How You Can Use a House as Both Residence and Handy Tax Shelter
QUESTION: We recently purchased our first home. It is a fixer-upper that we plan to gradually upgrade as we have the funds available. Can we deduct our repair and fix-up costs?
Please clarify deductions for insurance, depreciation, property taxes and mortgage interest. We already know we made a profit, as we bought the house at least 25% below what comparable nearby homes were selling for.
It took us over three months to wear the seller down and get him to sell to us for just 10% down. He agreed to carry the first mortgage at 10% interest for 30 years. At age 74, he knows he won’t live 30 more years, but he told us his kids now won’t be able to waste their inheritance. What are the tax advantages of fixing up our new home?
ANSWER: Your careful and patient negotiation paid off in many ways. Not only did you obtain excellent terms at minimal cost, but you maximized your “acquisition mortgage” so all the interest will be tax-deductible. In addition, you can deduct interest on a home-equity loan up to $100,000, or on a home-improvement loan.
However, your costs of repair and capital improvements are not tax-deductible.
But you can add these expenses to your home’s cost basis, thus reducing your profit when you eventually sell the house. Of course, your property taxes qualify as itemized deductions on your income tax returns, but the insurance premium is not deductible because it is a personal expense. Sorry, but you can’t depreciate your personal residence, either.
30-Day Listing Helped Seller Find Good Agent
Q: Thank you for explaining why you list your properties for 30 days with a realtor who knows you will renew the listing if it expires with the home unsold and the agent is doing a good job. We listed our home for sale on a 30-day listing with an agent who is a good friend’s daughter. She turned out to be a real dunce who failed to disclose to us she is a part-time agent and a full-time schoolteacher.
Although this agent held one weekend open house, not one other local realty agent showed our home to prospective buyers. We were very unhappy. When the listing expired, we switched to a much better agent who found us a buyer within about three weeks. Many thanks for keeping us from signing a long listing.
A: I greatly appreciate your letter. Many realtors criticize me for recommending 30-day listings because they want to tie up listings for 90 to 180 days. Some even hate me for saying agents work harder, smarter and faster just before a listing expires. But that is the truth.
When I was selling properties as a broker, I always told my sellers they could cancel their listings at any time. Fortunately, that never happened. As an alternative to the 30-day listing, be sure the listing agent agrees in writing to allow the seller to cancel the listing at any time without cause and without cost. If an agent refuses to agree to such a condition, the agent doesn’t have confidence in himself/herself.
Termites Work Too Slowly for Tax Loss
Q: We recently sold our home, and to our surprise, the buyer’s termite inspector found almost $16,000 of damage, which we had to pay to have repaired. Fortunately, we made a large profit but this took a big chunk of it. We talked with our tax adviser about how to get the greatest tax benefit from this expense. But she wasn’t very helpful. Since we bought a larger home, all the tax on our sale profit is deferred, so we don’t have anything from which to deduct this large expense. Any ideas?
A: Termite damage usually does not qualify as a casualty loss income tax deduction. The reason is, casualty losses must be sudden, unusual or unexpected. Unfortunately, termites work very slowly and take many years to do their damage.
Examples of deductible casualty losses include fires, floods, thefts, accidents, tornadoes and earthquakes. There are a few Tax Court decisions allowing casualty loss deductions for termite damage, but in those cases the owners proved their termites worked very, very fast, causing damage in just a few months.
However, you can add the cost of the termite damage repairs as a capital improvement to your home’s adjusted cost basis, thus reducing your profit on which tax is deferred. I realize this will not immediately help since you are deferring tax by purchasing a replacement home, but this is the best I can recommend.
Consider Appreciation to Home a Bonus
Q: We are looking for a home to purchase. Last weekend, a realty agent showed us a very expensive home that is way over our budget. But we enjoyed inspecting it. When we got to the kitchen, the agent sat us down and took out of her briefcase a form called “Benefits of Home Ownership.” She worked out the benefits of buying that expensive house. The income tax savings for the mortgage interest and property taxes were obvious.
But the agent also included “projected increase in market value” at a 5% annual rate, compounded for 10 years. We felt this was unrealistic because there have been some years in our area where homes did not appreciate at all. What do you think of projecting appreciated market value?
A: Not much. I consider appreciation in market value just a bonus. As you may know, I recommend buying run-down, fixer-upper properties and then upgrading them to raise the market value. I think Mark Haroldsen was the first person to call this idea “forced inflation” and I like that term. But to project appreciation as an incentive for buying a home, in my opinion, is not a good idea because appreciation is totally unpredictable.
Only One Replacement Home Is Allowed
Q: We plan to sell our large old home for around $350,000. Then we would like to buy a Florida condo for around $200,000 where we will spend our winters and also buy a northern home for the summers, which will cost at least $150,000. As we are not yet 55, will this plan work to avoid tax on our large sale profit?
A: No. Nice try, but I’m sorry to report only one replacement principal residence is allowed when using the roll-over residence replacement rule of Internal Revenue Code 1034. The reason is that you can have just one principal residence.
If you will spend most of your time at the Florida home, it will become your principal residence. Should its cost not equal or exceed the net (adjusted) sales price of your old home, then you will owe tax on your profit up to the difference in the two prices. Please consult your tax adviser for further details.
If You Have Bargain Rental, Stay but Buy
Q: Our situation is unique, and I want to know if you would still recommend we buy a house anyway. My husband and I have a bargain rental in a very nice, three-bedroom apartment in a luxury complex owned by his mother. We help manage the 26 apartments, so that is one of the reasons our rent is so cheap.
However, my mother-in-law is 82 and we realize she won’t be around forever. When she dies, all her property will be divided equally among her five children. We presume the apartments will then be sold. But she is in excellent health, so we don’t anticipate that happening very soon. Would you still recommend we buy a house?
A: Yes. Of course, I highly recommend that you keep your bargain rental as long as you can. But today is a good time to buy a house where you might like to live someday when you eventually move out of the apartment.
By purchasing a house now you will be able to get some benefits from the house while it is rented to tenants, such as tax loss benefits and probable long-term appreciation in market value. Even if you never move into that rental house, you will have it available in case of need, and in the meantime you will receive benefits from it.
7-Day Limit Is Best for Home Inspection
Q: I look forward to your sound advice. However, as a professional inspector I beg to differ with you about the five-day time limit you suggest for having a professional inspection. My firm prides itself on prompt inspections, but we find it very difficult to arrange for an inspection, check the necessary information, such as building permits and prepare a written report within less than a week. I think you should reconsider and recommend at least seven to 10 days for the inspection time in a home purchase offer.
A: Thank you for the suggestion. Perhaps I have been spoiled by outstanding service from professional inspectors. But I am also thinking of the home seller who does not want to tie up a home while the buyer hires a professional inspector.
If property appraisers can complete their appraisals in a week or less I don’t see why professional inspectors can’t also hustle to give top-quality service. However, I will amend my suggestion to set a seven-day time limit for a professional property inspection contingency in a home purchase offer.
