your loan is approved. Should your loan still not be approved, contact the nearest office of HUD (U.S. Department of Housing and Urban Development). You also may want to notify the newspaper that carried ads about the new subdivision because responsible newspapers will not carry ads from home builders who illegally discriminate.

How Long Should It Take to Close Sale?

Q: We are novice home buyers trying to buy our first home. Several months ago we made an offer to buy a home, but it fell through when the seller wouldn't accept our bid and refused to make a counteroffer. When the realty agent wrote the offer she said it would take 90 days to close the sale. Do all home sales take this long?

A: No. Typical home sales close within 30 to 60 days after the seller accepts the buyer's purchase offer. Of course, the buyer and seller can agree on a longer time for closing the sale if mutually desired.

Copyright © 2019, Los Angeles Times
EDITION: California | U.S. & World
61°