How to Avoid Tax When Moving to a Less Expensive Community
QUESTION: My problem is just the opposite of most home sellers you write about. Instead of buying a more expensive home, I will be selling my home near Los Angeles for about $375,000 and moving to a small town where I can buy a luxury home for around $150,000. The company that is relocating me to a better job says I should be prepared to pay tax on most of my sale profit. Is there any way I can avoid tax?
ANSWER: Yes. But you must be flexible, comply with the tax law and realize the slight inconvenience is worth the tax savings. I’ll presume you are not 55 or older and do not qualify for the $125,000 “over 55 rule” home sale tax exemption, which would help if you are eligible.
Your first tax avoidance step is to move out of your home and rent it to tenants. The law does not require a minimum rental period but most CPAs suggest at least six to 12 months before selling the home. A lease-option would be ideal since your tenant would probably then be an eager buyer.
By renting your old home, you thereby convert it to rental property. Then it becomes eligible for an IRC 1031 tax-deferred exchange of investment or business property.
Your second step for tax avoidance is to acquire one or more rental properties, preferably houses, in your new city. The total acquisition price must equal or exceed your old home’s sale price but you will be taxed on any personal property “boot,” such as cash or net mortgage relief, that you receive in the exchange. Work with a knowledgeable tax adviser, especially since you may need to use a Starker delayed exchange, which would be appropriate for your cross-country trade situation.
Proving Seller Knew of Defects Is Difficult
Q: My wife and I recently bought our first home. After the seller’s furniture was moved out, we found holes in several walls, rotted flooring in the bathroom, every room needs paint, two of the gas stove burners don’t work, the sewer drains very slowly and the electrical system seems dangerous.
When I called the realty agent she said, “Well, these things will happen.” How can we get the seller to pay for the necessary repairs?
A: Your situation shows why it is so important to reinspect the home the day before the sale is scheduled to close. Before the closing you have maximum leverage over the seller. But after the seller receives your money, you have zero leverage to get problems corrected.
Another protection is to obtain a one-year home warranty from the seller. These warranty policies, which cost the seller or realty agent about $350, pay for repairs to plumbing, wiring, built-in appliances and furnace within one year after the sale. For an additional premium, air conditioning, swimming pool and outside plumbing can be included.
If the seller or realty agent are to pay for correcting the defects, your problems are to prove the defect was known and to collect on any judgment you obtain. When a seller has left town, your chances of collecting are minimal. Please consult your attorney for more details.
When Moving to New City, Lease With Option
Q: In a few months my wife’s job will be transferred, and we have decided to accept the move because I am a truck driver and can get a job just about anywhere. As we have never moved before in our 18 years of marriage, we are unsure how to go about picking a new home and neighborhood. Any suggestions?
A: Don’t be in a hurry to buy a new home. Realty agents hate me for saying this, but your best bet is to lease a home with an option to buy. Then you can try out the new home and its neighborhood before you buy. If all is well, exercise your purchase option. But if you don’t like the home or its location, when the lease expires you are free to move elsewhere.
IRS Seems Correct on Imposing Tax
Q: Two years ago I sold my duplex and about eight months later I bought a larger and more expensive duplex. I reported the transaction on IRS form 2119, sale of a residence, with my income tax returns. Last week, I received a notice from the IRS to contact them because my transaction is taxable. How can this be? Do you think the IRS made a mistake?
A: No. I think you are the one who made a taxable mistake. Your profit from the sale and replacement of your personal residence unit in the duplex can be deferred using Internal Revenue Code 1034 because you bought a replacement principal residence of equal or greater cost within 24 months before or after the sale.
This tax break is available to all home sellers. But it does not apply to the profit from your sale and replacement of the rental unit in your duplex. Your sale profit from that portion of the duplex is taxable. However, you could have deferred tax on that part of the profit also if you had made a tax-deferred exchange using Internal Revenue Code 1031. It appears the IRS is right and you were wrong.
Forfeited Deposit Not Tax-Deductible
Q: We made a $1,000 earnest money deposit on a home purchase. Then my wife and I decided the home was located in a neighborhood where we didn’t want to live. The seller and the realtor agreed to cancel the purchase if we forfeited our $1,000 deposit.
Our lawyer advised us to do so rather than risk being sued for breach of contract. We made a wise decision because the house was sold five months later for about $7,000 less than we offered, so we could have been sued for damages. My question is, can we deduct our $1,000 lost deposit on our tax returns?
A: No. The forfeited deposit is not tax-deductible because the property being purchased was your personal residence. Losses on personal residences are not tax-deductible. However, if the deposit had been lost on the purchase of investment property, then it would be tax-deductible as a business expense. Please consult your CPA for more information.
Don’t Be Shy About Making Purchase Offer
Q: Since last April, my wife and I have been seriously looking at homes for sale. Although we haven’t kept records, I estimate we have inspected at least 75 houses. We only made one purchase offer, which was rejected by the seller. These homes are so badly overpriced. How can we buy one at a fair price?
A: Don’t be afraid to make a purchase offer at a price you think is fair for the home. The best that can happen is a motivated seller will accept your offer. The worst that can happen is the seller might reject your offer and make a counteroffer.
Are There Advantages to Buying Corner Lot?
Q: We contracted to buy a house in the first phase of a new subdivision that will be finished in about three months. The development was sold out except for the house we bought, which is located on a corner lot.
The developer charged a $7,500-premium for the corner lot. However, now we are having second thoughts. Although the lot is 5 feet wider than the other lots, I don’t think that justifies the extra price. Also, we are wondering why this lot was the last one to be sold.
The developer has offered to let us buy another lot whose buyer was unable to qualify for a mortgage. Do you think we should give up our corner lot?
A: Corner lots used to be considered more valuable than interior lots. The advantages include neighbors on only two sides instead of three, more light and air, and the garage driveway takes less space because it enters from the side street.
But there are disadvantages, such as traffic noise from two streets, lack of privacy on the side of the home and safety problems if you have small children.
Only you, not I, can decide if the drawbacks of a corner lot outweigh the advantages. In established neighborhoods, homes on corner lots rarely command any premium in price over similar homes located on interior lots. I don’t especially like houses on corner lots because of the traffic on two sides and lack of privacy.
How to Avoid Tax Buying Low-Cost Home
Q: Due to a job transfer, we will soon be selling our home and moving to a much lower-cost town in Oklahoma. We are not yet eligible for that “over 55 rule” $125,000 tax exemption you often discuss. As we can buy a much nicer home in Oklahoma for about 50% of our old home’s sale price, how can we avoid tax on our profit?
A: As you probably know, the “rollover residence replacement rule” of IRC 1034 requires you to defer profit tax when selling your principal residence and buying a replacement home of equal or greater cost within 24 months before or after the sale.
However, when a less expensive replacement residence is purchased, your profit is taxed up to the difference in the two prices. To illustrate, if your sale profit is $100,000 and you buy a home which is $55,000 less expensive, $55,000 of your profit is taxable and $45,000 is tax-deferred.
But there is one way you can avoid tax. Before selling your old home, rent it to tenants to convert it to investment or business property, which is eligible for an IRC 1034 tax-deferred exchange. Then you can trade for other investment or business property, perhaps two or three rental houses in Oklahoma.
After renting those homes for a respectable time, at least six to 12 months in my opinion, then you might wish to convert one into your personal residence. Please consult your tax adviser for further details.
Home Seller Praises Short Listing Advice
Q: Thank you for mentioning a few months ago that you only list your properties for 30 days with a realty agent but with the understanding you will renew if the listing expires but the agent is doing a good job. So many of our friends had bad experiences with realty agents selling their homes, we decided to try your technique.
After interviewing four agents, my wife and I agreed one young man was by far the best. He has only had his sales license since January but has compiled an impressive sales record and is very sharp. All the other agents wanted 90-day listings but this fellow was thrilled with our 30-day listing. He ran nice newspaper ads every day at his personal expense.
As a result he showed our home to prospects almost every day for about two weeks. Finally he got a purchase offer which was so close to our asking price we accepted it. We want to thank you and agree that short listings make realty agents work, as you say, hardest, smartest and fastest.
A: Thank you for that valuable feedback. When a home seller gives a realty agent a listing, that is cost-free inventory for the agent. Although a realty salesperson’s broker can’t afford to advertise a listed home every day, when a salesperson believes in a listing there is no reason the agent can’t spend his own money to get that listing sold. I’m glad everything worked out well. Your situation is an excellent example for other home sellers and their realty agents.
Agent Dislikes Advice to Interview Several
Q: I hate you. As a real estate agent you make my life miserable. Please stop telling home sellers to consult at least three realty agents before listing their home for sale. I have been selling homes for 14 years in my community and am the top agent in sales volume.
As my husband and I have been very active in community affairs for many years, we know almost everyone in town. When people are ready to sell their home they usually call me first.
However, thanks to your articles about consulting three realty agents, I often lose my potential listing to a novice agent who will either cut their sales commission or who estimates a higher sales price. Why don’t you just tell home seller to list their homes with the most experienced agent in their area?
A: As the best agent in your town, you should welcome competition. The reason I suggest consulting at least three local realty agents before listing a home for sale is that the seller will thereby obtain a quick and free education about selling the home.
If a seller relies on just one agent, there is too much opportunity for that agent to mislead the seller into listing at too high or low a price, signing too long a listing or hiring a lazy agent.
As you know, another criterion I recommend is checking each agent’s references of previous home sellers. You would be shocked to learn that many agents can’t come up with the names of at least three previous sellers. By asking “Were you satisfied with this agent and would you list your home again with the same agent?” sellers quickly know which agent should receive their listing.
