Owner of Quake-Damaged Home Has to Figure Tax Angles of Loss
QUESTION: My daughter lives in San Francisco and her cute little two-bedroom house (I call it a cottage) twisted and jumped off its foundation in the recent earthquake. The house can be jacked up, a new foundation constructed and the house lowered back and bolted for about $30,000.
As you know, this is far cheaper than building a new house. Her mortgage company will finance the work without increasing her 9.5% fixed-interest rate. I thought that was nice of the S&L.; However, she earns about $75,000 net per year as a San Francisco lawyer and could only deduct about $22,500 of her loss on her income tax returns. That will save her only about $7,500 in taxes. Should she make the repairs or sell the property to a developer who wants to build apartments on her lot?
ANSWER: Let your daughter decide. You and she have correctly calculated that a casualty loss is deductible only to the extent that it exceeds 10% of adjusted gross income. Estimating that she is in about a 33% combined state and federal tax bracket, she would save in taxes only about a third of her $30,000 repair cost, which is $7,500.
If your daughter likes her small house, with a new, properly constructed foundation, the house should withstand severe earthquakes. The houses and apartment buildings that were badly damaged in the recent earthquake were older buildings with inadequate foundations. The newer, properly engineered buildings came through just fine.
Sales Contract Usually Can Be Reassigned
Q: I contracted to buy a new house but find I am not qualified for a new mortgage. But I got a really good price on the house and a friend wants to take over my purchase contract. She will pay me $1,000 to assign the contract to her. Is this legal?
A: Contracts are generally assignable. If yours was an all-cash sale and the seller was not carrying back financing for you, unless the contract bars assignment, it can be transferred to your friend. For further details, please consult a real estate attorney.
Get Home in Top Shape to Get Top Dollar
Q: We plan to sell our home next March. But we’re debating whether we should do some repair work. The house needs a complete painting and the kitchen and bathrooms need renovation. The cost of this work would be about $10,000. We talked to a realty agent and she says we will have no trouble getting back our additional investment, and she feels the house will sell quicker if we do the work. What do you advise?
A: Listen to your smart real estate agent. If you want to get top dollar for your home, get it into tip-top condition before putting it on the market for sale.
Your realty agent correctly advised you that money spent renovating the kitchen and bathroom should not only produce a profit but it will make your home sell faster than it would without the remodeling.
Now is a good time to do the indoor work. When the weather turns warm next March, before listing the home for sale, perhaps you should also give the exterior of the home a coat of paint because paint is the cheapest and most profitable improvement you can make.
Be Cautious of Home Equity Sharing Deals
Q: I recently saw a newspaper ad of a realtor who is advertising for home buyers who don’t have a down payment but who can afford to make monthly payments. It seems the realtor puts together investors who will make the down payment with residents who will pay the mortgage payments, property taxes, insurance and maintenance.
While I realize my husband and I can’t be too fussy since we only have a few thousand dollars in savings, it seems to us this plan puts all the burdens on the resident and gives all the benefits to the investor. I don’t like the idea of getting only 50% ownership in return for making all the payments. What do you think?
A: You discovered a major reason why equity-sharing residents often default. Of course, don’t forget the non-resident investor is putting up the down payment of perhaps 20% of the home’s purchase price in return for 50% of ownership. Without the investor’s down payment you wouldn’t be able to buy half of the home.
Frankly, I think equity sharing is riskier for the investor than for the resident. The reason is, if the resident stops making payments, the investor must get the resident out of the house and off the title. If the resident resists, costly litigation can develop. Further details are in my special report, “How Equity Sharing Works, Especially Between Parents and Their Adult Children,” available for $3.50 from Newspaperbooks, 64 E. Concord St., Orlando, Fla. 32801.
Select Individual Agent, Not the Firm
Q: My husband and I are getting our home ready to sell. We are following your advice to get it into top condition. Although we have decided not to try selling our home alone, we’re unsure which realty agent should get our listing.
Several agents “farm” our neighborhood for listings and they are constantly giving us note pads, pens, potholders and other gimmicks, but we’re not impressed with any of them.
One agent, who works for a big Century 21 office, emphasizes her company’s success but she has only been selling real estate about six months.
Another agent works for a local company and has been successfully selling homes in our area for about 10 years but his company has no relocation affiliation. There are also agents from RE/MAX, Red Carpet and Merrill Lynch who contact us occasionally. Which of these companies do you think is best?
A: When deciding which agent should get the listing, it is best to make your selection on the success of the individual agent rather than the famous name on the door.
When you are ready to sell your home, interview at least three active local realty agents who sell homes in your neighborhood. Each agent should prepare a written “comparative market analysis” form showing you recent sales prices of similar neighborhood homes, asking prices of nearby homes currently for sale (your competition), and information about recently expired listings that didn’t sell.
You’ll find each agent will give you his or her opinion of your home’s probable sales price. But watch out for an agent who may estimate a high sales price without justification. This is called “high-balling.” It is sometimes used by an agent to obtain an overpriced listing that later must be reduced in asking price if a sale is to take place.
Ask each agent lots of questions about their services, fees, success record, and anything else you want to know. Also, be sure to obtain the names and phone numbers of each agent’s recent home sellers. Phone those people to ask, “Were you in any way unhappy and would you list your home for sale with the same agent again?” You will soon know which agent should get your listing.
Second Mortgage Can Be Good Investment
Q: Our home has been for sale about three months. No offers so far. The realty agent says our insistence on an all-cash sale and our unwillingness to carry back a second mortgage hurts our chances of a sale. But we will be moving out of state. Don’t you think carrying back a second mortgage would be risky in such circumstances?
A: No. If the buyer doesn’t make his payments to you, all you need do is hire a local real estate attorney to foreclose. You will probably get paid off at the foreclosure sale, but if there are no bidders you get the house back to sell for a second profit. Either way you are protected. Ask a real estate attorney to explain further.
Title Insurance Proved Worthwhile
Q: Thank you for writing, about six months ago, to always get an owner’s title insurance policy when buying real estate. We bought a small lot from an ex-neighbor for just $15,000. The title insurance policy cost just a few hundred dollars.
But last month we learned the man who sold us this parcel had forged the signature of his ex-wife, and his secretary, who is a notary public, fraudulently acknowledged the forgery. Our title insurer has paid the ex-wife $7,500. I presume they will go after the ex-neighbor if they can find him. Many thanks for saving us $7,500 so we can keep the lot.
A: Thank you for sharing your title insurance experience. Forged signatures are the prime cause of title insurance company losses. As you discovered, title insurance can be very important when acquiring real estate from neighbors, friends and especially relatives.
Counteroffer Cancels the Original Offer
Q: We made an offer to buy a house. The seller liked the price but didn’t like the 90-day closing time or the 8% interest rate offered on the second mortgage we wanted her to carry back. She counteroffered for a 30-day closing settlement and a 10% interest rate. We decided not to accept the counteroffer.
The next day, the realty agent phoned to say the seller had decided to accept our original offer. But by then we has changed our minds about buying that house. Can the seller make a counteroffer and then later accept our original offer?
A: No. Your situation is a classic textbook example of how a counteroffer to an offer rejects the original offer. As a result, the home seller cannot later accept your original offer because her counteroffer rejected it. Please consult a real estate attorney for further details.
How to Avoid Tax on Profitable Sale
Q: Why don’t you tackle tough real estate problems like mine? You often write about that simple “over 55 rule” $125,000 home sale tax break. Everyone knows how that tax rule works. But I’ve never seen you explain if it is possible to avoid paying tax on a home sale profit greater than $125,000.
My son is a real estate agent. He evaluated my house and we figured out if I sell I will have about a $160,000 profit.
We understand $125,000 of it will be tax-free, since I am well over 55 and have lived here about 22 years. The only thing that is stopping me from selling is the tax I would owe on the remaining $35,000 profit. How can I avoid tax on the $35,000?
A: That’s easy. I thought you were going to ask a difficult question. To avoid tax on the remaining $35,000, profit all you need to do is combine the “over 55 rule” with the “roll-over residence replacement rule.”
Since you didn’t include your home’s probable sales price, let me pick a price to illustrate how this works. Suppose your home sells for $220,000 and you have about $20,000 of sales costs, thus bringing the adjusted net sales price to $200,000. From $200,000 you would subtract your $125,000 “over 55 rule” tax exemption to arrive at a “revised adjusted sales price” of $75,000.
But you will still have the $35,000 of remaining profit. To avoid paying tax on the $35,000, just use the “roll-over residence replacement rule” of Internal Revenue Code 1034, which is available to taxpayers of any age. All you need to do is buy a replacement principal residence costing at least as much as your revised adjusted sales price of $75,000 in this example within 24 months before or after the sale. By combining these two tax rules you can completely avoid tax on your sale profit.
Divorced Spouse Wants Home Sale Benefits
Q: I just went through a nine-month divorce proceeding with my now ex-wife. When she filed, she obtained a court order giving her use and possession of our home until it is sold. Local realtors say this will take three to six months. If our residence is sold within two years of my moving out, can I qualify under IRC 1034 and do I only have to buy a house at half the sales price to avoid tax on my profit share?
A: If I read your letter correctly, you will not have not been living in the house for 12 to 18 months before its sale. That will make it difficult for you to defer your tax on half the profit by using the IRC 1034 roll-over residence replacement rule since the home was not your principal residence for over a year before the sale.
IRC 1034 says you must defer the profit tax on the sale of your principal residence when you buy a replacement home of equal or greater cost within 24 months before or after the sale. In divorce situations where the sale price and profit are equally divided, then you would only need to buy a replacement home costing one-half of the old home’s net sales price. Perhaps your tax adviser can figure some way to get you over the hurdle of proving it was your principal residence at the time of sale.
