Sell Replacement Home Too Soon and You Risk Losing Tax Deferral

QUESTION: We sold our home about a year ago and bought a more expensive home to avoid having to pay tax on our sale profit. But a month ago, my wife had twins and we need to buy a larger home quickly. However, our tax man says if we sell our home now we will have to pay tax on our deferred profit, since we owned our home less than 24 months. If this is true, is there any way to get around this tax rule?

ANSWER: Yes. But first let’s back up. When you sold your first home you deferred the profit tax by purchasing a replacement principal residence of equal or greater cost within 24 months before or after the sale. This is the “roll-over residence replacement rule” of Internal Revenue Code 1034.

However, this rule can be used only once every 24 months. The one exception allows a tax deferral on a sale in less than 24 months if the sale is due to a job location change, which qualifies for the moving expense tax deduction (new job must be at least 35 miles further away from old home than was the old job). But I’ll presume you do not qualify for the moving expense deduction since you didn’t mention any job location change.

To avoid having to pay tax, just wait to sell your current home until you have owned it at least 24 months. However, your letter says you need a larger home immediately. One solution is to lease your current home to a tenant, perhaps with an option to buy after your 24 months expires, and either buy or lease a larger home, so you can move now. Several Tax Court decisions say a temporary rental of your old home, while it is available for sale, will not convert it into rental property and you will not lose the tax deferral of IRC 1034. Please consult your tax adviser for full details.

Faxed Counteroffer May Not Be Binding

Q: I am selling a large commercial building. It is listed with a fine real estate broker. He found a buyer from Hong Kong who inspected the building, went back to Hong Kong and transmitted his purchase offer bid via Federal Express. I counteroffered and sent the counteroffer back via Federal Express. Then the buyer sent his acceptance of my counteroffer via fax. It clearly shows his signature and the date.

That was about two months ago. Recently he wrote that he is unable to complete the purchase because of financial reverses. I don’t think I can get a replacement offer that is as good as this buyer’s offer. He has put up only a $20,000 deposit. Do you think we have a valid contract since the only copy I have was sent via fax?

A: I don’t know if you have a legally enforceable contract. Some attorneys think fax acceptances are valid, but I am not aware of any appellate court decision upholding contracts that were accepted via fax. Most attorneys recommend that fax acceptances be followed up by obtaining the original copy of the document, so it can be enforced in court if necessary.

Considering that your Hong Kong buyer may not be willing to part with the original copy of the accepted counteroffer, you may have a difficult situation if you try to sue that buyer.

How to Earn Profits in a ‘Flat’ Market

Q: The real estate market in our area seems to be “flat.” For the long term, I think houses will continue to be good investments, but I am reluctant to buy now because I don’t see much appreciation in our town. Is there any way to earn profits in a flat real estate market?

A: Yes. I recommend buying houses that need fix-up work. My goal is to increase the market value by at least $2 for each $1 spent on improvements. Whether a local real estate market is stagnant or appreciating, buying fix-up property and immediately upgrading it is usually the best way to profit in real estate.

The most profitable improvement is paint. Other profitable improvements include cleaning, repairing, new carpets and new landscaping. But avoid unprofitable improvements such as new roof, new plumbing, new wiring and other necessary structural work that doesn’t increase the home’s market value by more than its cost.

It Doesn’t Pay to Buy Retirement Home Early

Q: My husband and I are thinking of buying a lot where we will build our retirement home in Florida. But he thinks we should wait, because he is about six years away from retirement. We have been vacationing in the same area for the last few years and enjoy it very much every winter. I think we should buy a lot now, before prices go higher, don’t you?

A: No. It usually is not wise to buy real estate you cannot use within six months after purchase. I hate to be negative, but too many things can happen to change your plans before retirement.

Death, disability, change of plans and many other unexpected circumstances can arise. If you buy that lot on which you plan to build a retirement home now it may be difficult to sell for as much as you paid. Or you may find it is just as economical to buy a nearby existing home for less than it will cost to buy a vacant lot and build a house on it in a few years.

Real Estate License Can Be a Disadvantage

Q: I own my home plus a rental house, which I recently fixed up and plan to sell at a considerable profit. Do you think I should study to get a real estate sales license, so I can get the inside track on the new listings when they first come on the market?

A: No. A real estate sales license can be a major handicap to a real estate investor. Many property sellers and buyers are afraid of real estate licensees and they are extremely cautious when dealing with them.

I find that when I disclose my broker’s license to buyers and sellers they become extremely cautious. Unless you plan to sell real estate to earn sales commissions on your transactions I do not recommend you obtain a realty sales license.

Title Insurance Is Excellent Protection

Q: In a few months I will be buying my sister’s house. She owns it free and clear. Her plan is to give me a 100% mortgage (nothing down) so she can live off the interest income. It will give my family and me a place to live and provide good income for my sister. Do you think I should buy title insurance on this family sale?

A: Yes, always obtain an owner’s title insurance policy, especially when buying real estate from relatives. It is cheap peace of mind protection. The insurance protects you as long as you own the property. It would be a shame to make all your mortgage payments, only to discover your sister didn’t convey marketable title to you.

Don’t Buy Land Not Used Within 6 Months

Q: I am considering buying a vacant lot. How can I avoid a prescriptive easement, since I’ll be away from this land until about 12 years from now, when I want to build a house on it? Also, what contingencies should I include in this offer?

A: My advice is don’t buy land unless you plan to use it within six months. Too many things can happen if you don’t use it immediately. For example, you might be able to build a nice house on the lot today, but in the future the city might change the rules and either reduce the size of a home which can be built or require a larger minimum lot size for building a home.

As for avoiding a neighbor acquiring a prescriptive easement or, worse yet, title by adverse possession, be sure to inspect the lot at least annually. If you discover anyone using the property without your permission, have them ejected so they don’t acquire any rights in your property.

I am not certain what you mean by contingencies to include in your purchase offer. If you need financing, be sure your offer is contingent on obtaining a specified mortgage. You also may want to include contingencies such as checking availability of utilities and making sure you can obtain a building permit under current circumstances. But there is no guarantee that you will be able to build on that lot in the future.

Every State Requires Real Estate Sales License

Q: Please send me a list of the states that do not require licenses to sell real estate. I will be retiring in a few months and want to go into real estate, as I am sure I could earn big money selling homes. However, I am too old to study for an exam.

A: Every state requires a written examination to obtain a real estate sales license. In addition, many states require completion of one or more basic real estate courses before taking the exam. To learn the specific real estate license requirements of the state where you want to sell real estate, please write to the Real Estate Commissioner at the state capitol.

Remedies When Seller Changes Her Mind

Q: We contracted to buy a beautiful old home. But about two weeks before the scheduled closing date, after we had arranged our new mortgage and were getting ready to move out of our old home, the seller notified her agent that she had decided not to sell after all. She changed her mind about moving and wants to stay in her present house. She is a sweet old lady, but we don’t think she is being fair to us. The realty agent advises us to consult an attorney. What should we do?

A: Your seller seems to have a bad case of seller’s remorse disease. As a buyer, your legal remedies are to bring a specific performance lawsuit to force the seller to honor the sales contract and deliver the deed as agreed, sue the seller for damages (this can be hard to prove) or terminate the contract and get your earnest money deposit refunded. Please consult your attorney for more information.

Deferral Only Works With Replacement

Q: We are in the process of selling our home. The profit will be about $75,000 net. I realize that we can defer our profit tax by buying another home of equal or greater value. But we want to move into a rental house we bought about six years ago. It cost us about $20,000 more than we expect our old home to sell for. Will this qualify for tax deferral?

A: No. The “roll-over residence replacement rule” of Internal Revenue Code 1034 says you can defer your profit tax when selling your principal residence and buying a replacement principal residence of equal or greater cost within 24 months before or after the sale. Since your rental house was bought six years ago, it doesn’t qualify.