With Prices on Rise, Buy Home Now to Build Up Equity
Question: Should I buy a home now or wait for interest rates and house prices to drop? Will they go down any time soon? I have been waiting for a while, but it seems house prices go higher and higher. I never thought the house market would maintain its high peak for so long.
Answer: Real estate prices tend to go in seven-year cycles; however, the price trend is always up over the long term. In most communities, home prices go up for a few years, then plateau or decline slightly for a year or two before starting up again. Because of the robust economy, home prices probably won’t decline any time soon. Interest rates seem to be stable or possibly to be continuing up.
When I bought my first home in 1967 for $28,000 with a $5,000 down payment borrowed from my parents, my friends thought I was crazy to pay so much. But I’m glad I did. And when I bought my current home, all my friends thought I had gone mad. But since then, it has appreciated to at least six times its purchase price.
If you live in a diversified community that is not dependent on one industry or employer, you will probably have similar experiences. My suggestion is to buy a home now to start building equity from market-value appreciation and mortgage balance pay-down. If interest rates drop, you can refinance to reduce your interest rate.
Exchange of Rental Home Defers Taxes
Q: I have owned my rental property for about 12 years, and I plan to sell it because it is almost fully depreciated. But my tax bill will be huge. Can I do a tax-deferred exchange for a rental house that, in four to six years, will become my permanent residence? What happens to my capital gains taxes on the rental property?
A: Congratulations. You have discovered the best way to escape capital gains tax on your rental property sale. You can eventually move in to the home of your dreams in a few years.
A Starker delayed tax-deferred exchange is perfect for your situation. It is authorized by Internal Revenue Code 1031(a)(3). First, sell the rental property, but be sure the sales proceeds go into a Starker tax-deferred exchange intermediary account beyond your constructive receipt. Many title insurance companies, bank trust departments and real estate attorneys can handle the details.
Next, after the sale closes, you have 45 days to designate the property you want to acquire and up to 180 days to complete the acquisition with funds from the rental property sale.
You could buy with the sale proceeds, for example, a luxury rental house to which you will move in four to six years. Meanwhile, you will receive its rental income. The cost of the qualifying acquired property must equal or exceed your old rental property’s sale price, and you cannot take out any sales proceeds “boot” from the transaction.
When you convert the acquired rental house into your personal residence, that is not a taxable event. You can then live there without owing tax. However, when you eventually sell that home, Uncle Sam will be waiting to tax your sale, except for your $250,000 home-sale tax exemption.
Title Policy Required for Refinanced Loan
Q: We are in the process of refinancing our home loan. The primary reason we are refinancing is to get rid of the private mortgage insurance on our old mortgage. The lender refuses to cancel our policy, so we are refinancing with a larger mortgage because we added considerable improvements to increase our home’s value.
But our new mortgage lender says we must buy a new lender’s title insurance policy, which costs about $1,250. Because we bought our home only about two years ago, do we need to pay for a new lender’s title insurance policy?
A: Yes. During the last two years, lots of things could have happened that might affect your home’s title, especially given that there was construction.
For example, maybe a contractor or subcontractor wasn’t paid in full and filed a mechanics’ lien against your home. Perhaps the IRS recorded an income tax lien. Or you might have incurred a judgment lien that would impair your home’s title.
Mortgage lenders must be certain the borrower’s title is marketable without any title problems. Your new lender won’t make the loan without a new lender’s title policy. Consider your savings on the private insurance as the way you will pay for your lender’s title insurance policy.
By the way, congratulations on getting rid of your nasty mortgage lender who wouldn’t cancel the private insurance.
Biweekly Mortgage Scams Continue
Q: In the past, I read your items about the biweekly mortgage solicitations of borrowers by their lenders, and last week I received one of those letters from my mortgage lender. It offers to save me $23,953 for the balance of my loan if I sign up and pay a $459 fee, plus a $6 monthly fee. The lender will automatically withdraw 50% of my current principal and interest payment from my checking or savings account on the first and 15th day of each month. Should I sign up?
A: Let me put it this way: I wouldn’t sign up. You can accomplish the same interest savings on your mortgage without paying extra.
The setup you describe involves 26 payments each year. That is the equivalent of 13 monthly payments each year. You can accomplish the same result without wasting $459 plus $72 per year.
Just divide your monthly principal and interest mortgage payment by 12. Add that amount to each monthly payment that you send to your lender. You will be making the equivalent of 13 monthly payments each year. The result should be the same $23,953 interest savings over the remaining years of your mortgage.
Living Trusts Often Aren’t Recorded
Q: Is there a form I can get to remove an old living trust from the county records?
A: Living trusts usually are not recorded. A few states provide for “registration” of living trusts, but there is no requirement to register, nor is there a penalty for failure to do so.
Perhaps you are referring to some other document that was recorded. Although virtually any document in proper recordable form can be recorded, I am not aware of any way to remove an old existing living trust from the public records. For further details, please consult a local real estate attorney.
Add ‘Stepped-Up Basis’ to Inherited Rental
Q: About a year ago, my partner died. For about 20 years, we held title to a rental house as joint tenants with right of survivorship. I now hold title to the house. My tenant wants to buy it, but my problem is that the house has been depreciated down to only its land value, about $20,000, and it is worth at least $200,000. That would be a huge capital gain tax to pay. I know you often explain tax-deferred exchanges, but at my age I want to “lighten up” and do not want another rental property. How can I avoid tax on this sale?
A: Please consult your tax advisor. Since you inherited 50% of the house from your late partner about a year ago, you received a new “stepped-up basis” on that half.
Assuming the house was worth around $200,000 a year ago, you received a $100,000 stepped-up basis for your late partner’s half. Adding your half of the land value, gives you at least a $110,000 adjusted cost basis.
Did you add any capital improvements during ownership? If so, add their cost to your basis. The result will probably be a capital gain of about $90,000. At the federal tax rate of only 20% for capital gains, the federal tax will only be about $18,000 on a $200,000 sales price.
Qualifying for $250,000 Home Sale Exemption
Q: We have owned our house about four years. We lived in it for almost three years but moved out about a year ago. It is in a desirable neighborhood where market values have skyrocketed in the last year. Our tenant wants to buy our house, but a friend told us we must own the house at least five years before selling, if we are to claim that $250,000/$500,000 home-sale tax exemption. True or false?
A: False. Internal Revenue Code 121, the home-sale tax exemption rule, requires only aggregate ownership and occupancy for two of the last five years before the principal residence sale. It appears that you easily qualify for this $250,000 per qualified seller tax exemption. Please consult your tax advisor for more details.
Be Content With the Existing Tax Breaks
Q: I bought my home many years ago for about $55,000. Today, it is worth more than $450,000 because it is in a high-demand neighborhood. If I sell, I will owe a huge capital gain tax. Is there any way to avoid paying tax on my profit exceeding $250,000 (I am single, never married)?
A: Many sellers would love to have your “problem” of a $345,000 capital gain with a $250,000 principal residence exemption and only a $95,000 taxable long-term capital gain. With the federal long-term capital gains tax rate of just 20%, plus any state taxes, you are in an enviable position.
The only way to avoid tax on that $95,000 profit exceeding your $250,000 home-sale exemption would be to (a) convert your home to a rental property, (b) make a Starker delayed tax-deferred exchange under Internal Revenue Code 1031(a)(3), (c) have the proceeds held in trust beyond your constructive receipt and (d) use the money to acquire a qualifying rental property of equal or greater cost.
Do you want to go through all that hassle just to save capital gains tax on $95,000? I don’t think so. Pay the tax and be happy. For more details, please consult your tax advisor.
How to Calculate Tax on Home Sale Profit
Q: We owe about $96,000 on our mortgage. Our home is worth around $275,000. Will we owe any tax on our profit if we sell our home within the next few months?
A: The mortgage balance is completely irrelevant to calculating your taxable capital gain. Instead, you need to consider another important fact--your home’s adjusted cost basis.
Adjusted cost basis is usually your purchase price, plus any capital improvements added during ownership, minus any depreciation deducted for business use.
Just subtract your adjusted cost basis from your home’s net sales price (after paying selling costs such as the real estate sales commission). The difference is your capital gain or profit.
If you have owned and occupied your principal residence an aggregate two years of the last five years before its sale, you qualify for the $250,000 home sale tax exemption ($500,000 for a married couple filing jointly).
By subtracting the $250,000 exemption from your estimated $275,000 home-sales price and assuming you paid more than $25,000 for your home, it looks like your principal residence sale will be exempt from federal tax. Consult your tax advisor for full details.
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Letters and comments to Robert J. Bruss, a San Francisco-area lawyer, author and real estate broker, may be sent to P.O. Box 280038, San Francisco, CA 94128. Bruss suggests consulting an attorney or tax advisor before making important real estate decisions.
