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Claiming $500K tax break after spouse dies

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POSTED December 23, 2011 7:49 p.m.

DEAR BENNY: My husband died this past August. We owned and lived in our house for more than 15 years, but now I want to sell. Am I eligible for the up-to-$500,000 exclusion of any profit that I will make? --Annie

DEAR ANNIE: According to the Internal Revenue Sesrvice, you may qualify to exclude up to $500,000 of gain, if you meet all of the following requirements:

•the sale took place after 2008;

•you sell the house within two years after the date your spouse died;

•you have not remarried;

•you and your spouse met the ownership and use test at the time he died (this means that you both owned and lived in the house for two out of the previous five years prior to sale); and

•neither you nor your spouse excluded gain from the sale of another house during the last two years before the date of death.

You can get more information from IRS Publication 523, entitled “Selling Your Home,” for use in preparing your 2010 federal tax return.

DEAR BENNY: My wife and I bought a house in 2009. We are divorcing and both want to sell the house. I am not sure if the house can be sold to cover the loan on the house. What happens to us if the house is sold for less than what we owe on the loan? --Joel

DEAR JOEL: You are referring to a short sale, where your mortgage lender allows you to sell the house at a price that is lower than what you owe. Much depends on the terms and conditions that the lender imposes when it gives you permission to sell.

If the lender will permit the sale without conditions, then more power to you and your wife. Of course, she will have to cooperate with the sale, and both of you will have to sign any documents required by the lender.

On the other hand, should your lender require that a certain sum be paid over and above the sales price, this is something that you and your wife (via your respective divorce attorneys) will have to work out.

Have you given any thought to holding the property as a rental investment? There are taxable consequences (good and bad) you should discuss with your attorneys, but it is an option you might want to consider.

DEAR BENNY: I had two properties foreclosed on this year. Although we had short-sale offers on both properties, for some reason the banks would not accept the offers. One of them was my primary residence, which had a first loan of $417,000, and a second in the amount of $180,000. The second home was an investment property, for which the first loan was $290,000 and the second loan was $60,000.

I have some assets, including a commercial building that produces very little income due to the fact that there is a large vacancy within it. Because of the vacancy, my income is less than $10,000 a year.

Will the lender come after me for unpaid debt in regards to the aforementioned foreclosed properties? If so, how will it know whether I have assets or not? Can the lender put a lien on my commercial property? What are the statutes of limitations for the lenders? Is there anything I can do to get out of this mess aside from declaring bankruptcy? --Kim

DEAR KIM: I am surprised that you were getting different answers, especially from attorneys. All of your questions are state-specific, and depend on the various laws in your state.

For example, in general, the statute of limitations around the country is three years. That means that when three years pass after an event for which you could have been sued over, the courts will not allow such lawsuits to proceed.

The purpose of a statute of limitations is to make sure that if you have a valid claim, you should bring it promptly. Otherwise, witnesses forget facts or die; documents get stale, and it is unfair to file a lawsuit so long after the event took place.

However, state law differs, both with respect to the number of years as well as to the type of incident involved. For example, in many states you cannot file a libel suit after one year.

Additionally, if a document is under seal (i.e., with a notary seal or even just the letters LS -- for “legal seal”), many states allow such matters to be brought for a much longer period of time, even up to 12 or more years.

Additionally, state laws differ on whether a lender that has foreclosed can sue the borrower for a deficiency judgment, a situation that could happen if, for example, a borrower owed $250,000 on the mortgage but the lender received only $150,000 from the foreclosure sale, leaving a deficiency of $100,000.

In the District of Columbia where I practice law, a lender can sue for the deficiency. However, in some 10 states such as Alaska, California, Arizona and Minnesota, laws have been enacted that specifically prohibit a lender from suing for the deficiency.

DEAR BENNY: When it came time to sign our mortgage loan, a great deal of emphasis was put on the fact that nothing in the loan could be changed -- it had to be signed as written. No one would tell us why. Can you? --Mona

DEAR MONA: That’s not completely accurate. I have often changed terms and conditions of a client’s loan when we were at the settlement (escrow) table. However, I needed the lender’s approval, and depending on the change, we needed corrected loan documents.

However, the great majority of loans are sold by the original lender. And the buyers of these loans want to make sure that there are no hidden changes in the documents that could hinder the holder of the papers from collecting on the promissory note or foreclosing on the property.

In other words, uniformity is important, and thus lenders do not want their legal documents changed.

DEAR BENNY: I read your column on gifting. It notes that everyone has a $5 million lifetime gift tax credit through 2012. My question has to do with the receiver of the gift. For example, if the reader in your piece just gifts the $460,000 residence to his aunt in 2012, does the aunt owe taxes on the receipt of the gift? --Rick

DEAR RICK: In general, the recipient of the gift (donee) has no immediate tax consequences. However, it is important to understand that when you get a gift of real estate, the tax basis of the donor (or giftor) becomes the tax basis of the giftee.

Let’s analyze this: I own a house that I bought years ago for $50,000 and have made no improvements to it. My tax basis is $50,000. The house is now worth $400,000. I gift the entire house to my aunt. She does not have to pay any tax on the gift, but her basis for tax purposes is $50,000.

If she should sell it for $400,000 and not be eligible for the up-to-$500,000 exclusion of gain (or $250,000 if filing a separate tax return), and if she held the property for at least one year, she would have to pay capital gains tax on her $350,000 profit ($400,000 minus $50,000), which, at today’s 15 percent rate, comes to $52,500.

If she inherited the property, she would be able to take advantage of the stepped-up basis, namely the value of the property on the date of death. In this case, if she sold for $400,000, she makes no profit and thus pays no tax.

That is why I always caution parents against giving their children the family home. In most cases, you may be giving them a tax problem as well as the house.

One note of caution, however: The only situation in which the donee would be liable for gift tax is if the donor has gifted more than the exempt lifetime exemption amount and owes tax but doesn’t pay it. Then the gift tax could follow the gift in the hands of the donee.

Benny L. Kass is a practicing attorney in Washington, D.C., and Maryland. No legal relationship is created by this column. Questions for this column can be submitted to benny@inman.com.

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