DEAR BOB: My wife and I own a four-unit rental apartment building that we want to trade for a rental house where we would ultimately like to live. Would such a trade qualify as tax-deferred? If the answer is “yes,” will Uncle Sam recapture and tax the depreciation we have deducted on the rental apartments? –Corrie A.
DEAR CORRIE: As long as you trade equal or up in both price and equity, your proposed exchange of the apartment building for a rental house can qualify as a tax-deferred exchange using Internal Revenue Code 1031. However, the acquired rental house should be rented to tenants at least six to 12 months to show rental intent at the time of the exchange.
Purchase Bob Bruss reports online.
If you plan to do a Starker delayed tax-deferred IRC 1031(a)(3) exchange, please be aware you have only 45 days after the sale of the apartment building to designate the replacement rental house and up to 180 days to complete the acquisition.
Because this is a tax-deferred exchange, your depreciation deductions will not be “recaptured” (which means taxed) at the time of the trade. If you eventually sell the rental house, at that time the depreciation will be recaptured and taxed at the special 25 percent federal tax rate.
If you own the rental house “forever” until you die, Uncle Sam will be so overcome with grief at your passing he will forgive any capital gain or recapture tax that would be due if you sold that property during your lifetimes.
One last important comment: If your plan is to eventually sell the rental house, after moving in and converting it to your principal residence, to qualify for the Internal Revenue Code 121 tax exemption up to $500,000 for a married couple filing jointly (up to $250,000 for a single owner), you must 1) occupy the principal residence at least 24 of the 60 months before its sale, and 2) own the house acquired in a tax-deferred exchange for at least five years.
This five-year ownership tax law change was effective Oct. 22, 2004, but only for homes acquired in tax-deferred exchanges. For full details, please consult your tax adviser.
SHOULD HOME BUYER AGREE TO ARBITRATE DISPUTE WITH HOME SELLER?
DEAR BOB: We are buying our first home and finding it quite an adventure. In my work, I negotiate contracts with lots of wonderful as well as sleazy businesspeople. But that is nothing like some of the extremely unpleasant home sellers we have encountered in the last few months. However, we finally found a home we want to buy. The purchase offer was accepted. Our buyer’s agent strongly encouraged us to sign the arbitration clause in the printed sales contract. But we decided not to sign. Did we do the right or wrong thing? –Daryl R.
DEAR DARYL: Yes, you did the right thing. Congratulations for not signing that arbitration clause in your home purchase contract.
If you had signed it, in the event of a future dispute with the home seller, perhaps over undisclosed house defects, you would have given up your right to a jury trial, court rules of evidence and discovery, and the right to appeal. You would be at the mercy of an arbitrator.
The moment of buying a home is stressful enough. Why give up your future legal rights at the same time? If a dispute arises in the future with the home seller, at that time after discussing the matter with your attorney, you and the other party can decide if arbitration is appropriate.
ARE OPTION MORTGAGES A GOOD OR BAD DEAL?
DEAR BOB: What is your opinion of the new so-called “option mortgages?” If I understand them correctly, we can refinance our home with an option mortgage and then decide each month if we want to pay the full 30-year amortized mortgage payment, interest only, or a partially amortized payment. Do you recommend these mortgages? –Cynthia F.
DEAR CYNTHIA: The answer depends on how long you expect to stay in your home. If the answer is “forever,” then you want a fully amortized mortgage so you will eventually own the home free and clear with no mortgage.
However, if you plan to stay in the home less than 10 years, with an amortized mortgage you won’t accrue much principal paydown so you would be better off cutting your monthly payment and paying just interest only.
As a long-time rental property investor, I love interest-only mortgages because they minimize monthly mortgage payments, make my monthly interest-only payments fully tax deductible, and increase my cash flow.
Years ago, my banker told me banks also love interest-only mortgages because they keep the bank’s money working full-time and they don’t have to be concerned about reinvesting principal payments.
To summarize, if you plan to stay in your home over 10 years, you probably should obtain an amortized 30-year mortgage because the interest rate is usually lower than for a so-called “option mortgage.” But if you expect to keep your home less than 10 years, an interest-only option mortgage will minimize your monthly payments and make those payments 100 percent tax deductible.
The new Robert Bruss special report, “Pros and Cons of Fast and Slow House Flipping for Big Profits,” 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.
(For more information on Bob Bruss publications, visit his
Real Estate Center).
