Posted on Fri, Feb. 24, 2006     The Charlotte Observer - displayed by permission

ROBERT BRUSS

If tenant-relative lingers, you may lose tax break

Q. I have owned and lived in my house for 11 years. If I decide to rent it to a family member, am I correct that the capital gains won't be taxed until after five years? My wife and I owe $75,000 on our $350,000 house.

Your understanding is not quite correct. To qualify for up to $500,000 tax-free principal-residence sale profits (up to $250,000 for a qualified single homeowner), Internal Revenue Code 121 says you must have owned and occupied your principal residence at least 24 of the 60 months before its sale. You appear to qualify.

You can rent the house to your family member for up to 36 months after you move out. If you don't sell within 36 months after vacating, however, you lose your $500,000 tax-free principal-residence sale exemption.

Snowbird selling condo

Q. I am a part-time Florida snowbird who wants to sell my condo and buy another. Your articles emphasize passing the 24-60 test. But how important are the home seller's location of employment, location of the main home for family members, mailing address for bills, address on federal and state tax returns, driver's license, car registration, voter registration, bank accounts and civic affiliations?

It sounds like you have been studying. All those criteria are important if you own more than one residence. Those tests are listed in IRS literature and various tax books to help determine where your principal residence is located.

However, you omitted the primary test: Where do you spend the most time each year?

Although you might meet the 24 out of last 60 months ownership and occupancy test of Internal Revenue Code 121 to qualify for up to $250,000 principal residence sale tax-free profits for your Florida condo, you could also meet the same test for another home. That's when the criteria you listed become important if the IRS audits you.

The only court tax decision so far interpreting IRC 121 (the Guinan case) placed heavy emphasis on where the home sellers filed their income tax returns. For full details, please consult your tax adviser.

`Negative am' mortgages

Q. What do you think about "negative am" home loans? My husband and I keep hearing the radio ads and investigated. We want to refinance our home to take out tax-free cash to pay for a family room addition. Although my husband's employment is stable, he is subject to transfer to another city. In fact, we expect a transfer within five years. Meanwhile, we badly need more home space for our two energetic kids. We love the community, especially the great schools. Only a corporate transfer promotion will get us to move. But a "negative am" mortgage will give us the lowest monthly payments. What do you advise?

An adjustable rate negative amortization mortgage means your monthly payment is fixed for six to 12 months (and sometimes longer), but the loan interest rate adjusts more often, usually monthly.

When the interest rate goes up, but your payment remains fixed, the unpaid interest is added to your principal balance. The result is you will probably owe more than your original mortgage balance.

That's fine as long as homes in your community are appreciating in market value as fast as your mortgage "negative am." However, if home values in your area don't go up as fast as your mortgage balance increases, you might have a mortgage balance that exceeds your home's market value when you decide to sell. Can you handle that?