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Managing Money : The Tax Benefits of Playing ‘Musical Houses’

Q: My wife and I are considering buying a house that we would rent for about five years and then convert into our primary residence when we retire. We own a home and another rental, both of which will generate substantial profits when we sell. What are the tax consequences of our plan, and how do we take advantage of the rollover of profits from the sale of a primary residence if we already own the home we are moving into? What about using the $125,000 exclusion of profits from the primary residence sale? --R.C.L.

A: You have raised a series of important and complicated questions that all taxpayers should get answered before embarking on a plan such as you have outlined. Unfortunately, you haven’t given us enough information to give you the answer you need.

Your best bet is to see a qualified accountant or tax attorney to understand how all the issues you have raised interplay.

Some of the key facts your accountant or attorney will need to know are: the tax basis of each of your properties, how long you have owned them, when you expect to sell, your age and your tax bracket.

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Our advisers say it is likely that the plan you have proposed is doable provided that you and your wife are willing to move around among your properties over the next few years to establish them as primary residences.

One adviser notes that the plan may require you to rent one of your residences that you would prefer not to convert into a rental.

The bottom line is that it is possible to play “musical homes” to take the fullest advantage of the tax laws that give the best tax breaks to your home--wherever that may be.

How IRS Looks at Sales of Stock

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Q: We have 500 shares of a utility stock. We purchased our first 100 shares in 1979 for $13.875 each. We bought 200 more shares in 1985 for $19.375 each. The final 100 shares were purchased in 1986 for $30.25 each. We sold 100 shares this year at $28.50 each. We have photocopies of the stock certificates and have kept meticulous records. When we file our taxes we would like to claim that the shares we sold were the last block we purchased, thus claiming a loss of $1.75 per share. Will the Internal Revenue Service allow us to do this, or will it consider the shares we sold to be the first block that we bought? --D.T.P.

A: If you can readily identify each block of stock you own and delivered the certificate for the block of stock that you wanted to sell, you should have no problems with the IRS. Typically, the IRS takes the position that unless you can precisely identify the stock you are selling, you are deemed to be selling the first shares you purchased. This is the “first in, first out,” or FIFO, method of accounting. However, if you can deliver the certificate for the stock you want to sell, or can get your stock broker to produce a statement of purchase verifying that you are selling shares bought on a certain day, you can sell whichever shares you want.

Getting Written Notice of IRA Account’s Value

Q: How do I get the trustee of my individual retirement account limited partnership to provide me an Internal Revenue Service Form 5498 showing the value of my IRA at the end of the year? Is there some law that I can wave under the nose of the trustee to get his attention? --D.T.

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A: According to legal and accounting sources, you should refer your recalcitrant trustee to the Tax Reform Act of 1986. That act was amended in mid-1987 to require all IRA trustees to file annual reports with IRA holders and the IRS stating the fair market value of the IRA as of Dec. 31 of the year for which the report is being made. But note that the law does not require the trustee to file a Form 5498. Trustees are only required to file a report, which can be in any written format. A Form 5498 is acceptable, but not mandatory.

If your trustee needs further details, refer him or her to Internal Revenue Code Sect. 408(i) and/or Internal Revenue Code Regulation 1.408-5(a).

What’s the Best Way to Forgive a Loan?

Q: My parents loaned my wife and me the money to build a new house. I gave my parents a second trust deed on the home and make monthly payments on the loan to a family trust. My parents say they want to forgive the loan by “gifting” it to us upon their deaths. How do they do this so that we pay the minimum tax? Do they make an addition to their will, amend the trust or what? --V.S.

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A: It’s not difficult. Your parents should amend the trust to note that your share of the inheritance should include a forgiving of the construction loan. Unless you are an only child, they probably do not want to forgive the loan as well as give you a full share of their estate because that would be unfair to your siblings.

Think about it this way: If your parents had a $360,000 estate to divide among three children, each would receive $120,000. But if your loan--we’ll value it at $60,000--were to be forgiven above and beyond your share, that would reduce the pot to $300,000 and leave one-third shares of $100,000. Of course your total inheritance would be $160,000, compared to your siblings’ $100,000 share. Isn’t fair, is it?


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