Should a Jobless Homeowner Sell Now or Wait?
Q: My husband lost his job and we can no longer make the $2,000 monthly payments on our $190,000 mortgage. The house, which we purchased for $30,000 and spent another $100,000 remodeling, is worth $600,000. If we sold it, we would realize a huge taxable gain. Our daughter is willing to take over some of the mortgage payments. How could we deed a portion of the house to her in exchange for doing this? Would she be entitled to an interest deduction if she did take over the payments? We don’t want to sell, but if we did, should we get a divorce first so we could both take advantage of the $125,000 exemption on home sale profits available to taxpayers over age 55? Any advice you can give would help. --E.M.S.
A: Even if times are desperate, there is no need to panic or resort to the drastic measures you are apparently contemplating. In fact, the steps you are considering could put you in even worse financial shape.
First, you must assess whether your husband has a reasonable chance of finding another job--and when. Will it take a year? Two years? Or do you think he is out of the job market entirely and facing an earlier-than-desired retirement? The answers to these questions, say our experts, should determine what you do next.
If you think your husband will find work again, then you are merely facing a temporary interruption in his income and only need a one-time cash infusion to get you through this period. You don’t need to sell your home--or even a part of it--to get the $25,000 to $50,000 you would need to make the payments for one or two years. The Internal Revenue Service would likely consider the deeding of a portion of the house to your daughter in exchange for taking over those payments as a sale of a partial interest in the house. You would be expected to pay taxes on the gain you would realize--a consequence you surely want to avoid in your present circumstances. Furthermore, because your daughter doesn’t live in the house, she would be unable to deduct those mortgage payments on your behalf from her own income taxes. As you can see, this is not the wisest choice you could make.
Instead of taking over the payments, perhaps your daughter would consider making you a short-term loan, or a series of monthly mortgage loans over the next year or two, until your husband finds work again. In exchange, suggests West Los Angeles attorney Paul Gordon Hoffman, you might consider granting her an option to purchase the house at a later date at some agreed-upon price. Your proceeds from granting the option are not taxable unless and until it is exercised.
If it doesn’t appear likely that your husband will find work again, you might want to consider selling the house and moving to smaller, less-expensive quarters that you could purchase with your sale proceeds. However, as you already know, the tax bite on your proceeds will be substantial, even if you exercise the one-time exclusion of $125,000 of profits. It is true that it you divorced prior to selling the house, both you and your husband would individually be entitled to a $125,000 exclusion, thus doubling the amount of profits you could shelter from taxation. However, as you might guess, Uncle Sam would likely challenge the validity of the divorce if you remarried shortly later.
Repaying a Loan Between Friends
Q: I gave about $100,000 to my roommate over the last five years. Half of it was to help her start a business; she used the other half to support herself. Now her business is finally making money and she wants to repay me. Our concern is that no written documents exist regarding this money. How can she repay me without triggering an audit from the Internal Revenue Service? --A.L.K.
A: First, let’s start off by dividing the $100,000 into its two parts: the $50,000 business loan and the $50,000 living expenses. The living expense money poses no problem. You essentially gave her $10,000 per year over five years, or $10,000 per year--the exact annual limit on gifts the IRS permits from one person to another with no reporting requirements. She can repay the money at the same rate over the next five years without raising any questions at the IRS at all. The $50,000 business loan is only slightly trickier. She can repay you in installments or in a lump sum if she wants, but she must pay you a minimum amount of interest if you are going to legitimately claim this was a business loan. Further, you must report the interest as ordinary income on your income tax filing when you receive it. Even if you want to forgive the interest, you still must report it and pay taxes on it. The interest rate you charge need not be outrageous. The IRS sets a minimum rate for loans such as these and changes it periodically throughout the year. By checking with your local IRS office you can determine the rates for the period of your loan and make the necessary calculations.
Surely you realize that a $50,000 loan with no written documents supporting it would raise eyebrows at the IRS, where agents are trained to look for suspiciously large cash transfers. If the facts of your story are as you have recited, you would be wise to put the terms of your loan agreement in writing to substantiate your story.
How the IRS Views Short-Term Rentals
Q: I recently rented out my condo to a film crew making a television movie and received a “location fee.” The crew used the apartment for 14 days and told me that they would report my fee to the IRS. Later I was told that I didn’t have to report this income because they used the condo for 14 days. What should I do? --D.S.
A: Even though the film production company will report their payment to you to the IRS, the actual income to you is not subject to taxation because Uncle Sam allows homeowners to rent their residences up to 15 days each year without declaring the payment as income.
