DEAR BOB: I am confused about your recent answer to a home seller who wants to add her mother to the title. You said the mother would be eligible for an Internal Revenue Code 121 principal residence sale tax exemption up to $250,000 after only 24 months of ownership and occupancy. How can she qualify with less than 60 months of ownership? – Donald M.
DEAR DONALD: Internal Revenue Code 121 is very generous to principal residence sellers. After as little as 24 months of both ownership and occupancy, a home seller can qualify for up to $250,000 tax-free capital gains. That is the situation for the letter writer who plans to add her mother, who will live in the house for 24 months, to the home’s title. Both daughter and mother then qualify for $250,000 individual exemptions.
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However, a husband and wife can qualify for up to $500,000 tax-free principal residence sale profits if they file a joint tax return in the year of home sale. Only one spouse’s name need be on the title, but both spouses must meet the occupancy test of 24 months within the 60 months before the sale.
IRC 121 does not require 60 months of home ownership if the seller meets the 24-month principal residence occupancy test. But there is one exception.
If the property was acquired as a rental residence in an Internal Revenue Code 1031 tax-deferred exchange, then it must be owned at least 60 months to qualify. However, owner-occupancy is only required for 24 of those months. For full details, please consult your tax adviser.
HUGE MISTAKE FOR MIXED-UP HOME OWNER
DEAR BOB: About five years ago, my spouse and I had an attorney transfer our joint-ownership house title to our daughter. We retained life estates. Now it appears our daughter, who lives in another state, will most likely not want to move into our home for two years to obtain that $250,000 home sale tax exemption of Internal Revenue Code 121. We had an appraisal made at the time of the title transfer. Will that help her? – James B.
DEAR JAMES: I hope you now realize that was a huge mistake for you to transfer your home title to your daughter and retain life estates.
What were you thinking? Why would you make that foolish mistake?
The home’s market value on the date of title transfer doesn’t matter. The reason is a gift donee takes over the donor’s basis, presumably very low if you owned the house many years before the gift.
After you and your wife move out, die, or renounce your life estates, unless your daughter lives in the house at least 24 months as her principal residence to claim the IRC 121 $250,000 tax exemption, when she sells the house she will owe capital gains tax.
Her capital gain will be the difference between the net sales price and her low-adjusted capital gains tax. You and she should consult a tax adviser for more details.
DON’T RENT FORMER HOME OVER 36 MONTHS AFTER MOVING OUT
DEAR BOB: A few years ago we decided to move to Florida on a trial basis to see if we liked living in Florida year-around. Although the summer heat and humidity were tough the first year, we got used to it. Fortunately, we followed your advice and rented a condo with an option to purchase. About four months ago, we exercised our option to buy and are very happy. However, a friend tells us if we don’t sell our former principal residence, which we rent to tenants, soon we will lose our $500,000 tax exemption. Is this true? – Herb W.
DEAR HERB: I see your letter is from one of my favorite Florida cities, Sarasota. You made a very wise decision to move there.
Yes, your friend is correct. To qualify for the Internal Revenue Code 121 principal residence sale exemption up to $250,000 for each spouse, you must have owned and occupied your home at least 24 of the 60 months before its sale.
That means you must sell your old home within 36 months after moving out or lose your tax exemption up to $500,000. I’m presuming you owned and occupied it the previous 24 months. If you exceed the 36-month rental limit, of course you could move back in as your principal residence to meet the occupancy test. Ask your tax adviser to explain further.
STEPPED-UP BASIS RULE DEPENDS HOW TITLE WAS HELD
DEAR BOB: I recently lost of wife of almost 60 years and have decided to sell our home. We owned it as tenants-in-common. I have obtained a professional appraisal of its market value. My understanding is that I get a new “stepped-up basis” for tax purposes. Is this correct? – Lee R.
DEAR LEE: Presuming you and your late wife each owned 50 percent of the house as tenants-in-common, and presuming you inherited her half, you received a new stepped-up basis to market value on that inherited 50 percent of the home. But your adjusted cost basis is not stepped-up on the other half that you already owned.
I notice your letter came from a non-community property state. If you and your wife had lived in a community property state, then you could have received a new stepped-up basis on the home’s entire market value. Ask your tax adviser to explain further.
DO CONDOMINIUMS MAKE GOOD INVESTMENTS?
DEAR BOB: I am a busy dentist, so I don’t have much time for real estate investing. But my wife and I recently talked about our best investments. They are our home, our former home, which we kept as a rental investment, and our vacation condominium, which we rent to tenants when we’re not using it. Now we are thinking of investing in one or two rental properties. Since neither of us has much time available, do you recommend rental condominiums as good investments? – Bruce N.
DEAR BRUCE: No. Condos make great personal residences. I own one, and have owned several others. But they usually are not great investments. Personally, I recommend single-family house investments.
Here’s why I don’t recommend condo rentals: (1) their market value appreciation depends on recent sales prices of comparable condos in the same or nearby complexes, and (2) condos are subject to rising monthly fees and special assessments.
As my good friend Jimmy Napier told me years ago, shortly after he received a fee increase notice for a rental condo he owned, “I don’t like other people voting on how much I have to pay.” He soon sold his one and only condo investment.
SHOULD HOME BUYER SUE OVER THE DINING ROOM CHANDELIER?
DEAR BOB: We recently bought our first home, for which we paid top dollar. It is an older Craftsman house, probably built in the 1930s, which has been very well maintained. We’re very happy except for one thing. The sellers took the beautiful dining room chandelier and replaced it with a cheap one they probably bought at K-Mart. When I phoned them, the husband said their daughter wanted the chandelier and it would break her heart to have to return it. However, the sales contract said all fixtures are included and there was no exclusion for the dining room chandelier. Buying a new one of equal quality will cost at least $750. Should we sue the sellers in small claims court? – Brent T.
DEAR BRENT: Your situation is not unusual where a home seller removes a fixture that is permanently attached to the structure and is legally included in the sales price.
This problem should have been resolved during your “walk-through inspection” the day before the title transfer. At that point, you had maximum leverage over your sellers. Now you have none.
When I bought my home, I had a similar situation where my sellers took the mailbox, which I realized was missing after the transfer. But it wasn’t worth arguing about. I bought a new mailbox.
Recently, I encountered my sellers and almost asked, “When are you going to return my mailbox?” But I didn’t. Although you are right, and would win a small claims court lawsuit, some things aren’t worth arguing about unless you want to sue over $750.
UNRECORDED SECOND MORTGAGE MIGHT BE DANGEROUS
DEAR BOB: My husband and I recently loaned our son and daughter-in-law $50,000 toward the down payment on their first home. This helped “the kids” avoid the dreaded PMI (private mortgage insurance), which you often warn about, so they got an 80 percent mortgage. However, that $50,000 is a lot of money to us as we are retired on limited income. After the closing of the sale, we were given a promissory note and an unrecorded mortgage. The terms provide they will repay us over five years. So far, they made the first three monthly payments. Should we record our mortgage? – Judy G.
DEAR JUDY: If I were in your situation, for safety I would record your second mortgage. Although mortgage lenders frown on what you did, you actually made the first lender’s position more secure and you should receive a “thank you” from the lender.
The reason is if your “kids” default on the first mortgage payments, you will probably step in to make those payments and protect your $50,000 second mortgage. Instead of discouraging what you did, lenders should encourage second mortgages from family members.
The new Robert Bruss special report, “Foreclosure and Distress Property Profit Secrets,” is now 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. 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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