DEAR BOB: I heard that homeowners must now live in their homes at least five years, not just two years, to be able to claim the $250,000 home sale capital gains tax exemption. Is this true? – Minh H.
DEAR MINH: No. Good news! Your informant is mistaken.
Purchase Bob Bruss reports online.
To qualify for the principal residence sale tax exemption up to $250,000 (up to $500,000 for a married couple who both qualify), the home seller must have owned and occupied his/her home an “aggregate” 24 of the 60 months before its sale. The 24-month occupancy time need not be continuous.
It is possible to buy your house or condo, live in it up to 24 months to qualify for the Internal Revenue Code 121 exemption, and sell it in the 25th month with up to $250,000 (or $500,000) tax-free capital gains.
Your informant was probably thinking about the big change made to IRC 121(10) for a principal residence acquired in a “like-kind” tax-deferred exchange under IRC 1031. For those homes obtained as rental properties in such an exchange, and later converted to a principal residence, the 24-month minimum occupancy time remains the same.
However, to qualify for the IRC 121 principal residence sale exemption, such a property must be owned at least 60 months before its sale. This change became effective for such sales after Oct. 22, 2004, but it only applies to homes acquired in tax-deferred exchanges. For full details, please consult your tax adviser.
PROS AND CONS OF PAYING ALL-CASH FOR RETIREMENT HOME
DEAR BOB: I am 67 and my wife is 59. We plan to sell our business and our home to relocate to a less expensive area in Idaho. We are thinking about buying our new home for cash and investing the rest. But we know your guideline is: don’t pay over 20 percent cash down payment. However, we really want to avoid mortgage payments. What should we do? – Robert H.
DEAR ROBERT: I can’t tell you what to do. It’s your decision if you want to pay all-cash for a home in a community you might not like.
I do not recommend putting all (or most of) your eggs in one basket. Suppose you or your wife don’t enjoy the area or the house, but you have difficulty reselling your new home. You are the stuckee!
Please don’t blame me if you make a big mistake and pay all cash for your Idaho house. Safer choices include (a) leasing a house with an option to buy, or (b) making a 20 percent down payment and obtaining an 80 percent mortgage. After a few years, if you are sure you want to stay, then pay off the mortgage.
HOW TO AVOID TAX IF HOME SALE PROFIT EXCEEDS $500,000
DEAR BOB: How about writing an article about how to avoid capital gains tax on the sale of a principal residence when the profit exceeds the $250,000 or $500,000 exemption of Internal Revenue Code 121? – Frederick B.
DEAR FREDERICK: That’s a nice problem you have. I will include it in my “2006 Realty Tax Tips” series, which starts in January during tax season.
Until then, you can avoid capital gains tax on the sale of your personal residence by (1) moving out and renting it to tenants (they can be your buyers under a lease-option sale) to convert your home to rental status before sale, and (2) then make a tax-deferred Internal Revenue Code 1031 exchange for an investment, rental, or business property of equal or greater cost and equity.
Then you will have deferred your capital gain tax on the sale of your home and acquired an investment property. A popular choice today is to make a qualifying tax-deferred exchange into a tenant-in-common (TIC) interest in a commercial property such as a shopping center, office building, or apartment building. There are many TIC developers. Your realty agent or real estate attorney can probably make recommendations.
BE EXTRA CAREFUL IF HOME BUILDER IS “FINANCIALLY STRETCHED”
DEAR BOB: We are buying a brand-new second home in North Carolina. We know our builder is “financially stretched.” There have been subcontractor liens filed and we know more are on the way. We are closing our purchase soon. My understanding is the liens will be paid at the settlement. Are we liable for any liens filed after the title transfer to us? What if our builder files bankruptcy? What about the builder’s one-year home warranty? – Brad M.
DEAR BRAD: Be sure you obtain the “super-deluxe” owner’s title insurance policy at the closing settlement. Because you know the builder has financial trouble, you should hire a local real estate attorney to study the owner’s title insurance policy and other closing documents to be certain you are protected against all mechanics’ liens and other possible problems.
As for the home builder’s warranty, if the builder files Chapter 7 bankruptcy, that usually frees him of any warranty obligations. If possible, before the sale closes, ask him to purchase a 10-year home warranty policy from one of the major nationwide new-home warranty insurance companies. Even if you have to pay the premium, it might be worthwhile.
EXCELLENT BOOK ON LIVING TRUSTS
DEAR BOB: What is the name of that excellent book you recommended some time ago about living trusts? – Williamma M.
DEAR WILLIAMMA: The best book on that topic is “Make Your Own Living Trust, Seventh Edition,” by attorney Denis Clifford. Nolo Press in Berkeley, Calif., publishes it. This book is available in stock or by special order at local bookstores, public libraries, and www.Amazon.com
HOMEOWNER EXPECTS PROFIT AFTER ONLY SIX MONTHS
DEAR BOB: I bought my home about six months ago and have listed it for sale because I want to buy a bigger house. Will I get taxed by the IRS and how much will my mortgage lender tax me? Where can I find out exactly how much my fine will be? – Juan P.
DEAR JUAN: I will be shocked and very surprised if you have a net profit in your current home after owning it just six months. Usually, it takes at least two years of ownership to show a substantial net profit, after considering ownership and sales costs.
If you miraculously have a large sales profit, unless the home sale qualifies for one of the partial tax exemptions for principal residence sales in less than 24 months, if you sell within a few months after purchase you will pay ordinary tax rates on your profit.
To qualify for a partial principal residence sale tax exemption under Internal Revenue Code 121 in less than 24 months, the sales purpose must be for health reasons, job location change qualifying for the moving cost tax deduction, or “unforeseeable reason” such as divorce, death in the family, etc.
Mortgage lenders don’t tax, but they can impose stiff prepayment penalties in their loan documents. Study your mortgage papers. If they contain a prepayment penalty, that is your “tax.” But the good news is a prepayment penalty is tax-deductible as itemized interest.
Although you won’t owe any “fines” for selling your home quickly after purchase, please consult your personal tax adviser now to discuss the details of your “quick-flip” home sale.
HOW TO GET STARTED BUYING FORECLOSURE AND DISTRESS HOUSES
DEAR BOB: I love the way you write about complex real estate issues so even I can understand. I would live to invest in real estate, perhaps foreclosure auction properties that I can remodel and resell for profits. Is it a good business to buy auction property? – Patricia S.
DEAR PATRICIA: Investing in foreclosure and distress properties can be very profitable. Personally, I’ve done quite well with such investments. But you must know what you are doing to avoid costly mistakes.
I suggest you study my brand-new special report, “Foreclosure and Distress Property Profit Secrets,” available for $5 from Robert Bruss, 251 Park Road, Burlingame, CA 94010 or by credit card at 1-800-736-1736 or instant Internet PDF delivery at www.bobbruss.com.
After you learned the foreclosure basics from my new report, I suggest you study further by going to the excellent Web site www.foreclosures.com run by Alexis and Tim McGee. These long-time foreclosure investors provide great resources, including nationwide listings of foreclosure opportunities. You won’t find a better foreclosure resource.
(For more information on Bob Bruss publications, visit his
Real Estate Center).
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