Misunderstanding the Residence Replacement Rule Can Be Costly
QUESTION: Please straighten out the conflicting advice I am receiving from my real estate agent and my tax preparer. I am not yet 55 and will be moving from a high-cost to a lower-cost area. I have about $80,000 equity in my home, which I plan to sell in a few months.
After the sale, I expect to use this equity to buy a modest home for around $80,000 in Florida, which I will own free and clear. My real estate agent says I won’t have to pay any tax since I am reinvesting my $80,000 equity. But my tax preparer says I will owe tax if I buy a less expensive home. Who is right?
ANSWER: Your tax preparer is right. Your real estate agent is wrong. This situation shows why real estate agents should not give tax advice unless they also are tax experts.
However, even many tax professionals don’t understand the “roll-over residence replacement rule” of Internal Revenue Code 1034, so don’t be too harsh on your well-meaning realty agent.
This tax rule says home sellers who, within 24 months before or after the sale, buy and occupy their replacement principal residence costing at least as much as the net (adjusted) sales price of their old principal residence must defer their profit tax.
If a less expensive replacement principal residence is purchased, the sale profit becomes taxable up to the difference in the two prices.
Please notice this rule says nothing about mortgages or equity. All that matters are the net adjusted sales price of the old home and the purchase price of the replacement home.
To illustrate, suppose you sell your old home for $150,000 net after paying the sales commission and other selling expenses. That means to defer the entire tax on your sales profit, whatever the profit might be, within 24 months before or after the sale you must buy and occupy a replacement home costing at least $150,000, including any capital improvements you add within the 24-month replacement period.
However, since you will be buying a less expensive replacement home for $80,000, up to $70,000 of sale profit in this example ($150,000 minus $80,000) will be taxable.
As you can see, the rule is actually quite simple: Buy a more expensive replacement home, defer your profit tax; buy a less expensive replacement home, pay tax. You must report your home sale on IRS form 2119 whether or not you qualify for tax deferral. Your tax adviser can give you further details.
Don’t Try to Sell Home Without Agent
Q: We want to sell our home without a real estate agent, so we can save the sales commission. Please give us your checklist for selling our home alone.
A: There is only one item on my checklist for do-it-yourself home sellers. It says “Don’t do it.”
Selling a home today is a complicated business. Even the best professional real estate agents must work extremely hard to successfully complete every sale. As an amateur selling just one home you are at an extreme disadvantage competing against agents who belong to the local multiple listing service, which has hundreds of listings available to show to prospective buyers.
Frankly, I would love to encourage you to sell your home alone, so you can save the sales commission. But I would be doing you a disservice to recommend that you undertake such a task. The risks are too great for most home sellers.
For example, did you know that if you fail to disclose known defects in your home the buyer can sue you for damages? Do you know how to help the buyer obtain mortgage financing? Do you know how to arrange title insurance? Do you know how to have the sale successfully closed? These are just a few of the potential do-it-yourself home sale problems that can arise.
Although I am a licensed real estate broker, when I have a house to sell, unless I sell it to my tenant, I always list the property with a local realtor. Why? Because an owner cannot do an objective job of selling his own property without professional help.
Before you decide to sell your home alone interview at least three local realty agents who sell homes in your neighborhood. Ask them to give you their listing presentations. Inquire about their fees, services and anything else you want to know. Each agent should give you a written, competitive market analysis form showing recent sales prices and current asking prices of similar nearby homes, as well as the agent’s recommended asking price for your home.
After each agent has departed, phone their client references of recent sellers to ask, “Were you in any way unhappy with the agent’s service and would you list another property for sale with this agent again?” I think you will conclude you need a professional agent’s help to sell your home.
Homeowner Can’t Be Forced Into Selling
Q: Our real estate agent showed us a home listed in the multiple listing book. The price was reasonable and it said the seller would finance the sale with a 15% cash down payment. We made a full-price purchase offer with 15% down payment.
There were no contingencies in our offer because we knew it was a bargain. But the seller refused to accept. The agent said the seller had changed her mind about selling, but the agent was as mad as we were. We talked to our lawyer, but she says there is nothing we can do since we are not minorities and cannot charge racial discrimination. Do you agree?
A: Yes. A property seller cannot be forced to sell just because the property was listed for sale with a real estate agent. An advertisement in a newspaper or the local multiple listing service book is only an invitation for bids at the asking price. However, if the seller had accepted your offer and then refused to perform, you could bring a specific performance lawsuit to force the seller to honor the sales contract terms.
Property Manager Caught in the Middle
Q: For the last three years I have been resident manager of an 80-unit apartment complex. I enjoy the job very much, especially meeting the prospects, renting apartments and even handling their complaints. I get a free apartment plus a modest salary. As I have a real estate broker’s license I am thinking of becoming a professional property manager and opening my own management firm. Do you think this is a good idea?
A: In my humble opinion, the world’s most difficult and thankless job is professional property management. I greatly admire those who enjoy such work.
Property managers are middlemen between landlords and tenants. From the landlord’s view the rents are too low and the expenses are too high. From the tenant’s view, the rents are too high and the service is inadequate. The property manager is caught in the middle. Before you decide to open your own property management company, I suggest you work as a property supervisor for a property management company. Then you can decide if you really enjoy being a middleman.
No Minimum Period for Listing Home Sale
Q: Is it true that six months is the minimum term for listing a home for sale with a real estate agent? That’s what a real estate agent told me. She said the local multiple listing service requires 180-day listings. But I find that hard to believe.
A: There is no minimum listing term for property listings. I’ve seen listings as short as 24 hours. However, that was for unlisted property on which the agent had a purchase offer and he wanted the commission agreement in writing before presenting the purchase offer.
The listing term can be whatever the seller and agent agree upon. I suggest the listing term be not more than 90 days. Some sellers, like me, prefer 30- to 60-day listings because they motivate the agent to get the property sold quickly. Another alternative is to sign a 90-day listing with a clause allowing cancellation without cost upon 30 days notice to the agent.
Should Home Buyer Know Reason for Sale?
Q: My wife and I are looking at homes to buy. We saw one last weekend where I asked the agent why the seller is selling. She said it was none of my business. I courteously explained that I wanted to know, so we could make an offer meeting the seller’s time requirements.
The agent replied that the seller was flexible about when she could move out. The next day I phoned a realty agent who has shown us many houses to get her opinion of the house with the rude realty agent. She told me the house is in foreclosure and will soon be going up for auction. Don’t you think the sales agent should have told us that?
A: Yes. The foreclosure sale is a material fact that the buyer should know about because it affects the availability of the home for sale and the terms that the seller can accept. It is unfortunate the first agent tried to conceal that important fact from you. As a result, the house probably won’t sell soon enough to avoid loss by foreclosure. If the agent had honestly disclosed the reason for the sale, perhaps you could have made a purchase offer to save the house from foreclosure.
Pros and Cons of a Quitclaim Deed
Q: While on a winter ski vacation we looked at some ski cabins for sale. One is being sold to settle a divorce. The price is a bargain. But it is being sold by the husband who says he and his wife will give us a quitclaim deed and we can take over their mortgage. I have never heard of a quitclaim deed. Is it safe?
A: A quitclaim deed conveys whatever interest the grantor owns in the property. You could receive full fee simple absolute title. Or you could receive nothing if the grantor doesn’t own marketable title to the property.
For example, I could give you a quitclaim deed to the Empire State Building in New York City. However, you would be receiving nothing but a worthless piece of paper, since I don’t own that building. To protect yourself when receiving a quitclaim deed, be sure also to obtain an owner’s title insurance policy. Then you will be well protected.
Interview Competition to Find a Good 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 crackerjack. Even has a nice personal secretary who took care of many of the details, such as advising us which moving company was best. Perhaps you can use my idea of asking one agent for the names of their toughest competitors to find other agents to interview.
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.
You also brought up another indicator of top agents, a personal assistant.
Many of the most successful real estate agents now have one or more personal assistants or secretaries so the agent can devote most of his/her time to listing and selling, rather than to detail work.
Letters and comments to Robert J. Bruss, a San Francisco-area lawyer, author and real estate broker, may be sent him at P.O. Box 280038, San Francisco 94128.
