Living Trust Can Help Family Avoid Probate and Keep You in Control

QUESTION: Some time ago you mentioned a living trust is a good way to avoid probate. I talked to our family lawyer about it and he said a living trust really doesn’t serve any purpose and is a waste of time.

He said he would draw one up for my wife and me but it would cost $1,500. Why were you so positive about living trusts but my lawyer is so negative?

ANSWER: Unfortunately, many of my fellow lawyers do not recommend revocable inter vivos living trusts. Living trusts avoid probate, and lawyers then don’t receive their statutory fees for probating an estate.

To create a living trust, you deed your house, other real estate and major assets such as your automobile from yourself to yourself as trustee.

You are the initial trustee and the initial beneficiary of the living trust. As long as you are alive, you continue to manage these assets just as before. When you die, the alternate trustee takes over and distributes your property as you specified in the trust. Incidentally, deeding them into your living trust will not cause a property tax reassessment.

But a living trust has another very important feature. If you should become unable to make financial decisions, your alternate trustee, such as your adult offspring, takes over management of your assets in the living trust. This avoids having a conservator appointed.

To summarize, the major benefits of living trust are avoidance of probate costs and delays, as well as management of your assets, if you should become unable to do so. There are no disadvantages--except the little bit of paper work to create the living trust.

Incidentally, the $1,500 fee your lawyer quoted sounds rather high. I know many excellent attorneys who charge about $750 for doing the simple living trust paper work. An excellent book to read is “Plan Your Estate” by attorney Denis Clifford (Nolo Press, Berkeley), available in stock or by special order at local bookstores. You will find sample living trust forms in that book.

Lack of Title May Not Preclude Deductions

Q: My wife and I are buying our home on a contract for deed. When our landlord moved away from the area, she offered to sell us the home we were renting from her. But we had no cash for a down payment.

She agreed to sell to us for nothing down on a contract for deed. As security for our payments, she holds the title to the house, we make our monthly payments to her, and she pays the mortgage company.

When the property taxes and insurance come due, we send her extra checks for those amounts. As we just signed the contract last March, we are wondering if we are entitled to any income tax deductions for the property taxes and interest which we pay?

A: Yes. As the buyer under a contract for deed, also known as an agreement for deed, land contract, contract for sale, installment land sale contract and about 20 other names in various states, you are the “equitable owner.”

The seller is the “legal owner” who retains the property title. You are entitled to the income tax deductions for mortgage interest and property taxes. The legal owner, your seller, must report the net interest she receives as taxable income. She does not have to pay tax on the interest she pays to the mortgage lender.

I congratulate you on working out a solution to your problem of wanting to buy a home although you lacked cash for the down payment.

At the same time, you solved your landlord’s problem of not being able to manage property from a distant city. The contract for deed usually works well.

However, the big risk is that after you have faithfully made all your payments and become entitled to receive the deed, the seller may not be able to deliver marketable title.

To minimize this risk, I suggest you check the title to be sure there are no undisclosed liens or encumbrances. There is no guarantee the title will remain good, but the chances are no problems will develop.

Also, you should insist that your seller give you monthly proof she is making the mortgage payments, such as a copy of her canceled check. For further contract for deed details, please consult your attorney and tax adviser.

Abandonment Loss Requires Action

Q: About four years ago, we got suckered into buying some recreational property. We were shown pictures of glowing plans for the development.

We made a $5,500 down payment and have been paying $54 per month since then. Last year, we went to visit our property and saw very little development. Only a few cheap homes have been built. It is not a place we would ever want to live.

We talked to local people and they told us the lots in this development have been sold over and over again since the 1960s. The locals laugh at stupid people like ourselves who buy these lots sight unseen. My question is, how can we get out of this and can we take a tax loss for our payments?

A: You can take an abandonment tax loss if you can show the property has no value and there is no resale market.

But you must be able to prove this to the IRS if your tax return is audited.

You may want to list the lot for sale with a local real estate agent. Or at least get a letter from a nearby realty agent stating there is no resale market for lots in your development.

The next step is to do something giving up all right to the property. You might give a deed in lieu of foreclosure to the lender. Or fail to pay the property taxes and let the property go to tax sale.

Forfeited Deposit Is Not Deductible

Q: We forfeited a $1,000 earnest money deposit which we paid on the purchase of a home.

We had difficulty qualifying for a mortgage and decided we didn’t really want the house after all, so we walked away. Can we deduct our loss on our income tax returns?

A: Sorry, there is no income tax deduction for a forfeited earnest money deposit on the purchase of your personal residence.

However, such a deposit would have been deductible as a business expense if you were buying the property for investment.

Hard to Sell House? Lease With an Option

Q: For almost a year, I have been trying to sell my parents’ home. I inherited it after my father died last year.

I grew up in the house, but the neighborhood has declined badly. I had the house listed with two different realtors, but they were unable to sell it.

Another problem is that I live out of town and am unable to fix up the house. It needs some work. I don’t want to rent the house because it will attract undesirable tenants. Any idea how to get rid of this house?

A: Lease it with an option to buy. I have yet to find a property which cannot be sold by using a lease-option that is done correctly.

To be sure the purchase option is exercised, give a 100% rent credit toward the purchase price. You will be pleasantly surprised with the top quality tenants attracted by lease-options. They usually treat the property as if they already owned it.

To illustrate, suppose the house is worth $100,000 and will rent for $800 per month.

On a lease-option, you can probably get $1,000 a month because tenants will pay more than market rent to get a lease-option.

You might run a newspaper classified want ad with a bold headline such as “$5,000 moves you in, $1,000 per month rent applies toward purchase price. 3-BR, 2-BA home. Needs some work. Call Lucinda, 555-5555.”

Be sure to carefully screen applicants, just as you would when renting an apartment.

Conserve Cash When Buying New Home

Q: Thank you for your recent article about how to avoid tax when selling one home and buying another of equal or greater cost.

That is exactly our situation. We expect to sell our home and buy a larger one by summer.

However, we have around $100,000 equity and would like to use part of our cash from the home sale to buy a new car, which we badly need.

Is there some way we can use part of the cash from our home sale for a new car without having to pay tax on it?

A: Yes. Let’s review the “roll-over residence replacement rule” of Internal Revenue Code 1034.

It says you must defer the profit tax when selling your principal residence and buying a replacement principal residence of equal or greater cost within 24 months before or after the sale.

Please notice it says nothing about mortgages or down payments. You are free to do as you wish about the financing.

But because of the new tax laws, it is in your best interest to maximize your interest tax deductions by obtaining the biggest mortgage you can get on your new home and making the smallest possible mortgage.

Of course, I am presuming your home acquisition mortgage will not exceed the $1 million limit for interest deductibility.

To use an extreme example, you can defer all your profit tax even if you sell your old home for cash and buy your qualifying replacement home for nothing down, such as with a VA home loan.

In other words, you can spend your tax-deferred cash as you wish, such as to buy that new car you need.

Her Competitor Was a Good Sales Agent

Q: I agree with your suggestion to interview at least three real estate agents before listing with the best one.

However, we had a problem choosing three agents to interview because we knew only one.

While we were interviewing her, I asked, “Which agents do you consider your toughest and best competition?” She named several very successful agents with other firms.

After the first agent left, I called two of these agents and we interviewed them. As a result, we selected one who is the top sales agent in our town. She was a real cracker jack.

A: Thanks for your great idea. Of course, it could have backfired if the first agent named some really bad agents who, by comparison, would make the first agent look terrific.

Agent Should Have Delivered Your Offer

Q: I have been thinking about a realtor’s open house we attended the first weekend last December. It was a cold day and there were hardly any prospective buyers looking at houses.

We stayed about an hour and chatted with the realtor. The house was small and rather run-down. But we liked the location and it has possibilities for adding on another bedroom and bathroom. We wanted to offer $10,000 below the asking price, but the agent said she knew the sellers wouldn’t accept. The agent refused to even consider writing up our offer. Finally, we left.

But I drove by that house last week and it is still for sale. Do you think we should try again to make our offer even though it is $10,000 below the asking price?

A: Yes. The realtor should have written up your purchase offer bid. The worst that could have happened would be the seller might say “no.” But chances are the seller either would have accepted or made a counteroffer, which you could either accept or reject, and you could then make another offer.

By failing to write up and deliver your offer to buy the home, the agent breached her fiduciary duty to the home seller. This is a serious offense that can cost an agent his real estate sales license, if you wish to report the matter to the state real estate commissioner for investigation.

I suggest you contact the owner or manager of the brokerage office where the agent works. Explain the situation and state that you still want to make your purchase offer.

If you have any doubts that your offer might not be enthusiastically presented to the seller, just insist it contain words such as: “This offer to be delivered only in person to the seller and only in the buyer’s presence.” This will give you the opportunity to discuss your offer with the seller face-to-face.

Can Motor Home Be Replacement Residence

Q: My husband and I are thinking of selling our home for around $200,000, using our $125,000 “over-55 rule” tax exemption, and buying a nice motor home so we can travel around the country.

Since our sale profit will be about $160,000, could we do this in a way that would let us avoid tax on our sale profit?

A: Yes. Any principal residence you own can qualify. Examples include condominiums, cooperative apartments, mobile homes, houseboats, motor homes, and old-fashioned single-family houses.

To combine the “over-55 rule” $125,000 tax exemption with the roll-over residence replacement rule of IRC 1034, available to home sellers of any age, just subtract your $125,000 exemption from your principal residence’s $200,000 net sales price.

That would leave an approximate $75,000 “revised adjusted sales price,” in your case. If you buy a motor home costing at least $75,000 within 24 months before or after the sale, you can then defer the tax on the remainder of your sale profit.