DEAR BOB: My tenant in a rental house I own would like to buy it, and I would like to sell to her. Would an installment sale be a good way to save money on the capital gains taxes? Should I contact a Realtor or a real estate attorney? – Ed C.
DEAR ED: Installment sales benefit property buyers and sellers. Your profit will be taxed at the current maximum federal tax rate of 15 percent for capital gains, plus state tax. However, the depreciation deducted after May 6, 1997, is taxed at a special federal “depreciation recapture” tax rate of 25 percent.
Purchase Bob Bruss reports online.
An installment sale spreads out your capital gain tax over the years you receive principal payments from the buyer. The buyer’s promissory note is secured by a recorded mortgage or deed of trust on the property sold.
If the buyer defaults, you can foreclose to either get your property back to resell for a second profit, or the high bidder at the foreclosure sale will pay off your loan in full.
The big installment sale benefit for you, as the seller, is you will earn interest at a higher rate than you probably can obtain elsewhere with safety, currently at least 6 percent. However, the interest you receive is taxed as ordinary income.
For your buyer, an installment sale means easy financing without having to qualify for a mortgage loan. As a result, you can ask top dollar for your property and get it, thanks to easy financing.
You don’t need a Realtor because you already found a buyer. A local real estate attorney can handle the sale details, including the required disclosures, sales contract, and closing details. Be sure to have a written agreement with the attorney as to the maximum fee.
IS $250,000 ONCE PER LIFETIME? IS TENANCY IN COMMON WISE?
DEAR BOB: My first question is can that $250,000 principal residence sale exemption be used just once per lifetime? Second question: I am about to invest in a second home with a partner and we want it considered a tenancy in common. Does this have to be stated on the mortgage? It is a “for sale by owner” property so a realty agent won’t be helping us. My partner has remarried and wants her children to be the heirs – Ann H.
DEAR ANN: Wow! You sure need tax help! The $250,000 principal residence sale tax exemption only applies to your “main home,” not to a second home or rental property.
This Internal Revenue Code 121 exemption can be used over and over again, but not more often than once every 24 months.
To qualify, you must have owned and occupied your principal residence an “aggregate” 24 of the 60 months before its sale. A husband and wife can qualify for up to $500,000 tax-free home sale profits if they both meet the 24-month occupancy test.
To hold title as tenants in common with a co-owner, the deed must specify “as tenants in common.” When a tenant in common dies, their share goes to their heirs specified in their will.
Unfortunately, the unhappy result in most states is a tenant in common, including the heirs, can force a sale of an investment property by means of a “partition sale” if one co-owner wants to sell but the other doesn’t. Please consult a local real estate attorney for details on the best way to hold title with your partner. Until Jan. 14, for a free copy of my special report “2004 Realty Tax Tips,” please go to my Web site at www.bobbruss.com.
NO EQUITY, NO MONEY TO PAY SALES COSTS, NO PROBLEM
DEAR BOB: My partner and I bought a home six months ago for $500,000 with 100 percent financing, and a first and second mortgage. Our relationship may be ending. We are uncertain what to do about the house. We cannot afford to keep it or rent it out. We have no equity in it. If we sell, we won’t have enough money to pay the Realtor’s commission. What happens to us if we let the lenders foreclose? – Joseph E.
DEAR JOSEPH: If you and your partner stop making the mortgage payments, the lenders will begin foreclosure against you and your partner. The credit bureaus will report these defaults, ruining your credit. Obviously, defaulting on your mortgages is not smart.
Rather than defaulting, ruining your credit and eventually losing the house by foreclosure sale, I suggest trying to find a reliable buyer with good income and good credit to take over your mortgage payments.
Be sure to check the buyer’s income and credit extremely carefully before agreeing to sell for nothing down. You might even want to insist the buyer make a modest down payment to minimize the possibility of default.
However, your lenders probably won’t release you from liability if your buyer defaults. But you can ask! For full details, please consult a local real estate attorney.
QUESTIONS ABOUT THE GIFT-TAX EXEMPTION
DEAR BOB: In a recent answer, you were unclear about parents giving an interest in their house to their children. You said the $11,000 annual gift-tax exemption is per donor per donee. But then you said, “But no gift tax will be due if their lifetime gifts over $11,000 per donee per year do not total over $1 million.” Hasn’t the exemption gone up to $1.5 million? – Max M.
DEAR MAX: The lifetime federal gift tax exemption is currently locked at $1 million. But the federal estate tax exemption is $1.5 million for deaths in 2004 and 2005.
You can give annual exempt gifts up to $11,000 per donor per donee. That means, for example, mom and dad can give a total of $22,000 per year to their child without owing any gift tax.
However, any gifts exceeding $11,000 per donor to a donee require filing a federal gift tax return even if total lifetime gifts of that donor are below the $1 million exemption. For full details, please consult your tax adviser.
HOW TO GET STARTED LEARNING ABOUT REAL ESTATE
DEAR BOB: I am a first-year law student taking a real property course. Real estate has always been a great interest of mine. How might I work toward becoming a real estate attorney? Should I try to get my real estate license and sell real estate part-time while in law school? – Kevin V.
DEAR KEVIN: If you have the time, I suggest you take one or two evening real estate courses at a nearby community college. That’s what I did while I attended law school at the University of California’s Hastings College of Law in San Francisco.
Your real property law class teaches legal theory. But community college real estate courses teach the practical useful information you will need. I recommend starting with real estate principles. Later, take courses in real estate finance, appraisal, investments, practice, property management and whatever realty courses interest you.
NEW TAX LAW CHANGE AFFECTS TAX-DEFERRED EXCHANGES
DEAR BOB: In October 2004 the American Jobs Creation Act was passed by Congress and signed by President Bush. It refers to Internal Revenue Code 1031 tax-deferred exchanges. We did such an exchange in 2001. Before selling the house we acquired, we plan to live in it and then sell to avoid the capital gains tax. The new rule is you can’t sell the property acquired in such an exchange unless you have owned it more than five years. Does the owner now have to live in the house for five years, or is it still the old two out of last five years before the sale? – Joyce P.
DEAR JOYCE: The only change made was that for a rental property acquired in an IRC 1031 tax-deferred exchange to qualify for the $250,000 principal residence sale tax exemption of IRC 121, the acquired property must now be held at least five years. You still must occupy it as your principal residence at least two of the five years before sale. Of course, at the time of acquisition, it must be a rental property.
To show rental intent, most tax advisers suggest renting it at least a year before converting to your principal residence. For full details, please consult your tax adviser.
The new Robert Bruss special report, “Everything Homeowners Need to Know About the New $250,000 and $500,000 Home Salt Tax Exemption Rules,” is now available for $4 from Robert Bruss, 251 Park Road, Burlingame, CA 94010 or by credit card at 1-800-736-1736 or instant Internet download at www.bobbruss.com. Questions for this column are welcome at either address.
(For more information on Bob Bruss publications, visit his
Real Estate Center).
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