Tax Changes Trouble
Luxury-Home Sellers

Question: My wife and I are thinking of selling our house. We have owned the property for nine years. We purchased it for $750,000 and are looking to sell it for $1.7 million. From what I understand, we would need to pay capital-gains taxes on any profit above $500,000. Can this tax be deferred by reinvesting the proceeds in our next house? If so, how much will we have to pay for a house to avoid the tax bite?

-- Tom, Old Greenwich, Conn.

Tom: You are partly correct. Under the rules passed by Congress in the 1997 Taxpayer Relief Act, you can exclude up to $500,000 for a married couple, provided that you have lived in the home for two of the past five years and the home meets the requirements for a principal residence. From what you say, that means that you probably will be able to exclude the first $500,000 of capital gains. Check with your accountant to be sure.

However, you will have to pay tax on the balance of your capital gains above $500,000. Under the old rules you could have deferred the entire amount by rolling it over into a new home. But that rule was eliminated. It is an interesting sidelight that while the $500,000 exclusion for a married couple benefits most home sellers, it actually can hurt those who have significant capital gains.

How to Secure a Property-Tax Break

Question: Have you heard of Proposition 90 in California? Last weekend we invited several of our neighbors to our new home for dinner. An elderly gentleman said he was able to transfer the tax basis from his previous home to his new home. He is paying about 75% less in property taxes than I and the rest of the new homeowners. Can you explain Proposition 90? How do I take advantage of it?

-- Oscar, Pismo Beach, Calif.

Oscar: What you are talking about is a little-known but sometimes very useful part of the California Revenue and Taxation code. It actually refers to three propositions: 60, 90 and 110.

Without going into great detail, it essentially says that upon sale you can transfer the usually much lower tax base of your old home to your new home, provided some very stringent requirements are met. One is that you must be at least 55 years old or severely and permanently disabled, and the property must be your principal residence. Two, you must do the transfer within two years before or after the sale of the old property. Three, the replacement property must be of "equal or lesser" value.

There are a lot of other very specific requirements and definitions as well. For example, if the new home is purchased or constructed within the second year following the sale of the property, the value can be 110%. And you can only use this transfer one time.

The rule was designed to give older and disabled property owners tax relief when they sold one home and moved to another, often smaller, property. Since in California properties are always assessed at the time of sale, the property taxes on the new home might be significantly higher than the old property, which you might have owned for many years. This allows you to take that old tax base with you.

There are a number of counties that do allow you to transfer the base between them. You need to check with the tax assessor in the county in which you reside and into which you plan to move. For more information, Alameda County has prepared a brochure that describes the procedure in great detail.

Tricky Deal Raises Thorny Questions

Question: I recently became aware of a potential real-estate transaction about which I understand very little. In looking to buy a two-bedroom condo or co-op, I found a unit within my price range that is a pre-conversion (to co-op) rental property selling below market value -- or so the owner claims.

The seller requires a down payment for one-third of the purchase price and will provide a temporary loan at a low interest rate until the conversion is completed. Upon conversion, the buyer can take out a mortgage, paying off the loan. In exchange for his or her down payment, the buyer of this property will immediately and legally become 10% owner of this building, as there are 10 apartments, until the conversion is completed, at which time he or she will become holder of the entire co-op shares specific to this apartment.

Have you heard of similar arrangements? What are the possible upsides and downsides of such a deal?

-- Larissa, New York City

Larissa: This is one of those deals that you will be able to boast about -- if it goes well. Or forever swear at -- if it goes badly. Essentially, the owner is asking you to accept some of the risk of the conversion by putting up a lot of money. In exchange, you will, presumably, be able to buy in very cheaply and ahead of the crowd.

It might a good deal, if you immediately get actual title to 10% of the property (shared ownership can be a real trap; you need an iron-clad sharing agreement), are then able to purchase your unit being credited the amount you have already put up and are able to secure appropriate financing. But proceeding is wise only if you are getting the unit at a good price. But if, as you suggest, the price might not be below market value, then it probably isn't a good deal at all. After all, why shoulder the risk if the price is such that you can go out today and buy a property already converted where there is virtually no risk at all?

If you are serious about this property, contact a broker in your area who is familiar with co-op pricing and find out the actual value. If you decide to proceed, be sure to contact a good attorney who can look closely at the paperwork and help safeguard the money you put up.

-- Mr. Irwin has more than 25 years' experience as a Los Angeles-area real-estate broker. He is the author of more than two dozen books about real estate and is recognized as one of the most knowledgeable writers in the real-estate field. Mr. Irwin's most recent books are "How to Get Started in Real Estate Investing" and "How to Buy a Home When You Can't Afford It" (McGraw-Hill, 2002).

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