Sellers misled about real estate tax break

Large capital gains can't be erased with another purchase
By: Robert J. Bruss: Inman News
DEAR BOB: Due to a job promotion and transfer we must sell our house of 21 years. Our nice problem is the net profit will be about $625,000. My wife and I are aware $500,000 of that amount for a married couple will be tax-free, thanks to Internal Revenue Code 121. However, my insurance agent told me that if we buy a replacement principal residence of equal or greater cost, we could also avoid paying tax on the additional $125,000 capital gain. Is this true? -Cheryl R.

DEAR CHERYL: No. I hope your insurance agent knows more about insurance than he does about income taxes.

Since 1997, purchase of a replacement principal residence has nothing to do with avoiding capital gains tax on the sale of a former principal residence. Your insurance agent is nine years behind the times.

But the good news is the maximum federal long-term capital gains tax rate is only 15 percent, plus any applicable state tax. That is a small price to pay for enjoying your huge capital gain, which is tax-free except for $125,000. For more details, please consult your tax adviser.

HOW TO GET RID OF AN INEFFECTIVE HOME SALE LISTING AGENT

DEAR BOB: My husband and I are trying to sell our home. We stupidly chose a new Realtor who said she would list our house on a reduced sales commission. After almost two months, we have had only seven prospects inspect the house. Is there any way we can change Realtors? -Tracey P.

DEAR TRACEY: I suggest you contact the listing agent's broker or office manager to discuss the transfer of your listing to an experienced, successful agent within the same brokerage who sells homes in your vicinity.

To get more buyers' agents to show your home, you should adjust your sales commission upward to be competitive with other nearby listings.

After the listing transfer, your original listing agent will get a referral commission when the home sells and you will then have an experienced successful agent working hard to get your home sold. As the home sales market slows, primarily due to rising interest rates, you need the best available listing agent. This is no time to be cutting sales commissions or listing with an inexperienced new agent.

RECOMMENDED BOOK FOR FIXER-UPPERS

DEAR BOB: I am about to undertake my first fixer-upper house. I recall you recommended a "how to" book in the past. What is the title? – Frank C.

DEAR FRANK: A superb new book is "Find It, Fix It, Flip It," by Michael Corbett. You will love this unique book, which is not only "how to" but also explains how to upgrade a run-down house into a beautiful swan. The book is available in stock or by special order at local bookstores, public libraries, and www.Amazon.com.

CAN A 1 PERCENT CONDO OWNER BE EVICTED?

DEAR BOB: Fourteen months ago I rented a condo. The new owner resides out of town with no intent to live in the condo. We met each other and got along well. Then he learned the condo homeowner's association absolutely forbids rentals. So he deeded me a 1 percent ownership interest on the title so I can occupy as an owner. But I recently lost my job, am unable to collect unemployment, and am behind on the rent. Now the 99 percent owner has been threatening me, harassing me, and showing up to let himself into my unit without notice. He wants me out within a week. He is mean and relentless. What legal rights do I have? -Renee C.

DEAR RENEE: Your landlord must follow the unlawful detainer eviction procedures. They require giving you a Notice to Pay Rent or Quit. If you don't pay the rent, he must then serve you with a court summons and complaint, which gives you time to file an answer with the court. After that, a court hearing will be scheduled.

Only after the landlord has obtained a court judgment ordering eviction can he have you physically removed by the local sheriff. Meanwhile, the landlord has no right to enter your condo unit without at least 24 hours advance written notice (except in an emergency). If necessary, you can obtain a court restraining order against the landlord. For details, please consult a local real estate attorney.

SAVE ALL RECEIPTS FOR HOME IMPROVEMENTS AND REPAIRS

DEAR BOB: I recently bought a house where I hope to live for the next 30 to 40 years. But I have had to do costly repairs and maintenance, such as replacing aging wiring, replacing the main sewer line, installing a bathroom door, roof maintenance, interior painting, carpeting, and landscaping. Which of these expenses should be capitalized and added to my cost basis and which are non-deductible repairs? --Lauren C.

DEAR LAUREN: Save all your receipts for home improvements and repairs. Your goal is to capitalize as many expenses as possible and add the upgrade costs to your adjusted-cost basis.

For now, just save the receipts. When you eventually sell the house in 30 or 40 years, that's the time to categorize the expenses as improvements to be capitalized or repairs, which have no tax significance.

The general rule is if the expense extends the useful life of the property, or enhances its market value, it is a capital improvement. But other costs, such as painting, are repairs, which have no tax significance for your personal residence. More details are available from your tax adviser.

CHALLENGE PROPERTY TAX ASSESSMENT AS SOON AS POSSIBLE

DEAR BOB: In November 2005 I bought a brand-new house. But the county tax assessor recently sent me a letter than the assessed value will be approximately $25,000 higher than my purchase price. What should I do? -Paul C.

DEAR PAUL: You should pay a visit to the county tax assessor's office to review the appraisal for higher than your home's recent purchase price. Perhaps you got a bargain price because it was a builder's closeout or for another reason. As a property owner, you are entitled to look at your home's assessment file to determine if there was a mistake.

Unless there is a valid justification, after reviewing your file, you should consider filing an appeal with the assessor's office to get your assessed value reduced based on recent sales prices of comparable houses like yours.

DOES CONVERTING RENTAL HOUSE TO PERSONAL RESIDENCE ELIMINATE DEPRECIATION RECAPTURE?

DEAR BOB: About five years ago, I converted a rental house (that had been depreciated down to land value) to my personal residence. If I sell it today, can I take the $250,000 principal residence sale tax exemption, or will I have to recapture all the depreciation I deducted when it was a rental? - Thomas S.

DEAR THOMAS: Presuming you did not acquire the house in an Internal Revenue Code 1031 tax-deferred exchange, and you owned and occupied it at least 24 of the 60 months before its sale, as a single principal residence seller you can qualify for up to $250,000 tax-free profits. A qualified married couple filing a joint tax return in the year of home sale can qualify for up to $500,000 tax-free capital gains.

However, the depreciation you deducted while the house was a rental will be recaptured (that means "taxed" to us ordinary folks) at the special 25 percent federal tax rate. Please consult your tax adviser for full details.

SHOULD INVESTOR PAY OFF 10 PERCENT LOAN WITH 7.3 PERCENT LOAN?

DEAR BOB: I have an investor loan of $25,000 at 10 percent fixed interest with a two-year balloon payment on a rental property. Would it be beneficial to pay this loan off with my 7.3 percent variable home equity loan secured by my principal residence? -Eric P.

DEAR ERIC: Gosh, let me check my calculator. That 7.3 percent interest sounds much lower than 10 percent interest, especially since that high-interest loan has a balloon payment due in just two years. If there is no prepayment penalty, get rid of it.

EX-GIRLFRIEND NOT NEEDED TO ESTABLISH HOME'S BASIS

DEAR BOB: Fifteen years ago, my girlfriend was under a deluge of bills. She signed a quick claim deed on our house to me and disappeared. I've paid off the mortgage but can't locate her. The house has appreciated greatly in market value. I want to sell. How do I establish a cost basis? -Robert H.

DEAR ROBERT: As a general rule, your basis is the purchase price, plus closing costs that were not tax deductible at the time of home purchase, plus capital improvements added during ownership, minus any depreciation deducted for rental or business use of the property.

If your ex-girlfriend signed a quitclaim deed (not a quick claim deed) to you, and it was properly recorded, you don't need to locate her because you hold marketable title. For more details, please consult your tax adviser or a local real estate attorney.

The new Robert Bruss special report, "How to Get the Best Appraisal of Your House or Condominium," 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 delivery at www.BobBruss.com. Questions for this column are welcome at either address.