New tax law affects rental real estate

Tax-deferred exchange rule applies to home sales after Oct. 22, 2004
By: Robert J. Bruss: Inman News
DEAR BOB: In a recent response to a reader, you said Congress enacted legislation effective Oct. 22, 2004, affecting rental property acquired in an Internal Revenue Code 1031 tax-deferred exchange. Does this apply to all such property, or just to rental property acquired after that date? – Harry S.

DEAR HARRY: The amendment to Internal Revenue Code 121 affects a rental property, later converted into a principal residence, and sold after Oct. 22, 2004. The date of property acquisition in a tax-deferred exchange doesn't matter.

Thousands of savvy realty investors have sold their rental properties, such as apartments, commercial property, or a business property, and made IRC 1031 tax-deferred exchanges for single-family residences of equal or greater cost and equity.

To qualify for the IRC 1031 exchange, the acquired property must be held for investment or business purchases. After renting the house for a reasonable time, perhaps six to 12 months, the investors often move in to convert it to their principal residences.

Then, after owning and occupying the principal residence at least 24 of the 60 months before its sale, it can qualify for the IRC 121 principal residence sale tax exemption up to $250,000 (up to $500,000 for a qualified married couple filing jointly).

However, the Oct. 22, 2004 tax law change now requires the acquired property be owned at least five years before the principal residence can qualify for the IRC 121 $250,000 or $500,000 sales exemption. The sales date is what matters; the date of acquisition is irrelevant. For full details, please consult your tax adviser.

UNLESS YOU CAN FIND THE OWNER, YOU CAN'T ACQUIRE TITLE

DEAR BOB: There is a vacant lot next to our house we want to buy. Our purpose is to build a modest house for my wife's mother so she will live nearby but not in our house where we don't have extra room. But we can't find the owner of the vacant lot. Title is held in a trust which is apparently managed by an out-of-town bank. My letters and phone calls produce no results. The property taxes haven't been paid for 16 months. How can we locate the lot owner so we can negotiate a purchase? – Neil W.

DEAR NEIL: Until you find the owner, there's nobody to convey title to you because the bank trustee can't act without the approval of the trust beneficiary.

One approach I used years ago to get the attention of a bank trust department was to deliver a client's purchase offer on an apartment building with a $10,000 deposit check to the bank trustee. As a fiduciary, the bank had a legal duty to deliver my client's purchase offer to the property's owner.

Eventually, after about six months my client bought the property held in the trust. But until that purchase offer was made, bank trust department wouldn't even disclose the name of the trust beneficiary. The same technique might work for you.

UP TO $500,000 EXEMPTION FOR HOME SALE IN YEAR OF SPOUSE'S DEATH

DEAR BOB: My wife died in April 2005. If I decide to sell the house where we lived together almost 50 years, can I qualify for a $250,000 or $500,000 tax exemption? I am receiving conflicting answers – Fred W.

DEAR FRED: If the house was the principal residence for both you and your late wife, if at least one of you held title, and if both spouses occupied it at least 24 of the 60 months before its sale, then you can qualify for up to $500,000 tax-free capital gains if the sale closes by Dec. 31, 2005.
The reason is 2005 is the last year you and your late wife can file a joint income tax return.

However, don't rush to sell by the end of 2005 if you don't want to do so. If your wife's name was on the title, and if you inherited her half of the house, then you receive a new stepped-up basis to market value on the date of her death for that half. If the house was community property, then as surviving spouse inheriting her share you get a 100 percent stepped-up basis. For full details, please consult your tax adviser.

The new Robert Bruss special report, "The Whole Truth About Senior Citizen Homeowner Reverse Mortgages," 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 PDF delivery at www.bobbruss.com. Questions for this column are welcome at either address.