Q&A: Adding daughter as co-owner of mother’s home could trigger costs

Dear Liz: My father passed away last year, and my mother wants to add my name to her house so there is no probate. Do I need to change the title or the deed or both? Are there any negatives to doing so? Also, we already have a durable power of attorney between us. Does that offer me any benefits as far as real estate? What does it offer me in general?

Answer: A deed is the legal document that transfers the title or ownership of a property. Please don’t alter the home’s documents until you consult an estate-planning attorney. Your mother’s desire to avoid the costs of probate could inadvertently trigger much larger costs.

Adding you as a co-owner could mean giving up a big tax benefit, for example. If your mother bequeaths the house to you when she dies, you won’t owe any tax on the gain in the house’s value during her lifetime. If she adds you to the title, she’s gifting you half the house. In that case, you potentially could owe tax on some of that gain even after she dies. If she wants to preserve tax benefits while avoiding the court process known as probate, she may need a living trust.

There could be other complications if you should die or be sued, which is why it’s important to get good advice before proceeding.

As for the durable power of attorney: It isn’t designed to give you benefits. Powers of attorney allow you to make decisions for your mother if she becomes incapacitated. Those decisions need to be in her best interest, not yours.

Q&A: Reverse mortgage due when borrower dies

Dear Liz: I was laid off from my job this year and decided to move in with my widowed dad in the suburban home that he and my mother purchased outright in 1989. However, over the years they apparently took out a reverse mortgage with a current balance of about $500,000 (the house was recently appraised at $680,000). When my father dies, how much longer can I live in the house? If there is little or no equity left, can I walk away from the house and let the lien holder handle the sale?

Answer: Reverse mortgages, which allow people 62 and older to tap the equity in their homes, are due and payable when the borrower dies, sells the home or moves out. You won’t be expected to vacate the premises the day after he dies, but you typically would have to leave the property within six months. You may be able to get an extension of that time if you’re selling the house or trying to get a loan to pay off the mortgage.

If there is still equity left in the home, it might make sense for you to try to sell it yourself to get the maximum value. Lenders only want to recoup what they’re owed and aren’t required to go to any extra effort to maximize the amount going to the heirs.

If the home is worth less than what’s owed, you can do a “deed in lieu of foreclosure,” which essentially allows you to hand over the keys and walk away. The good news is that you’re not on the hook. Reverse mortgages are non-recourse loans, which means that the lender can’t pursue the estate or the heirs for the balance owed.

Q&A: Long-term capital gains tax

Dear Liz: I’m very confused about the long-term capital gains tax. Several years ago, I bought a house for $525,000 in Texas. I’ve been thinking about selling, and my real estate agent informed me that my home is now worth $1.5 million. I am a disabled veteran and have no tax liability because my income is tax-free. Since this is my primary residence, I know that the first $250,000 in gains is exempt from tax. What I just don’t understand is what my tax liability will be on the rest of the money.

Answer: If you sell this house, you’ll essentially go from the bottom tax bracket to the top. Single people with incomes over $415,050 in 2016 are subject to the 39.6% marginal tax rate.
Most people pay capital gains tax at a 15% rate, but those in the top bracket face a 20% rate.

Improvements you’ve made to the house and some other expenses, such as selling costs, can reduce the amount of gain that’s subject to tax.

This big windfall could have other effects on your taxes, so you’ll want to consult a tax professional before proceeding.

Q&A: Invest or pay down mortgage?

Dear Liz: I usually finish the month with $1,000 to $2,000 left over after expenses to invest. My savings are with a money manager who has conservatively invested in a diversified portfolio. Given the uncertainty of the market, does it make any sense for me to start using that monthly excess to pay down the balance on my 15-year mortgage rather than continue to invest? The mortgage has about 91/2 years to go with a balance of just under $75,000. One added point: I would like to retire in about five years.

Answer:
It’s time to talk to a fee-only financial planner who can review your entire financial situation and offer personalized advice. The planner can give you a better idea if you’re really on track to retire within five years. If you are, then paying down the mortgage may be an excellent use of the money. Having a paid-off home will reduce your monthly expenses, which in turn can reduce how much of your retirement funds you’ll need to tap.

Before you prepay a mortgage, though, you should make sure all your other financial ducks are in a row. In addition to saving enough for retirement, you should have paid off all your other debt, accumulated a decent emergency fund (at least six months’ worth of expenses) and be properly insured.

Q&A: Using Roth IRA earnings for a first-time home purchase

Dear Liz: My 29-year-old son recently married, and as a gift I pledged $20,000 as a down payment on a house. My daughter-in-law is beginning a career as a registered nurse and I know they will not be buying for a few years. Is there any type of account that will grow tax-free or tax-deferred for a first-time buyer? Maybe I could gift this money to them into a retirement account for the time being?

Answer: You may be able to give them enough money to fund Roth IRA accounts for both 2015 and 2016. They would be able to withdraw those contributions tax- and penalty-free at any time in the future for whatever purpose they wanted.

Withdrawing earnings from a Roth can trigger taxes and penalties, but that’s not likely to be an issue in this case. Each person is allowed to withdraw up to $10,000 in Roth earnings for a first-time home purchase. If they plan to buy a home within a few years, it’s highly unlikely that your gift would generate enough earnings to cause concern.

The ability to contribute to a Roth begins to phase out for married couples filing jointly at modified adjusted gross income of $183,000 in 2015 and $184,000 in 2016. Assuming their incomes were below those limits, they each can contribute up to $5,500 per year to a Roth. The deadline for making 2015 contributions is April 15, 2016. If you give them the money now, they could fund two years’ worth of contributions at once.

Q&A: Student loans and mortgages

Dear Liz: I recently completed a master’s degree in counseling and am now paying student loans. I am punctual and consistent in my payments. How does having a $30,000 outstanding student loan look to home lenders? We recently sold our home and moved. We are planning to buy another home and have a large down payment. Does this student loan affect my home purchase potential? My husband and I are retired, and we pay our bills on time.

Answer: Student loans can have a positive effect on your credit scores if they’re paid on time. On the other hand, your payments are factored into the equation of how much mortgage you can afford and will reduce the amount you can borrow.

You should be rethinking the notion of borrowing more in any case. It’s not clear why you spent so much on a degree if you’re not using it. Perhaps a health setback made working impossible or an inheritance made it unnecessary. Generally, though, you should borrow for an education only if you expect it to increase your earning power enough to easily replay the loan. If you’re pursuing an education just for the pleasure of it or for a feeling of accomplishment, you should pay for it out of pocket or with savings.

A mortgage in retirement is tricky as well. Although some wealthy people keep their mortgages so they can invest the money elsewhere, most people are better off without loans once they stop working. Having to pay a mortgage often means having to take more out of your retirement funds and increasing the odds of running short of money. Also, remember that your income will drop when one of you dies because one Social Security check goes away. That could make it harder to pay the bills.

Consider meeting with a fee-only financial planner who can assess your financial situation and offer advice about the best course. It could be that you can well afford student loans and a mortgage. Or you could be headed for disaster. It’s better to find out while there may still be time to put that degree to work to boost your income or take steps to conserve your funds.

Q&A: Divorce and mortgages

Dear Liz: Our daughter was divorced in 2012 from her husband of 20 years. He still lives in the house they shared and she lives elsewhere. He pays the mortgage. When she asks him to remove her name from the mortgage, he says she is harassing him. What are her legal options and steps to accomplish this?

Answer: The couple’s divorce agreement should have addressed this issue. If he agreed to take sole responsibility for the mortgage, she should consult an attorney about holding him to that agreement.

It’s not as simple as requesting that the lender remove her name from the loan, said Emily Doskow, author of “Nolo’s Essential Guide to Divorce.”

“Every once in a while you’ll come across a mortgage lender that is willing to release one of the parties,” Doskow said. “But that’s very, very rare.”

Typically, getting her off the loan would require him to refinance or sell the home. If for some reason the divorce agreement doesn’t address the debt, your daughter still has considerable leverage if her name is on the deed. If she’s still an owner of the home, she can force a sale, Doskow said.

If she’s not on the deed, her options are limited. She may need to ask a court to intervene, Doskow said.

As long as she’s on the mortgage, her credit and ability to buy another home are tied up with her ex. If he stops making the mortgage payments — because he can’t afford them or out of spite — her credit would be trashed, since they are jointly responsible for the debt.

This is why it’s so important to separate all credit accounts and refinance any loans before a divorce is final. Otherwise, the two exes can be tied together financially, if not for life then at least for the life of a loan.

Q&A: Homeowners association fees

Dear Liz: I am a single woman 10 to 15 years away from retirement. My town home will be paid off next month. Does it make better financial sense to sell my town home to avoid significant monthly homeowners association fees and invest in a single-family home?

Answer: It depends. Many single-family homes, particularly in newer developments, also have sizable HOA fees. Even when that’s not the case, you can face significantly higher repair and maintenance costs with a single-family home compared to a town home.

You also need to factor in the costs of selling your home and moving. Real estate commissions can eat up 5% to 7% of the value of your home, and moving expenses can add thousands of dollars to your costs.

Now would be an excellent time to consult a fee-only financial planner who can review your plans for retirement and discuss your alternatives.

Mistakes you make in the years immediately before and after retirement can be particularly devastating, so make sure you have an objective second opinion.

Q&A: Capital gains taxes

Dear Liz: My wife owns a house that was separate property before our marriage. She has since fallen ill and needs round-the-clock care. I am selling the house to support this and will net about $250,000 at close. Will we have to pay capital gains taxes, or can I claim a one-time exemption, based upon this not being community property?

Answer: If your wife lived in the property as her principal residence for at least two of the five years prior to the sale, the profit would qualify for the capital gains exemption of up to $250,000 per owner.

People who have to sell their principal homes before they meet the two-year residency requirement may qualify for a partial exclusion if the sale was triggered by special circumstances such as a change in health or employment or “unforeseen circumstances.” You’ll want to talk to a tax pro about whether your wife’s situation qualifies.

Even if the gain is taxable, she may not owe tax on the entire amount netted from the sale. When figuring home sale profit, her basis in the home — essentially, what she paid for it, plus any qualifying improvements — is subtracted from what she nets from the sale.

There’s another way to avoid paying taxes on home sale gains, and that’s to hold on to the property until your wife’s death. At that point, the home would get a “step up” in tax basis to the current market value. An inheritor who sold the home at that market value wouldn’t owe any tax, said Mark Luscombe, principal analyst for Wolters Kluwer Tax & Accounting U.S.

Q&A: Investment property

Dear Liz: Eight years ago, we bought a fixer-upper in an up-and-coming neighborhood. Now it’s mostly fixed up, and property values have soared. We would like to borrow against the equity to buy a beach house we could use and also rent out. This would be a long-term investment. We already own one rental property that is turning a small profit. Managing it allows me to bring in much-needed extra income while staying home with my children. I want to increase that income with a beach house we can also enjoy. Is this a smart use of home equity?

Answer: It may be. You’ve got some experience as a landlord, so you understand what’s involved in maintaining and repairing a rental property and dealing with tenants. A property that’s split between personal use and rental is somewhat different, since you won’t be able to deduct all the expenses as you could with a full-time rental. The expenses have to be divided proportionately, and you can’t deduct rental expenses in excess of the rental income you get. IRS Publication 527, Residential Rental Property, offers more details, or you can talk to a tax pro (which you should have, given that landlords can face some complicated tax situations).

Your first task is to ensure the beach house is in an area that allows short-term rentals on the scale you’re anticipating. Not all communities do. Some don’t allow “vacation rentals” at all, while others limit the amount of time that the property can be rented. Those that allow short-term use may require annual licenses and assess taxes or fees on the rentals, which are costs you’ll want to factor in before you buy.

Your next step, if your goal is to generate income, is to find a property that is “cash flow positive” from the start, with expected rents more than covering expected costs. Obviously, though, you can’t predict everything, which is why it’s essential to have a fat emergency fund for unexpected repairs or greater-than-anticipated vacancies.

Another smart move would be to lock in your interest rate if you don’t expect to pay back what you borrowed against your house within a few years. That means a home equity loan with fixed rates rather than a line of credit with variable rates. You put your home at risk when you borrow against it, so be conservative and lock in predictable payments.