For Homeowners
For Homeowners
16) Selling your home? Be sure you qualify for these
tax breaks. Fix-up expenses incurred prior to the sale
will reduce the amount realized from the sale. This in
turn reduces the amount you have to invest in a new
home to defer your gain, or the amount of taxable gain
you will have. But fix-up expenses must meet several
tests before they can be used to reduce the amount
realized. The work must be performed during the 90
days before the making of a sales contract that results
in a final sale. The expenses also must be paid no
later than 30 days after the sale is completed. The
costs must not be capital expenditures or improvements
(in which case they are added to your property's basis)
and must not be otherwise deductible. If your fix-up
expenses do not meet these tests, you have
non-deductible personal expenses. So time your fix-up
work carefully.
17) Sell your home, but don't move. The tax benefits
can be outstanding. When you are over age 55 and sell
your principal residence, you can exclude from income
up to $125,000 of gain on the home. You must have
lived in and owned the home for three of the last five
years, though the ownership and residence need not be
for the same three years. You can use this provision
to sell the home to your children or other family
members. The buyers won't need to put up any cash or
qualify for a commercial mortgage. The sale can be a
private loan to the buyer, installment sale, or private
annuity. In any case, you will be receiving regular
payments for a period of years or for the rest of your
life.
You will have turned your home's equity into cash
without moving. You also will have removed the home
from your estate and transferred it to your children.
The children can let you live in the home rent-free.
The fair rental value of the home would be a gift from
them to you. An alternative is for the children to
charge you fair market rent. If you are charged rent,
the children get depreciation deductions and other
rental tax breaks. Thus you will have helped them
reduce their tax bills. This strategy is extremely
flexible and can be adjusted to meet the particular
needs of you and your children. (Letter Ruling
8502027). This is a good way for children to put a
couple of hundred dollars a month into their parents'
hands without tax consequences. All that's needed is
for the loan payments to exceed the rent received from
the parents and the parents will come out cash ahead.
Since the children will be receiving depreciation and
other deductions, their tax savings will enable them to
afford the difference. This arrangement could be
subject to the limitation on "passive" losses, but it
should be easy for your children to argue that they are
actively managing the property and are entitled to the
loss deductions. At any rate, the tax losses probably
will not exceed the $25,000 per year limit on passive
losses. Beginning in 1994 the rules on passive losses
have become more liberal.
18) Double dip with tax exempt bonds. This is another
way to use the $125,000 exemption or the provision
allowing you to defer gain on the sale of a home by
rolling it over into another home. First you sell your
home for cash and buy a new home. But you aren't
required to use the actual cash proceeds from your old
home to buy the new home. You can make a down payment
with some of the cash and take out a standard mortgage
for the rest of the purchase price. The remainder of
your cash can be used to buy tax-exempt bonds. The
bonds will pay you tax-exempt income that can be used
to make the mortgage payments. In addition, the
interest on the mortgage payments will be deductible.
The IRS has ruled that this arrangement works. (Letter
Ruling 8530024)
19) Help your child buy a home -- with the aid of the
tax code. Here are five ways to do it. (1) Give your
child the downpayment. Make sure that the gift is less
than the annual exclusion, so you won't owe any gift
tax. The exclusion is $10,000 per recipient per year,
$20,000 if the gift is made jointly with your spouse.
If both you and the child are married, you and your
spouse can give $20,000 to the child and $20,000 to the
spouse for a total of $40,000 gift tax free. (2) Lend
your child money to "buy down" the mortgage interest
rate. By making an advance deposit with the lender,
your child might qualify for, say, a 7% mortgage
instead of an 11% rate. This low starting interest
rate will eventually rise, but you hope your child's
income will also. (3) Buy the home yourself and rent
it to your child with an option to buy. This entitles
you to deduct cash expenses plus depreciation, provided
you charge the child a fair market rent. (4) Your
child buys the home but borrows the downpayment from
you. On a loan of less than $10,000 you need not
charge your child any interest, and on a loan of less
than $100,000 you have to charge interest only if your
child's net investment income exceeds $1,000. (5) You
can enter into an equity sharing arrangement with your
child. Each of you puts up part of the downpayment and
you take title as co-owners. You each pay a
proportionate share of the mortgage installments and
upkeep. Your child must also pay rent to you for your
share of the house, and you can deduct rental expenses
for your share. You also share in the profits if the
home goes up in value.
20) If you don't want to leave your home to your kids,
a strategy you should not ignore is to give the home to
charity. You can take a deduction for this gift now,
though you continue to live in the home until you die.
Here's how it works. You give the charity what is
known as a remainder interest in the home, and you keep
a life estate. The home is yours for as long as you
live, but at your death the house becomes the charity's
property. You take a deduction now for the remainder
given to the charity. The size of the deduction is
based on mortality tables issued by the IRS. Since the
deduction is for the value of the remainder interest,
the older you are, the greater the deduction will be.
If you are 50, for example, you will be able to deduct
about 15% of the home's fair market value. At age 75,
you can deduct about 47% of the value. A tax advisor
can consult the current IRS tables to determine the
exact amount of what your deduction would be.
You might want to use this strategy even if you
have children to whom you would ordinarily leave the
home. The children might end up with more money
overall if you take the charitable deduction now and
use the tax savings to buy a single premium whole life
insurance policy payable to the children. The policy
can be kept out of your estate, and thereby avoid
estate taxes. This approach makes sense when the value
of the policy is expected to exceed the value of the
estate. Since SPWL policies earn market returns and
homes in many areas are appreciating at very low rates,
this could be a sensible strategy.
The 1993 tax law made this strategy better. In
the past, there was a possibility that the alternative
minimum tax could take away the tax benefits of this
transaction. But the new law eliminates charitable
contributions of appreciated property from the
alternative minimum tax.
21) Become a landlord before selling and boost your
cash flow. This strategy is useful for homeowners in
areas with soft or depressed housing markets. If your
home is difficult to sell at a decent price, rent the
home out while continuing to seek a seller at your
price. This will give you cash flow to continue making
payments on the house. In the past it was assumed that
if you took regular rental deductions such as
depreciation, you would not be able to use the $125,000
exclusion or deferral of gain if the home were
eventually sold for a profit. But a federal appeals
court has ruled that you can get both tax breaks.
While renting the home you can depreciate it and get a
year or two of tax sheltered income. Then when the
home is sold at a gain you can protect that gain. If
you plan to use the $125,000 exclusion you cannot rent
the home for more than two years because the home must
have been your principal residence for three of the
five years prior to the sale. In addition, the basis
of the home for computing depreciation or capital
losses is the lower of your regular basis and the fair
market value on the date of conversion. (Regs. Section
1.167(g)þ1;1.1165þ9(b)).
22) Your corporation can build you a house, on your
land, then "give" it to you. When you lease land to a
tenant, any improvements the tenant makes (including
the erection of a new building) become your property
tax free when the lease is up. This angle creates an
interesting loophole whereby you can purchase raw land
and lease it to your corporation. The corporation then
builds a house (the kind you happen to like) and rents
it to you. The corporation's lease payments to you for
the use of the land are deductible to the corporation,
and the company can also depreciate the house. Your
rental payments for the use of the house are income to
the corporation. When the land lease ends (say after
20 years) the land and building are both yours. You
need not recognize any income as a result of the
improvements the corporation made to your land, and
your basis in the house will be zero (because you
recognized no income). If you sell the house, all the
proceeds will be long term capital gain. If you occupy
the house as your residence, you can take advantage of
the one-time $125,000 exclusion. On the other hand, if
you leave the property to your heirs, the basis to them
will be the fair market value at the time of your
death, and the capital gain will never be taxed. Do
not undertake the leasing arrangements we've described
without expert tax and legal advice.
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