Even With a Foreclosure, You Have Options

By Robert J. Bruss
Saturday, February 10, 2007

Q: DEAR BOB: I am four months late on my mortgage payments because of a job loss. Now I am in the process of foreclosure. What are my options? I am working again but do not have all the money yet to catch up on my monthly payments. Any advice? -- Jawanna P.

A: DEAR JAWANNA: Please don't bury your head in the sand, as many borrowers who are in mortgage default do. Instead, contact your mortgage lender immediately by phone.

Explain your situation very politely. Ask for a forbearance agreement and a loan workout plan. The forbearance agreement could allow you to make reduced payments for a specified period; the loan workout plan lays out how you will eventually pay all that you owe. This presumes that you can now afford to pay at least the regular monthly mortgage payment.

Ask that your unpaid mortgage payments, probably totaling several thousand dollars, be added to your mortgage principal. That would extend your mortgage by several months, but then your mortgage can be reinstated in good standing with the lender.

Lenders do not want to foreclose. They lose money on almost every foreclosure. But lenders will insist that their borrowers make the monthly payments on time.

If you are unable to resume the regular monthly payments, then ask the mortgage lender for time to sell your home to pay off the mortgage balance.

Do everything you can to avoid a foreclosure sale. Worse yet, filing for bankruptcy would merely delay losing your home by foreclosure if you are unable to make the monthly payments.

DEAR BOB: I read an article on a Web site that says if you flip a property without holding title for 12 months, you will be taxed at 50 percent of profit. But if you hold longer, the tax is only 15 percent. True or false?

-- Puba H.

DEAR PUBA: Neither is fully correct. If you hold title to a fix-up "flipper" property or any asset for less than 12 months, your sale profit will be taxed as ordinary income, just like your job salary, dividends and interest. The exact federal tax rate varies widely, depending on your income tax bracket, from a low of 10 percent to a maximum of 35 percent, plus state tax.

However, if you hold a flipper property or any asset longer than 12 months, then your maximum federal long-term capital gain tax rate is 15 percent of your profit (plus applicable state tax). If you are in a low tax bracket, your long-term capital gain tax will be even lower than 15 percent.

DEAR BOB: Do I need to sell my house before the one-year anniversary of my husband's death to preserve that $500,000 home-sale tax exemption? My capital gain will be in excess of $250,000. -- Gloria R.

DEAR GLORIA: Please don't rush to sell your home. The anniversary date of your spouse's death is irrelevant for tax purposes.

To qualify for the $500,000 principal-residence-sale tax exemption of Internal Revenue Code 121, presuming both spouses met the 24-out-of-last-60-months occupancy test, the principal residence must be sold within the same tax year as the spouse's death.

The reason you don't need to rush to sell your home is that, presuming you inherited your late husband's share of the residence, you will receive a new "stepped-up basis" as of the date of his death.

If the principal residence is in a common-law state, you will receive a 50 percent stepped-up basis to market value as of the date of death. However, if the house is in a community-property state, as the surviving spouse you will get a new 100 percent stepped-up basis so you will have little or no capital gains tax if you sell the home within a few years after your spouse's death. For details, consult a tax adviser.

DEAR BOB: We had our house on the market for almost four months with no offers. None of the houses in our price range have sold. Our house shows well, according to the local real estate agents. We are thinking of taking it off the market for a short period and then relisting it to start clean. How long should we keep it off the market? Should we use the same agent? She has been great but won't give us a straight answer on this. -- Jan L.

DEAR JAN: It used to be possible to start clean so your home would look to buyers and their agents like a new listing. However, most multiple listing service computers can now report how many days a house has been on the market in the past 12 months, both in its current and previous listings.

If you are satisfied with your agent's services, relist with her, but never for longer than 90 days at a time. However, if she wouldn't give you a straight answer, I suggest that you interview at least three other successful local agents to ask them why, in their opinions, your home didn't sell.

The obvious problem is it might be overpriced. But some sellers discover that their listing agent is the obstacle. Perhaps she is uncooperative or disliked by local agents. Maybe she makes your home difficult for other agents to show to their prospective buyers.

By interviewing other agents, you will get their comparative market analyses to show your home's current market value based on recent sales prices of comparable nearby homes, and the asking prices of similar neighborhood residences.

DEAR BOB: I am considering investing in rental property. Is each property considered an entity, eligible for the $25,000 annual tax loss deduction from ordinary income? Or is the loss limited to $25,000 for all of an investor's properties? -- Martin S.

DEAR MARTIN: Unless you or your spouse qualifies for unlimited annual investment property deductions as a "real estate professional" spending at least 750 hours per year on your real estate activities, you are limited to a $25,000 total annual loss deduction from all your investment properties against your ordinary taxable income.

However, unused losses (mostly from the noncash depreciation deduction for wear, tear and obsolescence) are "suspended" for use in future tax years, or when you sell a property you can use suspended losses to cut your taxable capital gain. For details, consult a tax adviser.

DEAR BOB: My husband and I have been profitably flipping houses for several years. We are planning on separating soon. I plan to live in my next fixer-upper while making repairs. If we should both own and occupy separate principal residences for a minimum of 24 months within the next 60 months, and one or both of us decides to sell within that time frame, will we each qualify for up to $250,000 tax-free profits even if our divorce has not been finalized by then?

-- Sherry F.

DEAR SHERRY: If your husband lives in one principal residence for the required 24 of the last 60 months before its sale, and you live in another principal residence for the same required time, presuming that individual's name is on the title to the home he or she is living in and selling, then each can qualify for up to $250,000 principal-residence-sale tax-free profits, thanks to Internal Revenue Code 121. (One house per person, please -- you can use this tax break only once in 24 months.)

When your plans become definite, run them by a tax adviser to be certain each of you can qualify for $250,000 tax-free principal-residence-sale profits.

DEAR BOB: I own an unusually shaped lot that juts in front of my neighbor's house. I am willing to execute an equal land swap with him. What is the process to document this arrangement? Will this affect our title insurance?

-- Denis M.

DEAR DENIS: This is not a do-it-yourself project. Please consult an experienced real estate lawyer to guide the land swap through the bureaucratic maze, such as recording new parcel maps and insuring the new boundaries for each parcel.

DEAR BOB: I have paid all the property taxes on my mother-in-law's house for the last six years. She died in 2005. On my 2006 income tax return, can I deduct her 2006 property taxes that I paid? My husband and his sister are the sole heirs. The house is up for sale. I am not sure if probate is completed yet. -- Ellen H.

DEAR ELLEN: If your name is not on the title to the property, you have no legal obligation to pay the property taxes. Therefore, you are not entitled to any tax deduction for being a good daughter-in-law and volunteering to pay the property taxes.

It sounds as if the title is still in the estate, so even your husband, as an heir, wouldn't yet be entitled to the property tax deduction.

DEAR BOB: After much research, my husband, who is now 74, decided to get a senior citizen reverse mortgage on our home two years ago. Since I was only 60 at the time, I quitclaimed my interest in the house to him because I was too young. We chose the reverse-mortgage line of credit and have withdrawn only as much as our savings would cover if my husband dies. I know I could get a reverse mortgage, as I am now 62, but our question is whether our house will have to go into probate court when my husband dies, since I am no longer on the deed. How can we avoid this? Our home is our biggest asset. -- Sheila P.

DEAR SHEILA: That's easy. Your husband can transfer title from himself to his revocable living trust, which, presumably, will name you as the successor trustee and the future beneficiary should he die first.

Reverse-mortgage lenders have no objection to borrowers placing title to their homes into their living trusts after the reverse mortgage is recorded.

By placing the home title into your husband's living trust, probate costs and delays will be avoided if he dies first.

Equally important, if your husband should become incapacitated, such as with Alzheimer's disease or a severe stroke, as the successor trustee you can then manage the living-trust assets, including selling or refinancing of the house.

DEAR BOB: Thank you for writing about umbrella insurance policies some time ago. Until I read your article, I had been carrying $1 million liability coverage on my house and three rental properties and $5 million on my automobile policies. My insurance agent advised the high liability coverage because of my high net worth. When I clipped your article and faxed it to my insurance agent, he said I could reduce the liability coverage on each property and my automobiles to $300,000 each, and obtain a $5 million liability umbrella policy for slightly lower total premiums. Your advice more than paid for a lifetime subscription to the newspaper.

-- Carl W.

DEAR CARL: An umbrella liability policy is an insurance policy that takes over coverage on large liability losses exceeding the basic insurance policy coverage. It is best to have all your property liability policies with the same insurer so there is no conflict between insurance companies.

To illustrate, suppose you are at fault in a bad automobile accident that injures or kills several people. Your basic auto policy will pay the first $300,000 of liability coverage. Then your umbrella policy will take over and pay any additional liability losses up to $5 million total.

If you think you need additional liability coverage above $5 million, the additional premium for a few million dollars more will be only several hundred dollars.

DEAR BOB: You recently said a tenant should have renter's insurance to pay for damage to his apartment. The reader left a dinner on the stove, and the fire did about $15,000 damage to her apartment. It has always been my understanding that renter's insurance simply covers the tenant's personal belongings, such as clothing and furniture. But the owner is responsible for the apartment house or detached rented house. Am I wrong?

-- Beverly B.

DEAR BEVERLY: If a tenant has a renter's insurance policy, it covers loss due to theft and fire affecting the tenant's personal property. But it also provides liability coverage for the tenant's negligence.

For example, if I visit a friend's apartment, trip over a loose rug and am injured, the tenant's rental insurance policy will pay for my injuries due to the tenant's negligence. The same renter's policy also provides liability coverage if the tenant's negligence causes damage to the landlord's premises, up to the policy limit.

Similar insurance policies are available to condominium owners, who should always carry condo owner's insurance even though the condo homeowners association insures the complex's common areas, including the building structure, for fire and liability coverage. For details, consult an insurance agent.

DEAR BOB: I am 63 and hope I can continue working until I am 70, when my Social Security benefits will nearly double. My $935,000 home needs about $30,000 of repairs. I had hoped to live on reverse-mortgage income until I retire. But the amount I would receive is so small I couldn't afford the repairs. It seems I have no recourse but to sell my 50-year-old home. Any suggestions? -- Helen W.

DEAR HELEN: Your real problem is you are too young and your life expectancy is too long to gain maximum benefits from a senior-citizen reverse mortgage. Because you didn't mention any existing mortgage, I will presume there is none.

Another possibility is to obtain a home equity credit line to pay for the $30,000 of repairs. But the big drawback is a home equity loan requires monthly payments whereas a reverse mortgage does not require any payments.

As you probably know, there are three nationwide reverse-mortgage lenders: the Federal Housing Administration, Fannie Mae and Financial Freedom Plan. FHA and Fannie Mae are usually best for homes worth up to $500,000. Above that, Financial Freedom Plan often is the best alternative.

Please consult a reverse-mortgage representative who offers all three plans so you can compare them. You can find reputable reverse-mortgage originators at http://www.reversemortgage.org.

DEAR BOB: You often mention Internal Revenue Code 121. To qualify, you say the principal-residence owner must reside in the home at least 24 of the last 60 months before its sale. Does that mean I have to own my house at least 60 months before I qualify for the $250,000 exemption? Also, you say this tax break can be used every 24 months. How does that fit in with the 60 months? -- John L.

DEAR JOHN: Internal Revenue Code 121 is very flexible. To qualify for the principal-residence-sale exemption up to $250,000 for a single owner, or up to $500,000 for a qualified married couple filing a joint tax return, the seller(s) must have owned and occupied their primary dwelling an aggregate 24 out of the last 60 months before the sale.

The 24 months need not be continuous. For example, you could live in your house for a year, rent it out for two years to tenants, and move back in for another 12 months to qualify.

There is no need to own the home for 60 months. You can qualify for this tax break if you bought your principal residence as recently as 24 months ago, providing you occupied it as your "main home" for those 24 months.

IRC 121 can be used over and over again, without limit, but not more frequently than once every 24 months. For details, consult a tax adviser.

DEAR BOB: My daughter will be buying a house with her boyfriend, whom she does not plan to marry. How do you recommend they take title together? Is joint tenancy a good idea? -- Kenneth R.

DEAR KENNETH: I'm sure your daughter has her reasons for buying a house with a guy she doesn't plan to marry. But I can see endless complications.

I do not recommend they hold title as joint tenants with right of survivorship. That means if one of them dies, the survivor owns the entire property. Is that what they really want?

When two co-owners take title together, they usually hold title as tenants in common. Then, if one of the tenants in common dies, their ownership share passes according to the terms of their will.

But a big disadvantage of tenant-in-common ownership is that if one co-owner wants to sell but the other doesn't, one co-owner can bring a partition lawsuit to force a sale of the property.

Consider holding title in a partnership, which allows specifying terms that should be considered, such as a buyout agreement, or what happens if one partner can't pay his or her share of the mortgage payment and other expenses. Your daughter should consult a real estate lawyer in the community where the property is located to discuss her title choices.

DEAR BOB: My dad died in 2005. He had no will. Mom passed away in 1999. He left a house worth around $500,000. There are five adult children. His estate has been in probate almost two years, with no sign of any conclusion soon. Dad left debts of about $125,000. The estate executor has sold off dad's car, furniture, etc., to pay the unsecured debts. But there was a $40,000 mortgage on the house. I think we should sell the house to pay off the mortgage and then split the proceeds. But two sisters refuse to agree to the house sale. What can we do? -- Ralph S.

DEAR RALPH: Before the estate assets can be distributed to the heirs, who I presume are the five offspring, the estate debts must be paid. If there are not enough liquid assets to pay the debts, such as personal property, stocks, bonds and bank accounts, then the house will have to be sold even though the two sisters don't want to sell.

In most cases, it will be the probate court judge who makes the final decision if the estate administrator can't reach a consensus with the heirs.

Your situation shows what can happen when a property owner dies without a will and there is disagreement among the heirs. I can see why the probate has taken two years so far. At this point, the best you can do is try to get all the heirs to agree on a course of action. Otherwise, it will be up to the probate judge, and he might not decide what the heirs prefer.

DEAR BOB: Upon the recommendation of a trusted friend, my husband and I invested about $225,000 in a group investment in a shopping center. We had never seen the shopping center, but the real estate agent said it was in a good area. That's true. However, it is now about 40 percent vacant due to bad management. Also, it needs at least $200,000 of repairs just to make it attractive to prospective retail tenants. It is mortgaged to the hilt so we can't borrow more on a third mortgage. The other investors refuse to put any cash into the shopping center. The mortgage is two months in default. What can we do? -- Helen R.

DEAR HELEN: I do not recommend group real estate investing, especially when the property is located a long distance away and the owners are at the mercy of the property manager.

At this point, it appears selling the shopping center is the only alternative to losing it by foreclosure. I wish I could be more encouraging, but without any equity on which you can borrow, getting the co-owners to agree to a sale might be best.

DEAR BOB: In 2003 we bought a modular home and had it set up on a lot we owned. After all the expenses of having a foundation built, plumbing and wiring installed, etc., when we sold it in late 2006 we barely got our investment out. We learned modular homes can be lousy investments. Do we have to report this sale to the IRS? -- Thomas R.

DEAR THOMAS: If your sales proceeds did not equal the amount you invested in the modular home and the cost of the lot, then you had no capital gain profit. But the sale must be reported on Schedule D of your income tax returns, although no tax will be due if you had no profit.

However, if the home was your principal residence for at least 24 of the last 60 months before its sale, then Internal Revenue Code 121 does not require you to report the sale unless your capital gain exceeded $250,000 (or more than $500,000 for a married couple filing a joint tax return).

Readers with questions should write Robert J. Bruss at 251 Park Road, Burlingame, Calif. 94010, or contact him via his Web page, http://www.bobbruss.com.

© 2007, Inman News Service