Roanoke Times
Copyright (c) 1995, Landmark Communications, Inc.
DATE: MONDAY, November 6, 1995 TAG: 9511060010
SECTION: MONEY PAGE PAGE: A10 EDITION: METRO
SOURCE: MAG POFF
DATELINE: LENGTH: Medium
Mom has been in a nursing home for the past two years and is exhausting her assets. She now needs to draw on the house asset, but she would be subject to a huge capital gain if we sold the house because she did not live there for three of the past five years.
Are there any other options we have that are more tax-favorable? I understand that Mom would have to be a resident in the house for a reverse mortgage.
Mom is 95. My wife and her sister are the only children, are compatible, and will share any residual estate.
A: The law that requires people to live in their homes three of the past five years in order to claim a one-time tax exemption on the capital gain contains an exemption for people in nursing homes. However, it may not be broad enough to cover the situation of your wife's mother. You have compounded her problems in this connection by converting her house into a rental property.
Terrence Clem, a certified public accountant with the Roanoke firm of Miller, Morgan, Agee & Clem, said one important question to be answered, if your wife's mother sells her house, is whether the rental to the granddaughter has converted the residence to income-producing rental property. If so, the property would not be eligible for the $125,000 one-time gain exclusion for taxpayers over age 55.
Regarding the three-of-five-year use test, Clem said, there is a different test for a taxpayer who lives in a nursing home. In that case, the person who owns and uses property as a principal residence for periods aggregating at least one year during the five-year period (ending on the date of sale) is treated as using the property as a principal residence.
The key question, according to Clem, is whether she had spent at least one year of the prior five years actually using the residence. From your letter, it would appear she may not have actually lived in the home at least one year in the aggregate and therefore would not qualify for the $125,000 exclusion.
Should you determine, however, that the one-of-five-year test does apply, then you will need to determine whether or not the property was converted to rental property as a result of the rental to the granddaughter, Clem said. This will depend on the circumstances of the rental.
He noted that your letter does not indicate how long the granddaughter has rented the house, whether or not she is paying a fair market rent and whether there is a formal lease involved.
A number of situations exist that might mean it hasn't been converted to rental property. Some possible scenarios, Clem said, might include a short-term rental for an insignificant amount of money, a temporary rental of a former residence while trying to sell it, or a month-to-month lease at less than fair rental value that amounts to a caretaking arrangement pending sale. Property used rent-free or for a nominal rent by a relative is not considered held for the production of income.
Assuming the facts are not favorable in this situation and the house is sold, Clem said, the gain will be subject to tax.
You did not mention the husband of your wife's mother. Assuming he has died, Clem said, she probably has a "stepped-up basis" for the fair market value of the portion he owned and that she inherited. This could very well reduce the possible taxable gain significantly, he said.
Also bear in mind, he said, that if she should die before the house is sold, her heirs (your wife and your wife's sister) would inherit the property with the tax basis equal to the fair market value at the date of death. Clem said this means they could sell it with little or no gain - or perhaps even at a loss as a result of selling expenses.
Clem advised that a reverse mortgage would seem to be the best way to go if such an arrangement can be obtained. If a reverse mortgage can be obtained, Clem said, the need to sell the house would be delayed, perhaps until the death of the owner, at which time the stepped-up basis would provide a more favorable tax result.
Most reverse-mortgage plans do require the owner to live in the home, but one company recently introduced a program in Virginia designed for people who must move to nursing homes. The company, Transamerica HomeFirst of San Francisco, can be reached at 1-800-538-5569.
by CNB