Q DEAR BOB: About five years ago my wife and I were given a home in Florida that is now worth about $800,000. We use it four months each winter. If we sell it, and buy another property worth the same amount, is there a capital gain tax to be paid? What is the best way to avoid paying capital gain tax on our sale profit? -- Maxwell D.

A DEAR MAXWELL: Your first step is to determine your adjusted cost basis. If the property was inherited, your stepped-up basis is the property's fair market value on the date of decedent's death or alternate date used by the estate. If the property was a gift, the bad news is your basis is the donor's adjusted cost basis, which was probably low.

The cost of any capital improvements you added during ownership should be added to your original basis to arrive at your current "adjusted cost basis."

Your second step is to determine the property's approximate current market value, by hiring a professional appraiser or by checking recent sales prices of comparable nearby homes.

If you sell that property today, your capital gain will be fully taxable. You don't qualify for the Internal Revenue Code 121 principal residence sale tax exemption up to $250,000 (up to $500,000 for a qualified married couple filing jointly).

The property also is not eligible for an Internal Revenue Code 1031 tax-deferred exchange because it is not held for investment or for use in a trade or business.

You and your wife can qualify for up to $500,000 tax-free principal residence sale tax-free profits by making it your primary residence. To qualify, you must have owned and occupied it an "aggregate" two of the five years before its sale. Consult a tax adviser for details.

DEAR BOB: I am getting ready to sell my house. I am considering having the exterior painted. It is an older house with old plumbing, which works well enough. However, it does need copper pipes to increase the water pressure. Is it worth investing in new copper pipes to increase the asking price? I can't afford both the painting and the plumbing -- Franklyn A.

DEAR FRANKLYN: Painting the exterior of your home and the interior if you can afford it will substantially increase the marketability of your home. Installing copper pipes won't increase the market value, however. Some prospective buyers might avoid buying your home when they, or their professional home inspector, discover the need for copper pipes.

My suggestion is to get written bids from two local plumbers for installing copper pipes. If your home doesn't sell within 90 days after you list it for sale with a successful local realty agent, then you might consider discounting the asking price by the cost of the new plumbing.

DEAR BOB: A few weeks ago you had an item about how much liability insurance to carry on a principal residence and investment properties. You said your insurance agent recommends $300,000 liability insurance on each property and your auto, plus a $3 million umbrella liability policy. I carry $500,000 liability insurance on each property, and my cars, plus a $1 million umbrella policy. What about the fire insurance coverage? How much hazard insurance should I carry? -- Michael F.

DEAR MICHAEL: You might be able to save money and improve your coverage by dropping to $300,000 the liability coverage for each property and your cars, but adding an mbrella liability policy of $2 million or $3 million.

Be sure to carry replacement-cost insurance on each property.

Most insurance companies have stopped writing guaranteed replacement cost policies. Instead, they now write replacement cost policies for their recommended replacement cost, plus up to 10 percent or 20 percent additional.

Make certain your hazard insurance policy includes building code upgrade coverage because rebuilding a home damaged in a fire usually requires complying with today's tougher building codes. For full details, consult two or three insurance agents to discuss your coverage.

DEAR BOB: My question involves a rental house I inherited many years ago. It has dramatically increased over the years. I understand that nothing can be taken out of a trade, but what happens to the "value at death" portion of the value, which I feel should not be included in the price? The house I inherited was worth about $300,000. Today, it is worth around $700,000. Can I make a trade for a new property worth more than $300,000 without paying tax? Or do I have to trade for property worth more than $700,000? -- Delray G.

DEAR DELRAY: To make an Internal Revenue Code 1031 tax-deferred exchange of your rental house, you must trade equal or up in both market value and equity without receiving any taxable "boot," such as cash or net mortgage relief.

The $300,000 market value of the inherited rental house is irrelevant to your situation. To qualify for a tax-deferred exchange, you must trade for another rental or business property worth at least $700,000 in your situation.

DEAR BOB: Our adult son has decided to go into a different profession. My husband and I have agreed to assist him financially, so we will be paying his condo mortgage payments. Can we claim our son's mortgage interest as a tax deduction on our income-tax returns by showing our cancelled checks for the mortgage payments? -- Rose S.

DEAR ROSE: To qualify for the tax deductions of the mortgage interest and property taxes you pay on your son's condo, you must be legally obligated to make those payments -- you must be on the title.

Your son can easily add you to his title by signing and recording a quit claim deed, granting you an interest in the condo. The deed should also specify how title is to be held, such as joint tenancy with right of survivorship.

DEAR BOB: Thank you for the item about the ex-husband whose ex-wife defaulted on their mortgage on the house she got in the divorce, thus ruining his credit and now there's nothing he can do. You courageously said, "Your divorce lawyer messed up." When one ex-spouse gets the house and is supposed to refinance to get the other ex-spouse's name off the mortgage obligation, as a divorce attorney I insist this be done before the divorce is final. If it isn't, my experience has been the spouse living in the house usually fails to refinance and, if the mortgage payments are late, the other ex-spouse incurs credit problems. -- Clint W

DEAR CLINT: I also received a letter from a Virginia family law attorney who suggests the mortgage refinance requirement be part of the divorce judgment. She said, at least in Virginia, if the ex-spouse living in the house fails to refinance, that ex-spouse can then be held in contempt of court. But I like your suggestion better.

DEAR BOB: Next month I will be closing on the purchase of a new condo. I am paying cash so no mortgage is involved. The builder suggests I buy title insurance, at a cost of about $2,200. But I'm thinking, because the condo is new and I'm paying cash, there can't be any title problems. Is title insurance in my situation a waste of money? -- Agnes H.

DEAR AGNES: You need an owner's title insurance policy far more than most home buyers. There are so many potential title risks in your situation I can't list them all.

For example, if the builder failed to pay a sub-contractor, that sub-contractor can file a mechanics' lien on your new condo and, if he doesn't get paid, foreclose on your condo. Or there might be forged signatures on the title documents (the biggest cause of title losses). Or the builder's original title to the property might be defective.

Always insist on receiving an owner's title insurance policy when acquiring title to any property, especially a brand-new condominium.

DEAR BOB: My husband owned his home when we met and later married. We sold that home in 1993 and rolled over the profit into our current home. We are now thinking of selling our current home. How does the new capital gains tax law you often discuss apply to us? -- Christine M.

DEAR CHRISTINE: As you probably know, Internal Revenue Code 121 allows up to $250,000 (up to $500,000 for a qualified married couple filing jointly) tax-free, principal-residence sale profits. To qualify, you must own and occupy your principal residence an "aggregate" two of the five years before its sale.

Congress enacted IRC 121 in 1997. However, under the old, now-revoked IRC 1034, your husband deferred capital-gain tax on the sale of his previous principal residence by buying a replacement principal residence of equal or greater cost. Your adjusted cost basis for the current home is its purchase price, minus the amount of deferred capital gain from the sale of the previous home, plus any capital improvements added during ownership.

For example, suppose you and your husband paid $200,000 for your current home. But imagine there was $75,000 deferred "rollover" capital gain from the sale of the previous principal residence. That means your adjusted cost basis for your current home is $125,000, not $200,000. To that amount, add the cost of capital improvements you made during ownership. The result is your current adjusted cost basis.

To determine your present home's capital gain upon sale, subtract its adjusted cost basis from your adjusted sales price -- gross sales price minus selling costs.

You can then use IRC 121 to qualify for up to $500,000 (up to $250,000 for a single principal-residence seller) tax-free profits. There is no longer any need to buy a replacement principal residence, as there was under the old law.

DEAR BOB: Someone once asked about the tax implications of selling his $490,000 house to his son for its adjusted cost basis of $260,000 so he wouldn't owe any capital gains tax. You said there is no tax law requiring the sale of a home for its full market value. Clearly, you are right. But wouldn't there be a gift or estate tax implication? Presumably, the difference between the home's fair market value and the sale price can be considered a gift (minus the $11,000 annual allowable tax-free gift per donee). Otherwise, this seems like this a huge loophole in the gift and estate tax. -- Jim C.

DEAR JIM: Anyone can give away up to $11,000 annually per donee without any gift tax consequences. Over $11,000, however, a federal gift tax return must be filed even if no gift tax is due.

In the situation you describe, where the parent sold a property worth $490,000 to a child for its cost basis of $260,000, it is arguable that the $230,000 difference is a gift.

However, no federal gift tax will be due if the donor's total lifetime gifts exceeding $11,000 each did not surpass the current $1 million lifetime federal gift-tax exemption. Consult a tax adviser for details.

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

(c) 2004, Inman News Service