Tax Bite Isn’t Only Consideration in Home Sale

Q: My parents are in their 70s and thinking of selling their home, which is worth about $2 million, because of the steep, $20,000 annual property tax bill. Even with the $125,000 profit exclusion, they should clear about $1.5 million from the sale. If they sell now, Uncle Sam will take a big bite out of that nest egg.

I’m wondering if they should wait until one of them dies to sell. My theory is that because the house is community property, its tax basis will be increased upon the death of one of them, and allow the survivor to keep a much bigger share of the sale proceeds.

What do your experts think? --R.N.

A: We took your question to Howard Gordon, a Palm Springs certified public accountant, who offers the following analysis. Gordon assumes that your parents have a $500,000 mortgage that carries an 8% interest rate. He assumes that any proceeds from the sale would be invested at 8%. And he assumes that your parents’ have a 35% combined state and federal tax rate.

If they were to sell the home now for $2 million, Gordon estimates net proceeds of $975,000, a figure that includes a $500,000 mortgage payoff and a $525,000 tax bill.

Invested at 8%, the proceeds would grow over five years to $1.43 million. However, your parents would still need living accommodations, whose cost is estimated at $140,000 over the five years. This leaves your parents with $1.29 million at the end of five years.

Now, let’s assume the home is sold for $2 million five years later by the surviving spouse. From the sales price, Gordon deducts $500,000 to pay off the mortgage and $350,000 for the cost of paying taxes and mortgage interest over those five years. Even with no tax bite from Uncle Sam, the surviving spouse would net $1.15 million, about $140,000 less than if they had sold the home and paid the huge tax bill five years earlier.

What’s the big missing factor here? How much the house could appreciate over that five-year holding period.

If there is no increase, it clearly pays to sell now and be done with it. However, if the home can appreciate in value--a big if in some real estate markets today--it can pay to hold on to it. Gordon figures that it would take an average 1.5% annual appreciation rate over those five years for the home sale to net the same amount to the surviving spouse as an immediate sale. Any higher appreciation would mean an even greater reason to hold on to the house.

What’s the lesson here?

It’s one of Gordon’s favorites: Don’t let the tax tail wag the dog. Asset sales and estate planning should take into account a full range of factors. As this analysis demonstrates, taxes are only one of those factors.

No Reason Not to Pay Balance on 6.75% Loan

Q: Would it be wise to pay off my 6.75% mortgage? I owe $9,000 on it and my monthly payments are $260. The mortgage has less than six years to run. My annual income is $50,000, and I would be using money from an investment that is coming due in a few months. --R.R.

A: As long as you have enough cash to cover emergencies, our experts say there is no reason you shouldn’t pay off your mortgage now and be done with it.

Now, other experts might tell you that paying off your mortgage early deprives you of one of the few remaining tax deductions available to the average taxpayer. And they would be correct--as far as they went. However, unless you can find an investment paying 7% or more right now, you won’t be money ahead holding onto your mortgage.

In the end, either way you go isn’t likely to have a great impact because the amount involved is relatively small, and your mortgage has just about run its course. But, as a general rule, our experts believe that it makes little sense in today’s low-interest rate environment to invest money at low returns while holding on to higher-interest debts. Remember, a tax deduction isn’t a tax credit. Even in the highest tax brackets, you still have to spend $3 to get a $1.25-or-so deduction.

Legal Title Has No Impact on Assessment

Q: Are there any property tax assessment implications involved in how one holds title to one’s real estate? For example, if my wife and I hold title as community property would the property tax assessment be any different upon my death than if we held it in joint tenancy? --S.G.

A: There are no property tax assessment implications involved in how married couples hold title to their real estate. Whether you hold it as community property or as joint tenants, there is no change of ownership upon the death of one of the spouses. Income tax matters, as this column has discussed on many occasions, are entirely separate, and how title is held does have major tax implications.

Heirs Generally Inherit IRA Account Proceeds

Q: My husband and I married late in life and have separate heirs on our individual retirement accounts. I am age 58; he is 69.

In the event that one of us dies, do the beneficiaries of the deceased collect the proceeds from the IRAs regardless of their ages? --V.N.L.

A: To answer this precisely we must make one important assumption: that no contributions to these IRAs have been made since your marriage. If this is true, then your individual beneficiaries are entitled to inherit the proceeds of the IRAs regardless of their ages and the age of the deceased.

Although no early withdrawal penalties are imposed by the IRS, all deferred taxes on the IRA proceeds must be paid upon inheritance.