Q DEAR BOB: You recently suggested paying no more than a 20 percent cash down payment and never paying all cash for a house or condo. The reason you gave is unforeseen circumstances, such as finding that the condo association is broke or that you bought near a toxic-waste dump. You say that if a buyer puts down 20 percent, that is all you lose. Are you suggesting that the homeowner walk away from the mortgage? -- Jack R.

A DEAR JACK: I didn't suggest that a homeowner walk away from his mortgage obligation. In most states, a lender who loses money on a foreclosure sale can seek a deficiency judgment against the defaulting homeowner. However, lenders rarely do so because of the expense, unless the defaulting borrower is wealthy.

The primary reason to make no more than a 20 percent down payment when buying a home is to avoid tying up a major portion of your assets, especially if you are retired. If you are a multi-millionaire, take the risk and pay all cash.

Especially when buying a new house or condo, if you pay all cash, you could be stuck if it turns out to be bad. A modest 20 percent down payment limits your maximum loss. If all turns out well, you can later pay down your mortgage or refinance.

For example, who do you think suffered the bigger loss in Hurricane Katrina? Was it the flooded-out home buyer who recently bought with a 20 percent down payment? Or was it the homeowner who had no mortgage, had no lender-required flood insurance and lost everything?

Whether your home is vulnerable to hurricanes, tornados, earthquakes, floods, landslides, wildfires or something else, I don't want you to lose everything by buying your home with 100 percent cash, especially if that is most of your reserves.

DEAR BOB: As senior citizens, we are thinking of getting a reverse mortgage on our home for extra income. But are the upfront expenses and interest charged tax-deductible? -- Roberto L.

DEAR ROBERTO: Reverse-mortgage upfront expenses, such as the loan fee, as well as accrued interest over the life of the mortgage, are added to your reverse-mortgage balance. You don't have to pay these costs out of your pocket.

Because these expenses are not actually "paid," the IRS says they cannot be deducted until the reverse mortgage "matures" and is paid off in full when you eventually sell your home, permanently move out or die.

DEAR BOB: Eight months ago, I bought a single-family rental house with a 5 percent down payment using an adjustable-rate mortgage. As I read about "real estate bubbles," I worry that I should either refinance to a fixed-rate mortgage or sell and take my profit. If I wait five years, I am afraid, the home might be worth less than today. What is your opinion? -- Max B.

DEAR MAX: Sorry, my crystal ball is foggy today. If you think your area is in a real estate bubble of peak market values for homes, today would be a great time to sell to take advantage of your short-term profit.

Be aware the long-term trend of home values has always been up, but there are peaks, valleys and plateaus along the way. However, I don't know of a better long-term investment than sound, well-located single-family houses. Do you?

DEAR BOB: What is the cost basis for the capital-gains exclusion on the sale of a principal residence? Isn't the capital gain the difference between the purchase price (not what is owed) and the selling price? -- Elizabeth M.

DEAR ELIZABETH: I am puzzled by your first question. The answer to your second question should help.

The adjusted cost basis for your home (or any property) is its purchase price, plus most non-deductible closing costs, plus capital improvements added during ownership, minus any depreciation deducted (such as for a home office or rental use).

Your adjusted sales price is the gross sales price minus sales costs such as the real estate sales commission. The difference between these two numbers is your taxable capital gain. You are correct that the mortgage balance is irrelevant.

From your home-sale capital gain, subtract your Internal Revenue Code 121 tax-free principal residence sale exemption up to $250,000 (up to $500,000 for a qualified married couple filing jointly).

That's presuming that you owned and lived in the principal residence for at least 24 of the 60 months before sale. Any remaining balance is taxable as a capital gain.

DEAR BOB: My mortgage lender is unwilling to discuss dropping my $118 monthly private mortgage insurance payment until May 2006, when I will have 24 months of ownership. I am willing to pay for an appraisal to prove there is no need for PMI because I now have well over 20 percent equity. But I don't want to sell or refinance. My FICO credit score is 750. Do I have any other recourse than refinancing to get rid of my PMI? -- Randy H.

DEAR RANDY: Your mortgage lender gets to set the rules for removing that wasteful $118 monthly PMI premium.

Yes, there is a federal law on this issue, but it won't help you or any PMI borrower because it requires the mortgage to be paid to below 78 percent of the purchase price.

For most PMI borrowers, that won't happen until at least the 10th year of the mortgage. Increased market value due to capital improvements and market value appreciation doesn't count under the useless federal law.

Now you know why I recommend avoiding PMI whenever possible. Unless you are willing to refinance with a lender who doesn't require PMI, you will just have to wait until you meet the lender's nonsense 24-month requirement in May.

DEAR BOB: I found a property for rental investment that I want to buy and exchange. But I have not yet sold my rental unit. Can I do a reverse Starker exchange? What happens to the money received when my rental property sells? -- Beverly C.

DEAR BEVERLY: Yes, you can do a tax-deferred "reverse exchange" by acquiring the replacement investment property before selling your current investment or business property.

However, title must be taken in the name of a qualified third-party accommodator, using your money. Unless you have a lot of cash sitting around the house, you might be better off tying up the replacement property with an option, or a lease option, to give you time to first sell your current rental property. Consult a tax adviser for details.

DEAR BOB: I have lived in my home less than a year, but I wish to sell it to build a new home. Isn't there some way around the capital-gains tax? I heard you can invest the gain to avoid the tax. -- Dana C.

DEAR DANA: Sorry. The old "residence replacement rule" of repealed Internal Revenue Code 1034 was abolished in 1997.

If the reason for selling your principal residence after less than 12 months of ownership is to build a new house, your long-term capital gain will be taxed at the 15 percent maximum federal tax rate, plus any applicable state tax. However, if the reason for your home sale is a job transfer qualifying for the moving-cost tax deduction, unemployment, divorce, health reasons or other "unexpected circumstances," you might be eligible for a partial Internal Revenue Code 121 principal-residence sale exemption. Your tax adviser has details.

DEAR BOB: I inherited land that has a cost basis of about $100,000. It was recently sold for $400,000. I am looking to buy a rental beach condo for $250,000. Can I delay reporting the capital gain on $250,000 as a tax-deferred exchange? -- Charles S.

DEAR CHARLES: If you already closed the sale of your land without having the sale's proceeds held by a qualified third-party accommodator-intermediary beyond your constructive receipt, you can't qualify for an Internal Revenue Code 1031 tax-deferred exchange.

However, if the land sale has not yet closed, you can arrange for an IRC 1031 tax-deferred exchange if the beach condo will be a rental property. If it is to be your personal residence or a vacation home, then it can't qualify for a tax-deferred exchange.

However, since you will be "trading down" from a $400,000 investment property to a $250,000 investment property, the $150,000 difference will be taxable as a capital gain.

DEAR BOB: My brother, sister and I own four rental properties. Two of the properties are insured. But two vacant buildings are not insured. We now hold titles in a partnership. Would we be more protected from lawsuits by holding title in a limited liability company? -- Carol O'B.

DEAR CAROL: Forming an LLC to hold title to the properties might be desirable in your dangerous uninsured situation. But by all means, I suggest you obtain liability insurance on those two vacant uninsured buildings.

If you hold title to your properties in an LLC, and you get sued and a big judgment is rendered against you, the judgment creditor might be able to "pierce the corporate veil" of the LLC. The LLC is relatively new, and the law is still evolving.

DEAR BOB: I read in the newspaper about the problems of having your principal residence title held in an irrevocable trust regarding Internal Revenue Code 121. Is the same true for a revocable living trust? -- Harold S.

DEAR HAROLD: No. Comparing an irrevocable trust with a living trust is like comparing apples and oranges. They are completely different.

A revocable living trust is a method of holding title to real estate. The two primary purposes are to avoid probate costs and delays after the owner's death, and manage the property if the owner becomes incapacitated.

However, property titles held in an irrevocable trust are different. They are not eligible for the principal residence sale Internal Revenue Code 121 tax benefit of the $250,000 exemption (up to $500,000 for a qualified married couple filing a joint tax return in the year of sale). Consult a tax adviser for details.

DEAR BOB: My husband and I bought an investment property in June 2004 with a friend. We held the title as tenants in common. The friend died in February 2005 without a will or trust. The property has appreciated nicely in market value. However, because of the delays in the probate process, it has appreciated an additional 15 percent to 20 percent since his death. We want to sell the property and divide the proceeds with the estate. Does the estate receive 50 percent of what the property was worth on the date of death or 50 percent of the sale proceeds when it actually sells? -- Shirley W.

DEAR SHIRLEY: The deceased's estate is entitled to 50 percent of the net sale proceeds. It is a shame that the probate process takes so long and costs so much, thus delaying the property sale.

The situation you describe shows why it is so important for every real estate owner to hold title in a revocable living trust -- so his or her estate can avoid probate costs and delays.

Unfortunately, in the situation you describe, the estate administrator appointed by the court cannot convey the property title without probate court approval. Consult a lawyer for details.

DEAR BOB: Can you recommend a good book for first-time home buyers? -- Dan W.

DEAR DAN: The best-selling book for home buyers and, in my humble opinion, the best home-buying book available today is "Home Buying for Dummies," by Ray Brown and Eric Tyson.

DEAR BOB: We recently sold land that we bought for investment and retirement purposes. Is there any way to avoid or defer paying tax on our profit, such as reinvesting in real estate or using the money to pay down our home mortgage? -- John M.

DEAR JOHN: Sorry, if you received the cash from the sale, it's too late to avoid paying tax on your profit. Your land sale is fully taxable as a long-term capital gain if you owned the property more than 12 months.

You missed the only opportunity to avoid tax, by making a tax-deferred Internal Revenue Code 1031 exchange for another investment or business property of equal or greater cost and equity. Paying down your home mortgage won't avoid capital-gains tax. Because you received the sales proceeds and they weren't held by a third-party intermediary beyond your constructive receipt, your long-term capital gain is taxed at the maximum 15 percent federal tax rate plus any state tax. Consult a tax adviser for details.

DEAR BOB: My wife and I bought our home a little more than three years ago. According to the listing, it is supposed to be 2,083 square feet. The information was supplied by the realty agent. But the public records, confirmed with the county tax assessor's office, show the recorded square footage at only 1,889. That's quite a difference. Do we have good cause for legal recourse and damages because the square footage was misrepresented by the seller or realty agent? Should we have the house professionally measured? Should our agent have checked the square before the sale? -- George W.

DEAR GEORGE: You didn't say where the house is or what the typical construction or valuation price per square foot is. But 194 "missing" square feet at $100 per square foot is $19,400. That's not petty cash.

Start with the seller's and realty agent's written representation. Did it include a disclaimer, as it should? If it said something like "Information deemed reliable but not guaranteed," then you are out of luck. Forget it.

If there was no such statement on your copy of the written evidence you have, your next step is to show you made your purchase offer based on the square footage of the house. This might be difficult to prove.

Just because the public records show only 1,889 square feet, that is not necessarily correct. You should hire a professional appraiser to measure your house. If it has unusual shapes, even two experienced appraisers might measure differently.

Because you waited three years, even if the statute of limitations hasn't expired where the house is located, don't get excited about possible lawsuit recovery. Chances are limited of finding a good lawyer to take your case on a contingency basis for a small amount ($19,400 in my example). Unless you have a strong case, with large potential monetary damages, maybe you should forget it.

DEAR BOB: Regarding that $500,000 principal residence home sale tax exemption, how long does it last after a spouse dies if both spouses owned and lived in the home two of the past five years? -- Norma B.

DEAR NORMA: The surviving spouse has until the end of the tax year of the spouse's death to claim the Internal Revenue Code 121 tax exemption of up to $500,000 for a qualified married couple filing a joint tax return in the year of the death.

But don't panic and rush to sell the home. Presuming you are the surviving spouse, if your deceased co-owner spouse willed his share of the house to you, then you have a new "stepped-up basis" on that share (or on the entire property value if it is in a community-property state).

In most situations, you need not be concerned about the lost $250,000 exemption if you don't sell the home by the end of this year. However, if your deceased spouse was not a co-owner on the title, then you should consider selling the home by the end of 2005 because you received no stepped-up basis, as you continue to be the sole owner. Full details are available from your tax adviser.

DEAR BOB: I own two houses, about 75 miles apart. On weekdays, my wife and I stay in one house. On weekends, we go to the other house. We have been doing this for about two years. If we decide to sell our "weekend house," can we qualify for that $250,000 or $500,000 tax exemption you often discuss? -- Roger F.

DEAR ROGER: No. To qualify for the exemption, you must have owned and occupied the home as your primary residence for at least 24 of the 60 months before its sale.

The house where you spend the weekdays appears to be your principal residence, and the other house is your secondary home. Therefore, if you sell that second home, because you can't meet the principal residence test, then your capital gain will be taxed at the maximum 15 percent federal tax rate, plus the state tax rate.

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) 2005, Inman News Service