Couple Seeks to Remodel Cost Basis for Home
Q: We have lived in our home for 20 years and over time have made many costly improvements, some of which no longer exist. For example, we remodeled the kitchen twice and built a deck and spa that were later replaced with other landscaping. Now we are selling the house and are wondering if we may include the cost of the long-gone improvements to the home’s cost basis to reduce our potential taxable gain from the sale. We have pictures and records to prove that the improvements were made. --L.F.
A: The Internal Revenue Code allows a taxpayer to include the cost of “permanent improvements” to his home to the residence’s cost basis. The operative word is “permanent.” The improvements you discarded or replaced obviously do not meet this test.
If you are going to follow the strict letter of the law, say our experts, you should not include these now-demolished improvements when you compute the cost basis of your residence. If, however, you decide to include the costs of the temporary remodeling--on the theory that the IRS can’t possibly know the difference between a $30,000 kitchen overhaul and a $20,000 one--be advised in advance that this is considered potential tax evasion. If you are audited and cannot produce the receipts to support the cost you assigned to the permanent improvements, your deduction would likely be disallowed and you could be subject to more serious charges.
Should You Record Living Trust Transfer?
Q: Several years ago, I created a living trust and transferred my home to the trust. Now I have discovered that my attorney chose not to record the transfer document in the county recorder’s office. He says the recording could limit my ability to borrow money, and that it isn’t necessary to accomplish what I want. Some friends disagree. Whom should I believe? --R.W.
A: First of all, rest assured: Your lawyer has done nothing to inhibit the validity of your trust. The deed can still be recorded upon your death and your estate will be transferred to your heirs without going through the probate process.
Some lawyers believe that failing to record the deed allows their clients greater flexibility during their lifetime if they should decide to sell or refinance the assets placed in their living trusts. In these events, the unrecorded deed could simply be torn up as though it never existed and the property could be sold, refinanced or otherwise disposed of.
However, the experts on whom we rely dispute this approach. They argue that recording the deed does not pose a significant barrier to a taxpayer’s ability to sell or refinance property in a living trust. In these events, our experts say, the taxpayer could simply execute a reconveyance of the property from the trust to his personal assets before selling or refinancing the asset. At the same time, they note, recording the deed ensures that it will not be lost.
How to Transfer Tax Basis on a Duplex
Q: A few weeks ago, you talked about how homeowners over age 55 can transfer their property tax assessment to a newly purchased home. How can we do this if our home is half of a duplex and our new home is a single family residence?
Also, how many times may an older homeowner transfer their property tax assessment? Finally, my real estate agent says we can spend up to 10% more than what we sell our home for and still qualify for the assessment transfer--not the same price or less that you have said. Is he right? --H.S.
A: Assuming that the two units in the duplex are of equal size, you would be able to transfer half the assessed value of your duplex to your new home. If you lived in a fourplex and all the units were of equal size, you would be able to transfer one-quarter of the assessed valuation to your new residence. The bottom line is that the law requires that the assessed value of the property be prorated among the units.
The law does allow homeowners purchasing a replacement home within a year of the sale of their original to buy a home for up to 5% more than the amount for which they sold the first one. Homes purchased within two years of the sale may cost up to 10% more than the sales price of the first.
In your case, to qualify for the assessment transfer, the cost of your replacement home could not exceed half the sales price of your duplex, plus 5% if purchased within a year of the sale or 10% if purchased within two years.
The laws limit homeowners to a single transfer, whether it is within the county of residence (under Proposition 60) or to a county accepting outside transfers (under Proposition 90).
Retirement Planning on a Limited Income
Q: I am 35 years old, unmarried and make $22,000 per year at a job that has no retirement benefits. I own a home with a $60,000 loan balance carrying an interest rate of 9.4%.
In planning for the future, am I better off investing $1,200 in a tax-deductible individual retirement account or in using that money to pay down the balance on my mortgage? --J.O.
A: The answer hinges on how much risk you are willing to take. If you want an absolutely safe investment, the interest you will earn now will be considerably lower than what you are now paying on your mortgage--even after the tax consequences are taken into consideration. In this event, you would probably be better off paying down your mortgage principal.
However, if you are willing to invest in a stock market mutual fund--this is not terribly risky, but neither is it absolutely fail-safe--you could probably earn a high enough interest rate to make opening an IRA worth your while.
Consider this fact: Since 1925, the Standard & Poor Index of 500 stocks has earned an average annual reinvested return of 10.3%. The S&P; 500 is considered a fairly conservative stock market indicator. Riskier market investments could return far higher yields, but they could also cost you your precious capital. Perhaps you would be happy with a mutual fund that invests solely in the S&P; 500 such as that offered by Vanguard, a respected mutual fund that does not charge a sign-up fee.
