Purchase Contract Must Be Worded Exactly to Be Enforceable in Court
QUESTION: Some time ago, your column had a question from a home buyer whose seller changed her mind about selling. You suggested contacting a real estate lawyer about a specific performance lawsuit to force the seller to deliver the deed.
We had a similar situation. But when we talked to a real estate lawyer, she said our purchase contract was so indefinite there is no way a judge would order the seller to deliver the deed. I thought you said a specific performance lawsuit could force the seller to honor the sales contract. Please explain.
ANSWER: Your situation shows why the person preparing a real estate purchase contract should pretend a judge is looking over his shoulder. The purchase agreement you have apparently was poorly prepared and is too vague for a court to order specifically performed.
For example, if the finance contingency clause says, “This offer is contingent upon buyer finding a satisfactory mortgage at the current interest rate and loan terms,” the contract is probably too vague to specifically enforce. In fact, perhaps no contract was formed because there was no meeting of the minds.
But a finance clause such as, “This offer contingent upon property and buyer qualifying for a new 30-year $100,000 first mortgage with interest not exceeding 10%, a monthly payment not over $877.57, and a loan fee not more than 2 points,” is exact, so a contract can be formed.
I’m sorry you lost that house because the seller backed out. But you could have enforced the purchase contract if it had been prepared more carefully. In the future, be more exact.
Don’t Let Borrower Fall Behind on Loan
Q: About three years ago, we sold our home and carried back a $24,000 second mortgage. The borrowers made their payments on time every month for the first year. Then the payments came in later and later each month.
When I complained, the wife was real nasty to me. For the last four months we have not received any payments.
I called the borrowers and learned that the couple have separated, the husband is unemployed, and they may be getting a divorce. Since foreclosure will cost us several hundred dollars, do you think we should wait another month or two to begin foreclosure?
A: No. Don’t let your borrowers get further behind on your mortgage payments. Have you checked with the first mortgage lender? I’ll bet payments aren’t being made on the first loan, either.
Since you have already warned the borrowers, get busy and begin foreclosure. Filing the papers will either have the effect of getting the borrowers to shape up by making the payments, they will try to salvage their equity by selling the house or they will bury their heads in the sand and do nothing.
If the home goes to foreclosure sale, you will either get paid off from the successful bid or, if no bidders show up, you will get the house back to sell again for another profit. Please consult your attorney for further details.
Sale of Inherited Property Tax Bonanza
Q: My wife recently inherited her father’s house. I estimate it is worth around $225,000. As he bought it many years ago when it was brand new, we think his cost was around $10,000 but we aren’t sure. If my wife sells the house how will she figure the profit tax?
A: I have good news. Your wife’s basis in the inherited house is its market value on the day her father died. Presuming that is $225,000, she would only owe tax on any net amount she receives over $225,000. For example, if she sells it for a $230,000 net sales price, she would only owe tax on her $5,000 profit.
How Home Seller Can Figure Tax Benefit
Q: I am eligible for that “over 55 rule” $125,000 home sale tax break you often discuss. But my problem is my profit will be about $200,000. I want to buy a smaller house but hate to pay the IRS tax. Is there any way I can avoid tax in my situation?
A: Of course. Although you didn’t give the details on your home, let me illustrate.
Suppose your home is worth $300,000 and its adjusted-cost basis is $100,000. If you sell, you will have a $200,000 profit. However, since you are eligible for the $125,000 once-per-lifetime over 55 home sale tax exemption, you can combine this rule of IRC 121 with the “roll-over residence replacement rule” of IRC 1034, which is available to all home sellers.
Subtracting your $125,000 exemption from the $300,000 net sales price in this example leaves a $175,000 “revised adjusted sales price.” Since you had a $200,000 profit in this hypothetical example, to defer tax on the remaining $75,000 profit all you need to do is buy a replacement principal residence costing at least $175,000 within 24 months before or after the sale. Please consult your tax adviser for further details.
He Says Renting Home Better Than Owning
Q: I think you’re misleading your readers by encouraging them to buy homes. The tax deductions for mortgage interest and property taxes aren’t worthwhile because they require paying $1 to get 28 cents of tax deductions. I realize the mortgage is paying down gradually every month, but that is not spendable money. In most towns, renting a house is far smarter than buying.
A: What you say is absolutely correct. However, you overlooked the second source of home-equity buildup. In addition to gradually paying down the mortgage balance, homeowners also benefit as their homes rise in market value.
I realize there are a few towns where homes are not appreciating in market value, but in most areas homes are increasing at least 5% per year, according to the National Assn. of Realtors. Ask most homeowners what their best investment is, and they will tell you it is their home.
Will Big-Time Firms Help Time-Shares?
Q: I know you don’t recommend time-shares, and I agree they are not good real estate investments. However, since Marriott entered the time-share business and I hear Disney may become involved, do you think these reputable big-time promoters will add respectability to time-shares?
A: No. But I understand Marriott’s time-shares are the Cadillac of the industry. Disney would probably do a first-class job also.
Several months ago, I sat next to a gentleman on an airplane who told me he and his wife own 21 vacation time-shares around the world. They travel from time-share to time-share and were on their way to Orlando where they own four time-shares from Marriott, who they recommend very highly. I presume this man knows much more than I do about time-shares.
He confirmed the big time-share drawback is there is virtually no resale market. Unless the resale problem is solved, time-shares will continue to be illiquid investments. Invest only money you can afford to lose.
Don’t Sell Home If Near Exemption Age
Q: In February 1990, I will become 55 and eligible for the $125,000 home sale tax exemption you often discuss. However, my wife (age 53) and I want to sell our home now as I recently took early retirement and we plan to travel extensively. A nephew and his wife want to buy our home. What is the best way to delay our home sale but still make sure the buyers don’t change their minds?
A: Congratulations on delaying your home sale until after you become 55 so you can claim your $125,000 “over 55 rule” home sale tax exemption. But waiting until your wife becomes 55 is unnecessary because only one $125,000 tax exemption is allowed per marriage.
My suggestion is to lease your home to the prospective buyers. Give them a lease-option that provides the purchase option cannot be exercised until after your 1990 birthday.
However, although the buyers are trusted and reliable relatives, just in case they have any thoughts of changing their minds, I suggest you get them to put up a substantial non-refundable consideration for the purchase option.
No Need to Invest All Proceeds From Sale
Q: If we sell our home for all cash, I know we must buy a replacement home of equal or greater cost within 24 months to defer our profit tax. But I have been unable to find out if all the cash from our sale must be reinvested. I ask because we will net about $95,000 from which we would like to pay off debts before buying another house. Or do we have to reinvest all the cash from the sale into our replacement home?
A: The “roll-over residence replacement rule” of IRC 1034 does not require full reinvestment of all your home sale cash into the replacement residence. All that matters for tax deferral is your new home purchase price must equal or exceed the old home’s adjusted “net” sales price.
Two Homes Replaced Without Paying Taxes
Q: I recently married. My husband owns a small house and I own a condo where we are living temporarily. He hates my condo. But his mother wanted to move into his house. I think you get the picture.
We have decided to sell both the condo and the house so we can buy a three- or four-bedroom home. My husband’s mom wants to buy his old house. As we have nice profits in both the condo and the house, is there any way we can sell both and avoid paying any profit tax?
A: Yes. IRS Revenue Ruling 75-238 says two taxpayers who own their principal residences can defer their profit taxes by selling their old homes and buying a principal residence where they both reside.
However, the cost of the replacement principal residence must equal or exceed the total sales prices of the two former principal residences. You have up to 24 months from the sales date of the old principal residences to acquire your replacement home.
Don’t Let Buyer Move Before Loan Approved
Q: We are selling our home to a nice young couple. They are getting a VA mortgage. The mortgage company assures us that the buyers qualify, but it will take at least four more weeks for final approval. Since we have already moved out of our home and the buyers are staying in a motel, do you think it would be all right to let them move into our home? Our lawyer advises against it, but the buyers would pay us rent until the deed is recorded.
A: No, no, no. Please don’t let your buyer move in before the deed is recorded. That could be a major mistake if for some unexpected reason the buyers don’t get the VA mortgage they need.
Most VA mortgage lenders have automatic loan approval authority, so I am suspicious as to why the lender says it looks like the borrowers are qualified but will take at least four more weeks for final approval. In recent years, the VA has significantly cut the red tape for VA mortgages, so I question why the buyers are doing business with a lender who takes so long to approve their loan.
But a bigger problem of letting your buyers move in before the deed is recorded is that they may find a real or imagined defect in your home and refuse to close the sale unless you reduce the price. Still another difficulty can arise if something happens and the buyers don’t get the VA mortgage. Since they are paying virtually nothing down, you could be in a bad spot of having to evict them. Keep your house vacant a few more weeks could avoid endless potential problems.
If Mortgage Pledged, Plan to Pay Taxes
Q: We own a second mortgage with a balance of about $21,500. The borrowers, who bought our home several years ago, pay like clockwork every month. I talked to my banker about borrowing against this mortgage and he will loan me $20,000. But he said if I pledge the mortgage I will become subject to tax. Is that true?
A: Yes. Pledging or hypothecating your mortgage is much like selling it, thereby creating a taxable situation for you. Perhaps you can get your banker to loan you the $20,000 unsecured so you won’t have to pay tax on your installment sale profit. Please consult your tax adviser for details.
