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Saving taxes on real estate

by J. Robert Taylor, J.D.

Q Does the recent change in the federal tax law affect the taxes due on the sale of my home?

A Yes. The tax rate for long-term capital gains (property held for at least 12 months) is reduced to 15 percent for sales occurring after May 5, 2003, until 2008. The prior capital-gains tax rate was 20 percent. The sales of a personal residence is still exempt from capital gains tax for the first $250,000 in gain if you are single or $500,000 in gain for a married couple, assuming you meet the residency requirements.

For example, a married couple selling a $1,500,000 home that they purchased 20 years ago for $400,000 would have a taxable gain of $1,100,000. The first $500,000 in gain is not subject to tax, but the remaining $600,000 in gain would be taxed at a 15-percent rate costing the taxpayer $90,000. Under the old law you would have paid $120,000. The state tax rates for California have not been changed, and the $600,000 would be subject to tax on your state return.

Q I am married. Both my wife and I are retired and have a low fixed income. Despite Proposition 13 my property taxes have continued to go up and my income has remained the same. Is there any way I can reduce my taxes so I can have more cash flow?

A Yes, if you qualify you can defer paying your property taxes until the property is sold or when you and your spouse die. Basic qualifications are that you must be at least 62 years old or disabled, own at least 20 percent of your home, and have a household income of $24,000 or less. The unpaid back taxes will have to be paid when you sell the house or cease to be eligible (i.e., you die, move or your income increases). Even if you die, your spouse can continue to defer the payment of property taxes as long as she is eligible. To see if you qualify or get the proper forms to apply you may call the State Controller at (800) 952-5661 or on the Internet at www.sco.ca.gov/.

Q I am over 70 years old and want to remain in my home as long as possible. I have heard of "reverse mortgages" and "shared appreciation loans" and wonder if I should consider that as an option to increase my income?

A No loan increases your income; it is just a way to borrow money. The key to understanding these loans is to find out what the real costs of borrowing the money are. The typical reverse mortgage guarantees to make specific monthly payments in a fixed amount by securing that stream of payments with a trust deed against your home. The lender is guaranteed repayment either when you are no longer able to live in your home or you die. Both loans are very complex financial instruments that are beyond the ability of the vast majority of homeowners to understand.

The sole advantage of these types of loans is that it gives the homeowner a constant stream of income that could make it possible to stay in your home. The downside of these types of loans is the high interest rate and/or shared appreciation of the value of your property that make getting out of these loan contracts very difficult and sometimes financially impossible should your needs change.

Many seniors have a very strong desire to live in their home no matter what. While this emotional desire is understandable, the reality is that health concerns and other factors often make living in a home impossible, unsafe or undesirable at some point.

Anyone considering a shared appreciation or reverse mortgage should have independent legal advice to make sure they understand the costs, tax effects and estate-planning ramifications of entering into one of these agreements. The people selling these agreements do not have to live with the consequences of the transaction, you do.

Often there are other alternatives for borrowing money that may serve your needs, like an equity line or a conventional mortgage that do not require you to live in your home and may provide a more flexible solution to a shortage of cash flow. Each person's situation is unique and requires careful consideration before taking out any loan. I would recommend the Web page sponsored by the California Department of Real Estate as your first resource for information in this area at www.dre.ca.gov/reverse.htm. I will also send you a copy if requested.

Q I read your Q&A in the Home & Real Estate section of the Palo Alto Weekly every month. I want to find out more information about holding title as a married couple. You stated in a previous column: "Civil code Section 682.1 allows you to take title as 'community property with right of survivorship.' This means that upon the death of a spouse the property will be transferred as a matter of law to the surviving spouse without any probate and outside of whatever the deceased spouse's will provides."

Does this mean that the will of the deceased spouse will be ignored or made invalid? I thought that community property would only transfer to surviving spouse only if there is no will from the deceased spouse. Please help clarify this.

A If you hold title with your spouse "as community property with right of survivorship" this means that title to that property named in the deed will pass to the surviving spouse regardless of how the deceased spouse proposed to distribute his interest in that property in his will. Like a "joint tenancy" deed, this method of holding title is a "will substitute" and supercedes a will. It was designed by the legislature to help the surviving spouse avoid going to the probate court to clear the title when title is held merely as community property. If you desire to have your interest in your community property distributed differently I would generally suggest you have an attorney draw up a revocable trust agreement that will still allow you to bypass the probate court and at the same time allow the deceased spouse to distribute his/her property in accordance with an integrated estate plan.

Q I live in the Bay Area, but could never afford to buy here. About five years ago I bought a place in Santa Rosa that I rent out. The loan states that it is a "Rental." I am reaching retirement age and would like to sell the dwelling in Santa Rosa and buy something for me to live in. I don't know how to go about it because of the financial impact of taxes, or fees, or whatever the government takes because it is a rental and I want the new home in the Bay Area.

A I am assuming you have a taxable gain on the Santa Rosa property and would like to avoid paying that capital-gains tax when you sell the property. The only real option you have to avoid (defer) paying tax on the gain you have in the Santa Rosa property (other than to move to Santa Rosa for two years) is to do a 1031 tax-deferred exchange. This means you would sell the property in Santa Rosa and exchange it for a home of equal or greater value in the Bay Area. The exchange regulations allow you to sell the property and use a third-party neutral to hold the proceeds and then within a fixed period of time purchase the Bay Area property.

The law requires that the property that you exchange into be held for investment. I recommend that you rent the property out for at least two years, and then you could convert the property into your personal residence without having a taxable gain. The tax basis of your newly purchased property is calculated based on what you paid for the Santa Rosa property plus the additional costs (including debt or additional cash invested) of acquiring the Bay Area property.

It is beyond the scope of a news column to give you all the rules and procedures to follow in completing an IRS Code Section 1031 tax-deferred exchange. I would generally advise that you have a professional who is knowledgeable and experienced in this type of transaction give you guidance prior to making any decision; this may include a CPA and/or attorney. An experienced real-estate broker may also provide guidance, however very few brokers understand the details of this law and they specifically cannot give legal or tax advice.

J. Robert Taylor, J. D., a real estate attorney and broker for more than 20 years, has served as an expert witness and mediator and is on the judicial arbitration panel for Santa Clara County Superior Court. Send questions to Taylor c/o Palo Alto Weekly, P.O. Box 1610, Palo Alto, CA, or via e-mail at btaylor@taylorproperties.com.