Carrying Mortgage Better Tax Break

QUESTION: My wife and I own three rental houses on which we have small mortgages of about $19,000, $11,000 and $24,000. As we are ages 74 and 76, both in good health, we are thinking of selling these houses. But our tax adviser says the profit tax “will eat you alive.” We hope President Bush can get Congress to reduce the capital-gains tax, so we can afford to sell. But we are receiving conflicting advice from friends and family as to whether we should sell for all-cash or if we should carry back the mortgages. What would you advise?

ANSWER: If you sell for cash, you will have to pay all your profit tax in the year of the sale. However, if you sell on installment sales for a modest cash down payment and carry back mortgages for safe retirement income you will be delaying the tax payment, perhaps forever.

In today’s market you can easily get 9% yield on those mortgages. That is higher than you would earn at your bank or elsewhere with equal safety.

IRS Auditor on Solid Ground

Q: I own a house that I rent to my daughter and son-in-law. They are supposed to pay rent, but they haven’t paid any for the last four years. The IRS recently audited my income tax returns and questioned my deductions for this rental house. They said I must charge fair market rent if I am to claim tax deductions for this property.

I explained that my tenants can’t afford rent, since they have four children, one of whom has high medical bills. The IRS auditor denied all my deductions except for the mortgage interest and property taxes. Should I appeal?

A: No. The auditor is correct. You are not entitled to any tax deductions for your rental house, except mortgage interest and property taxes, if you do not have a profit motive. Since you are not collecting rent, your lack of profit motive is very evident.