Paying Cash for a Home Carries Risks

Q DEAR BOB: I plan on paying cash for my next residence. Are there any hidden dangers in paying cash? -- Mark N.

A DEAR MARK: Please don't do that unless you are (1) very wealthy, (2) will be spending cash you never need to see again and (3) can afford to tie up a large amount of cash in one asset.

A better alternative is to pay a 20 percent or 25 percent cash down payment and obtain a fixed-rate 15- or 30-year mortgage for the balance of the purchase price. Then, just in case you have purchased a bad house or a bad condo, you won't have all your nest egg tied up. After a few years of owning and living in the home, if all turns out well, then you can pay off the mortgage. (Of course, be sure it doesn't have a prepayment penalty.)

I still recall a nightmare letter I received a few years ago from a retiree who bought her retirement condo for all cash. Only after moving in did she discover that the complex was badly managed and occupied by about 50 percent renters, who caused many problems.

When she tried to sell her condo, she discovered that mortgage lenders either refused to loan to new buyers or charged high interest rates because of the high risk with so many renters. The only way she could get her cash out was to sell to another all-cash sucker.

DEAR BOB: I own a house that I lived in for four years, until converting it to a rental last month. If I sell it within 24 months, will my cost basis be calculated on my original purchase price or on the property value when I converted it to a rental? -- Leonard H.

DEAR LEONARD: Market value on the date of conversion to rental status is irrelevant. Your adjusted cost basis for the house is your original purchase price, plus capital improvements you added during ownership. This is your basis for calculating your rental depreciation deductions.

Presuming you meet the 24-out-of-last-60-months primary-residence ownership and occupancy tests of Internal Revenue Code 121, you can rent the house up to 36 months after moving out before losing your $250,000 principal-residence-sale tax exemption. However, upon sale, the depreciation you deduct during the rental period will be taxed at the special 25 percent federal recapture tax rate. For details, consult a tax adviser.

DEAR BOB: About three years ago I bought a condo as my primary residence. I recently got married and want to make my wife a co-owner to make conveyance easier if something happens to me. Refinancing isn't an option because the interest rate would go up by about 2 percent. What do you recommend? -- Jerry T.

DEAR JERRY: You can sign and record a quitclaim deed to your new wife for a 50 percent interest in the property. If you want her to receive full ownership if you die first, holding title as joint tenants with right of survivorship (or as tenants by the entireties in states allowing that method for married couples) avoids probate upon a co-owner's death. If she dies first, then you become the sole owner again.

Better yet, a revocable living trust can specify that when you die she receives title to the condo. That way, just in case your marriage doesn't work out, you haven't given up control of the condo. But when you die she receives the title without probate. Also, there are additional living-trust benefits if you become incapacitated. Your wife should probably be named successor trustee to your living trust.

DEAR BOB: About 18 months ago, I purchased a tenancy in common with a partner. There are two houses on one lot. We recently converted them into two separate condos. I have been living in my house since the purchase. I plan to sell my condo house next spring, two years after we originally purchased. Does the $250,000 principal-residence-sale capital gains exemption of Internal Revenue Code 121 apply from the date the property was purchased or from the date it was converted into a condo? -- John M.