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Inherited home is safe from due-on-sale clause

Q: My father passed away in January 2008 and I have inherited his townhouse. He had an existing mortgage, and I am continuing to make the mortgage payments. I have not notified the mortgage company. I am unable to obtain financing for the home in my name at this time. I have already been turned down twice. Does state law allow me to assume this loan, or if the finance company finds out, can it pull the loan? I don't want to lose the house. There was a will (I was the personal representative and sole beneficiary) and I had an attorney prepare the deed, which has been recorded in my name. It was my father's wish that the house be mine upon his death.

A: Please relax. State law has nothing to do with this. Federal law — called the Garn-St. Germain Depository Institutions Act of 1982 — protects you. This law, among many other matters, specially addressed your issue. According to that act, a lender "may not exercise its option pursuant to a due-on-sale clause upon . . . a transfer to a relative resulting from the death of a borrower."

Most mortgages (usually called "deeds of trust") contain a due-on-sale clause. That means that if the property is transferred to anyone, the lender has the right to call the entire loan. The purpose of such a due-on-sale clause makes sense. If a lender makes a loan with a low interest rate — say 5.5 percent — and interest rates rise significantly, the lender does not want another person to step into the shoes of the original borrower and continue making payments at the low rate.

But Congress recognized that the due-on-sale clause was unfair to many people, especially in situations such as yours where you inherited the property and the existing loan.

You should send your lender a copy of your father's death certificate and merely advise that you will be taking over the mortgage payments. There is absolutely nothing that the lender can do to hurt you.

'Rollover' rules create some confusion

Q: I purchased a home for $300,000 in 2000 and will be selling it for $800,000 this year. I have lived in the property for the full duration and file joint tax returns with my wife. I have been informed that I will be eligible for the $500,000 tax exemption, and must pay taxes on the balance of the sale ($300,000) even though I will be purchasing a new home for $400,000. I was always under the impression that $500,000 was tax exempt (joint filing) against the profit and any further funds from the sale were tax exempt as long as I purchased another property for my primary residence of equal value or more.

A: If your home cost you $300,000 — ignoring any improvements you may have made over the years — and you sell it for $800,000, you will have made a profit of $500,000. The law states, very clearly, that if you have owned and lived in the house for at least two years out of the five years before it is sold, and if you are married and file a joint tax return with your spouse, you can exclude up to $500,000 — which in your case is all of that profit. (If you are single, the exclusion is limited to up to $250,000 of your profit.)

Congress abolished the old "rollover" rule in the 1990s. That rule stated that you do not have to pay any capital gains tax if, within either two years before or after you sell one house, you buy another one whose value is equal to or greater than your former property.

But that's no longer the law. From your example, it appears that you will be able to exclude all of your profit and not pay any tax.

There is one caveat, however. Let's look at this example. In 1990, you bought your first house for $100,000. In 1995, you sold it for $300,000 and bought your present home for that same amount. In those days, you were eligible for the "rollover," which meant that while you did not have to pay any tax on your $200,000 profit, the tax basis of your new house (which you bought for $300,000) is reduced by the amount of your profit.

Thus, even though you paid $300,000 for your present home, your tax basis in our example is only $100,000 ($300,000 minus $200,000). So if you sell your house for $800,000, for tax purposes your profit will be $700,000 ($800,000 minus $100,000), and while the first $500,000 will be exempt from tax, you will have to pay tax on the additional $200,000 profit.

Talk with a financial advisor about your specific situation.

Lease, price for tenants who want option to buy

Q: Help! We have a home completely paid for and in excellent condition. We have a couple who want to lease it with an option to buy. How do you come up with a price for the house a year in the future? Do we have to do a background and credit check? My husband does not want to hire a Realtor to help with the contract. This is very scary to me! Also, once a lease with option contract is signed, can there be a loan made against the house during the lease, if an emergency comes along the way?

A: There are two ways to approach this. First, you can sign a lease and give your tenants a "right of first refusal." This means that when the tenants tell you they want to buy, you put the property on the market, try to find a buyer, and then the tenants have the right to match that other offer.

The other option is to sign a lease with an "option to purchase." In this scenario, you set a price in advance. In today's market, no one can predict what homes will be selling for a year or two from now. So I would just add 3 to 5 percent to the current appraised value of your house and use that number.

However, this is really academic since this is only an "option" to purchase. That means that your buyers do not have to exercise the option.

My suggestion: Use the option to purchase, but when the time comes for the buyers to decide whether they want to pay your price, explain that the price is negotiable and that you are willing to accept any reasonable offers.

Of course, if the market increases dramatically, your buyers will get a good deal.

Yes, I would make sure that you check their credit rating and do a background check. I recommend this for any landlord-tenant relationship. It is your house and you want to make sure that your tenants are qualified.

Can you tap into the equity of the house during the tenancy? A couple of years ago, the answer would have been yes. But in today's market, lenders are very reluctant to make loans on investment properties — but if you have enough equity in the house and have very good credit, you may be able to borrow against the house even though you have rented the property.

It is still your house, and when you sell it, you will pay off all outstanding loans.

Benny L. Kass is a practicing attorney in Washington, D.C., and Maryland. He can be reached at benny@inman.com.

Inherited home is safe from due-on-sale clause 01/23/09 [Last modified: Friday, January 23, 2009 3:30am]

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