Q. I bought a condo several years...
Q. I bought a condo several years ago for my principal residence. I want to sell it, but it has lost about 35% of its value since the purchase. May I convert the condo to a rental and declare the lost value as a tax deduction? I know losses on principal residences are not tax-deductible.
--B.O.
A. Yes, you may convert your condo to a rental, but it won’t do you any good. Why? Because the tax basis of your condo will be its value as of the date of conversion or its original basis at purchase--whichever is lower. So if your condo has already declined in value, that fact would have to be recognized in an appraisal conducted at the time you convert it. A decline before the conversion could not be written off as an investment loss.
If you think the condo will continue to depreciate, however, converting it to a rental now might make sense. In that case, the longer you hold it as a rental before selling it and taking this investment loss, the better. Our experts recommend at least six months, preferably a year or more.
Transferring Inherited 401(k) Funds to an IRA
Q. My sister’s husband died two years ago, leaving his 401(k) account intact at his employer. My sister inherited the account and now wants to transfer it into her individual retirement account. How can she do this without being slapped with withholding tax or a penalty?
--F.B.
A. Your sister should have the funds deposited directly into her IRA using what is known as a trustee-to-trustee transfer, a process that means the beneficiary never takes possession of the funds. What happens? The trustee of the 401(k) will send a check for the account’s proceeds to the trustee of your sister’s IRA account. It’s just that simple.
However, transferring the money into an IRA may not make the most sense. If your brother-in-law was born before 1936, your sister can elect to take a lump-sum distribution of the 401(k) proceeds and invoke a 10-year income averaging when including that income on her tax return. (Remember, to the extent that the 401(k) funds were accumulated on a pretax basis, they will be subject to ordinary income taxes upon withdrawal.) Be advised, though, that once the funds are transferred to an IRA, the income-averaging option is forever lost.
A note for widows and widowers inheriting 401(k) accounts: You may withdraw these funds and spend them, paying only ordinary income taxes on the disbursement regardless of your age. In other words, spousal beneficiaries of 401(k) accounts do not have to be 59 1/2 or older to take a penalty-free distribution from an inherited account.
Nonspousal beneficiaries cannot roll the funds into their own IRAs, but averaging options are available in most cases so all the income need not be declared in one year.
Risk Not a Concern for Insured Accounts
Q. I have my savings at a small bank that I believe is quite secure. I am earning about 2.63% on my funds. I recently saw that other banks are offering substantially higher interest rates. All carry Federal Deposit Insurance Corp. coverage. Should I be concerned about investing in a bank that pays considerably more since they could be investing in more risky securities? I am guided by the old risk-reward balancing act that teaches that you can’t get high returns without accepting some level of risk.
--S.E.
A. Assuming that you are comparing bank investments that are truly covered by FDIC insurance, this is one instance where you need not be concerned that a higher-yielding investment will be at risk. (But be careful; not all bank investments carry federal insurance. For example, some banks sell mutual funds that are not covered by the FDIC. In addition, FDIC insurance in general covers only the first $100,000 in an individual account, and other restrictions on coverage apply when an investor has multiple accounts at a single savings institution. Also, if your bank does fold, there can be significant delays before you will see money from insured accounts.)
Now that you know that risk isn’t a significant issue, you should be careful to determine whether the terms of the different savings accounts are the same. Banks often offer higher interest rates for accounts carrying certain restrictions, including minimum or maximum deposit limits and specific investment time limits. Check the fine print on the newspaper ads and you might also discover that higher rates are available only to new depositors, not existing account holders at a given institution. This is truly a case where the details matter. In the end, shopping for rates alone may not give you the most satisfaction.
