A Financial Planner Can Give Valuable Advice
Q: I recently inherited $55,000 and need help making the best use of this windfall. I am 55 years old and earn about $25,000 per year. I have about $15,000 in an individual retirement account and about $80,000 equity in my home. I know this money should be used for my retirement but am unsure how to proceed. --M. K.
A: Your first step should be a consultation with a qualified financial planner who has been recommended to you by a trusted colleague, adviser or relative. A professional can not only assess your individual needs but can also make the proper investments on your behalf. You will have to pay for this service--probably in the neighborhood of $1,000, but you would have to pay a brokerage commission for most any type of investment you make, so it all comes out fairly even in the end.
Our financial planning experts suggest that you consider investing half your inheritance in a deferred annuity and the other half in a conservatively managed mutual fund focused on growth stocks. The annuity, if purchased from a reputable and strong insurance company, will give you a regular, secure source of income during your retirement. The mutual fund should--if history is any guide--provide you a hedge against inflation and a source of income growth over the next decade. Until you retire, you should expect to reinvest whatever income your investments generate.
A financial planner can help you select the specific investments. The key is selecting the right financial planner. You cannot be too careful. Get referrals from as many people as you can before selecting your adviser. This is perhaps the most important decision you will make about investing this money.
Can’t Carry Over Part of Exemption
Q: Two friends say their accountants advised them that if the entire $125,000 profit exclusion on the sale of a residence by a person over age 55 is not used, the balance may be carried over and used with the sale of their next residence. I say the accountants are wrong. What do you say? --W. H. M.
A: It’s not what I say that matters; it’s what the law says. And the law says the $125,000 exemption is a one-time benefit. Either use it all, or forfeit the remainder. The balance may not be carried over and applied to a subsequent sale.
Loss on Trust Deed Is Valid Deduction
Q: I am holding a fourth deed of trust for $20,000. The borrower is behind in his payments. and I fear that he may be foreclosed on. I am trying to sell the note on the secondary market. If I am successful, I know I will have to discount it greatly. May I deduct whatever loss I suffer on the sale of the note from my taxes? If I can’t sell the note and the borrower defaults, may I deduct the entire $20,000 loss on this year’s tax return? --J. C.
A: In any tax year, you may deduct capital losses against any capital gains your investments generate. Your capital losses may also offset up to $3,000 of ordinary income each year. If you are unable to deduct your full losses in a tax year, you may carry the balance forward and deduct it in subsequent years. This principal would apply to any loss you would suffer on the sale of the trust deed as well as to the full $20,000 if your borrower defaults and your fourth deed of trust becomes worthless.
Nothing Wrong With Plan to Shift Homes
Q: I am age 53 and own a home worth more than $500,000. It has a tax basis of about $225,000. I also have a rental house with a market value of $300,000 and a basis of $150,000. I want to sell the rental, but I want to shelter as much of the gain as possible. Can I move into the rental, live there for three years, sell it and use the one-time $125,000 profit exclusion? Can I then move back into my other house and live there as long as I want? Is the tax basis of my first house affected if I turn it into a rental for three years? Will I have problems with the Internal Revenue Service? --J. G. K.
A: Your plan should work, and you should have no problems with the IRS. When you convert your first house to a rental, any depreciation you take on the house would decrease your basis, but that is the only real, long-term effect of your proposal.
To take advantage of the $125,000 profit exclusion, you must be at least age 55 and have owned and lived in the house at least three of the past five years. You are entitled to only one exemption in your lifetime, so if you use it on the sale of your rental, you will not get another when you sell your first residence.
To be on the safe side of the IRS, our advisers suggest that when you move into your rental you firmly establish that this is the home you now consider your principal residence. Make sure your mail is delivered to that address; change your driver’s license and other papers to reflect the new address. Register to vote at that address. Be sure to transfer your county homeowner’s exemption from your first house to your rental.
This should show the IRS that you seriously consider this home your new, full-time residence and should help avoid any prolonged and painful questioning of your activities.
