Foreclosure Related Fraud


The following is a list of government enforcement agencies and other organizations for reporting fraud activities.  Some of these agencies and organizations are also excellent resources for obtaining more information about foreclosure-related fraud.

Office of the Attorney General
California Department of Justice
Attn. Public Inquiry Unit
P. O. Box 944255
Sacramento, California 94244-2550
(916) 322-3360
(800) 952-5225 (in California only)
http://ag.ca.gov/consumers/mailform.htm (Consumer complaints)

California Department of Real Estate
P. O. Box 187000
Sacramento, California 95818-7000
(916) 227-0864
http://www.dre.ca.gov/cons_complaint.html (Consumer complaints)

Federal Bureau of Investigation (FBI) Headquarters
J. Edgar Hoover Building
935 Pennsylvania Avenue, NW
Washington, D.C. 20535-0001
(202) 324-3000
Or contact your local FBI field office
https://tips.fbi.gov/ (FBI tips and public leads)

Department of Housing and Urban Development (HUD) Headquarters
HUD Office of Inspector General Hotline (GFI)
451 7th Street, SW
Washington, D.C. 20410
(800) 347-3735
Or contact your local HUD field office
http://www.hud.gov/offices/oig/hotline/ (Office of Inspector General hotline)

Federal Trade Commission
Consumer Response Center
600 Pennsylvania Avenue, NW
Washington, D.C. 20580
(877) 382-4357
http://www.ftc.gov/ftc/contact.shtm

Better Business Bureau
The Council of Better Business Bureaus
4200 Wilson Boulevard, Suite 800
Arlington, Virginia 22203-1838
Contact your local bureau
http://www.bbb.org/

 
CONTINGENCIES AND CONTINGENCY REMOVAL

INTRODUCTION

Under contract law, a contingency provides a party to the contract the ability to condition performance on the occurrence or non-occurrence of another event.  For example, a buyer may condition performance under the real estate purchase contract on the outcome of the buyer’s inspection.  If the buyer is dissatisfied with the results of the inspection, then the buyer may cancel the contract without being held in breach of contract.  Another common example:  the buyer under a real estate purchase contract may condition performance on obtaining a specific loan (e.g., not to exceed 7.5% fixed rate and not to exceed 1 point).  After making a good faith effort to obtain such a loan, if the buyer is not approved for such a loan, then the buyer may cancel the agreement without being held in breach of contract.  A buyer of vacant land may want a contingency on city approval of building plans.

The are other types of contingencies.  One party may have a contingency that the contract be approved by an attorney or another third party.  With short sales, the contract is most likely contingent on lender approval.  Some sellers want to have a contingency of entering escrow on a replacement home before they are bound to perform on the sale of their existing home. 

This legal article focuses on some common contingencies arising in real estate sales transactions, in particular in C.A.R. Form RPA-CA (residential purchase contract), and the method for removing contingencies under the C.A.R. purchase contracts. 

I.  COMMON CONTINGENCIES IN RESIDENTIAL SALES TRANSACTIONS

Q 1.  Is there an inspection contingency in the C.A.R. residential purchase contract, the RPA-CA?

A Yes.  The buyer’s inspection contingency can be found in Paragraph 7A(i)(b) and arises from the contract language: “subject to Buyer’s investigations rights” and also the explicit language in Paragraph 9A, “Buyer’s acceptance of the condition of, and any other matter affecting the Property is a contingency of this Agreement....”  Paragraph 14B indicates by when the buyer must remove the inspection contingency (among others).  The default time is 17 days but may be contractually changed.

Q 2.  Can a buyer waive the inspection contingency?

A Yes.  There is no California law that prohibits the buyer from waiving the right to inspect the property.  However, sellers should be aware that whether the buyer inspects the property or not, the seller is still legally obligated to disclose all known material defects to the property.  (Lingsch v. Savage, 213 Cal.App.2d 729 (1963).)

Furthermore, for residential one-to-four properties, both listing and selling agents still have a duty to conduct a diligent visual inspection (Easton v. Strassburger, 152 Cal. App. 3d 90 (1984); Cal. Civ. Code § 2079).  See also the C.A.R. legal article, Real Estate Licensee’s Duty to Inspect Residential Property, found on http://qa.car.org.

Q 3.  Is there a loan contingency in the C.A.R. residential purchase contract, the RPA-CA?

A Yes. The loan contingency can be found in Paragraph 2 Section I.  There is a loan contingency unless Paragraph 2K or 2L is checked. There are two option boxes.  The default loan contingency period of time is 17 calendar days; the first box permits another number of days and the second box leaves the loan contingency in effect until the loan is funded.

It is recommended that buyer’s agents assist the buyer in completing Paragraph 2, Finance Terms, in the RPA-CA.  Even though, the buyer may not know what type of loan the buyer will be obtaining, it is important to insert a maximum interest rate and maximum points that the buyer would be willing to pay to obtain a loan.  If this paragraph is left blank, then the buyer has a obligation under the contract to accept any loan whatsoever or risk being considered as not acting in good faith under the contract.

Q 4.  What is the appraisal contingency in the RPA-CA?

A In Paragraph 2J of the RPA-CA, the contract default provides an appraisal contingency.  If the box is checked, there is no appraisal contingency.  This contingency differs from a loan contingency since it is quite possible for a lender to be willing to provide a loan even though the property does not appraise at the sales price.  For example, this might occur if the buyer is providing a substantial down payment and the loan amount is less than the appraised value.  Nevertheless, this contingency means the buyer need not proceed with the transaction, if the buyer will be paying more than the property appraises.  This contingency permits the buyer either to cancel or to renegotiate the sales price to reflect the appraised value of the property.

Q 5.  What other contingencies can be found in the C.A.R. residential purchase contract, the RPA-CA?

A The RPA-CA also contains other contingencies, contingency on sale of buyer’s property (Paragraph 13B and Form COP Paragraph A), approval of condominium/planned development disclosures (Paragraph 6B “Buyer’s approval of CI Disclosures is a contingency of this Agreement....”), tenant-occupied property agreement (Paragraph 3C(iii)), inspection reports (e.g., pest control, septic tank, wells) and disclosures (Paragraphs 4, 5, and 9A), insurability of the buyer and the property (Paragraph 9A(iv)), preliminary title report approval (Paragraph 12A), review of the sex offender database (Paragraph 9A(iii)), among others.

Q 6.  Are there any non-optional contingencies?

A Yes.  For residential properties built before 1978, federal law does require that the buyer be given a lead hazard information pamphlet, that the seller disclose the presence of any known lead-based paint and provide a statement signed by the buyer that the buyer has read the warning statement, has received the pamphlet, and has a 10-day opportunity to inspect before becoming obligated under the contract.  The buyer’s right to conduct a lead hazard inspection is a contingency of the contract required by federal law unless the buyer has had the opportunity to do so prior to execution of the purchase contract.

Furthermore in a residential one-to-four sales transaction, unless exempt, the seller must give the buyer the TDS and give the buyer the right to cancel within 3 days (or 5 days if the TDS was mailed to the buyer).  If the seller doesn’t give the buyer the TDS when obligated to do so, a California court has held that the buyer does not have to go through with the sales transaction. (Realmuto v. Gagnard, 110 Cal. App. 4th 193 (2003).)

Q 7.  Can a seller insist that the buyer have no contingencies?

A Yes, but only if the transaction is handled properly!  In a residential sales transaction, the law requires that the seller provide the buyer with certain disclosure documents.  See Question 6 for non-optional contingencies. 

However, the seller can avoid giving the buyer any disclosure contingencies by providing all the necessary disclosures prior to the buyer submitting the offer to purchase.  In addition, the seller would need to give the buyer the right to conduct a lead hazard inspection (for residential property built before 1978) before binding the buyer to the purchase contract.

Q 8.  How is the contingency on lender approval handled for short sales?

A If a sales transaction will be contingent on lender approval, either the buyer can attach C.A.R. Form SSA (Short Sale Addendum) to the offer or the seller can counter the offer with the SSA.  The SSA which is used as an addendum to the RPA-CA (or other forms) indicates in Paragraph A that the contract is contingent on lender approval.

If the seller doesn’t receive written consent from all the lenders by the specified date, then either party may cancel the contract.

II. CONTINGENCY REMOVAL

Q 9.  How is a contingency removed?

A Under the requirements of the RPA-CA in Paragraph 14B(3), the buyer must remove all contingencies in writing using C.A.R. Form CR.  This form provides check boxes in Paragraph A1 giving the buyer the option of removing only particular contingencies.  Instead of using Paragraph A1, the buyer may check Paragraph A2 giving the buyer the opportunity to remove all contingencies except for the ones indicated by checking another box or boxes.  The third option is for the buyer to check the box for Paragraph A3 whereby the buyer removes all the contingencies in the contract without any exceptions.

If the seller is given a contingency on the purchase of replacement property (C.A.R. Form COP Paragraph B is checked), the seller must remove this contingency in writing according to Paragraph B2.  The seller may also use C.A.R. Form CR.  However, the seller would check one of the boxes under Paragraph B.  There is also a box for the seller to remove any other contingency which the seller may have under the contract.

Q 10.  Must a buyer remove a contingency regarding a disclosure that the buyer has not yet received from the seller?

A Even if the contingency period has passed, under the RPA-CA Paragraph 14B(3), the buyer is not legally obligated to remove those contingencies related to “(i) government-mandated inspections/reports required as a condition of closing; or (ii) Common Interest Disclosures” until 5 days after receiving those disclosures.  The buyer has the latter of the 17 days (if this default time is used) or 5 days after the seller gives the buyer the above-mentioned disclosures.

For example, if the contingency period ends on Wednesday, April 16th but the seller gave the buyer the common interest disclosures (HOA documents) on Tuesday, April 15th, then the buyer has 5 days from the 15th, until Sunday, the 20th at 11:59PM (under the RPA-CA contract “days” means calendar days), to remove this contingency without being in breach of contract.

On the other hand, if the contingency period ends on Wednesday, April 16th but the seller gave the buyer the common interest disclosures on Tuesday, April 9th, the buyer still has until April 16th to remove this contingency--not just 5 days but the full contingency period.

Q 11.  Do the additional 5 days discussed in Question 10 apply to the preliminary title report contingency?

A No.  If the buyer has not received the preliminary title report by the end of the contingency period, the buyer does not have an additional 5 days from receipt in order to remove this contingency since this is not a government-mandated inspection/report.  The buyer has the option of cancelling the contract or proceeding without it.  However,  the buyer may have legal remedies should the preliminary title report contain information having a negative impact on the buyer’s desired use of the property.

In Field v. Century 21 Klowden-Forness Realty, 63 Cal. App. 4th 18 (1998), the buyer successfully sued the dual agent for breach of fiduciary duty.  One mistake, among others, made by the agent was not making sure that the buyer received the preliminary title report prior to close of escrow.

Q 12.  What happens when the buyer doesn’t remove a contingency in writing at the end of the contingency period?

A Under the RPA-CA Paragraph 14C(2), the contingency continues.  In other words, the contingency remains as a contingency until it is removed or escrow closes.  Thus, for example, if the loan contingency is not removed by the buyer, it gives the buyer the opportunity to cancel the contract at any time during the escrow (assuming the buyer is acting in good faith in trying to obtain a loan) if the buyer cannot obtain the specified loan and the buyer is not in breach of contract.

Q 13.  What can a seller do if at the end of the contingency period, the buyer doesn’t remove the contingency in writing?

A Under the RPA-CA Paragraph 14C(4), the seller has the right to give to the buyer a notice to perform (C.A.R. Form NBP) which gives the buyer an additional 24 hours (the default period of time) to remove the contingency in writing.  If the buyer doesn’t remove the contingency, then the seller may cancel the contract in writing and not be in breach of contract.

Q 14.  Can the seller give a buyer the notice to perform (C.A.R. Form NBP) mentioned in Question 13 before the end of the contingency period?

A Yes.  The seller can give the buyer the NBP as long as two days before the end of the contingency period but not more than that.  However, giving the NBP earlier does not shorten the contingency period.

For example, let’s say the buyer has until Wednesday, April 16th to remove the contingency in writing.  Then the seller gives the buyer the NBP on Monday, April 14th which states that the buyer has 24 hours to remove the contingency.  The buyer still has until Wednesday, April 16th 11:59PM to deliver the C.A.R. Form CR to the listing agent or seller.

Suppose, in the same example above, the seller gave the buyer the NBP giving the buyer 24 hours notice on Wednesday, April 16th at 3PM.  Now the buyer has until Thursday, April 17th 3PM to remove the contingency in writing (by delivering the CR to the listing agent or seller).

Q 15.  If the buyer doesn’t remove the inspection contingency at the end of the contingency period, does this give the buyer the right to continue conducting inspections of the property?

A No.  Under the RPA-CA Paragraph 14B(1), the buyer has 17 days (the default period of time) after acceptance to “complete all Buyer Investigations....”  Although a seller may choose to give the buyer additional time to perform the buyer’s inspection, the seller is not contractually obligated to give the buyer more time.  However, the seller is obligated to give the buyer the NBP which simply gives the buyer 24 hours (the default period of time) to remove the inspection contingency not 24 hours more to inspect the property.

Q 16.  Is closing escrow a contingency of the RPA-CA purchase contract?

A No.  The closing of escrow is considered a covenant or condition under the contract to which both parties are bound.  If the seller delays the close of escrow (e.g., if the seller doesn’t execute the grant deed), then the seller is in breach of the contract.

If the buyer delays the close of escrow (e.g., if the buyer doesn’t deposit the balance of the monies or if the buyer doesn’t sign the loan documents), then the buyer is in breach of the contract.

What should a buyer or seller do if the other party doesn't close escrow?  Either party can use C.A.R. Form DCE (Demand to Close Escrow).  In Paragraph 1 the seller is the one demanding that the buyer close escrow and in Paragraph 2 the buyer is one demanding that the seller close escrow.  After giving the DCE and the other party still refuses to close escrow, then it would be advisable to consult with an attorney to discuss all the possible remedies including suing for specific performance.

For additional information about contracts and remedies, see the C.A.R. legal article, Contract Law and Real Estate Transactions, found on http://qa.car.org.

Q 17.  What is meant by “active removal” or “passive removal” of a contingency?

A The term “active removal” used when talking about a contingency means that a party must do something to remove a contingency.  Typically this means removing the contingency in writing.  For “passive removal” of a contingency, the party need do nothing.  The contingency is automatically removed with the passage of time. 

The RPA-CA as well as all the other C.A.R. purchase contracts require active removal of the buyer’s contingencies.

Q 18.  What happens if a buyer removes all the contingencies and then discovers a material defect in the property prior to the close of escrow and wants to cancel?

A The answer to that question depends on many different factors.  One, if the seller was aware of the defect but didn’t disclose it to the buyer, the buyer may be able to cancel without breaching the contract.  Two, if the defect is visually obvious to the buyer but the buyer didn’t notice it other than during the walk-through, then the buyer may be held in breach of contract if the buyer cancels.  There is no clear cut answer to this question because it depends on the specific facts of each situation.

The Taxpayer Relief Act of 1997 (the “1997 Act”) and the IRS Restructuring and Reform Act of 1998 (the “1998 Act”) provide for an exclusion from income for certain amounts of gain from the sale of a principal residence.  The Mortgage Forgiveness Debt Relief Act of 2007 (the "2007 Act") also provides clarification regarding certain capital gains issues. 

Additionally, the Jobs and Growth Tax Relief Reconciliation Act of 2003 (the "2003 Act") made important changes to the federal taxation laws including, among other matters, lower capital gains tax rates, acceleration of a reduction in tax rates, increased child tax credits and a reduction in the so-called marriage penalty.  Sunset provisions in the 2003 Act were extended by the Tax Increase Prevention and Reconciliation Act of 2005 (the "2005 Act").

This legal article discusses portions of all of these laws having an impact on capital gains treatment for the sale of real property and providing an exclusion from income for gain from the sale of a principal residence.

This legal article is necessarily general in nature and is not intended to cover every fact situation.   Slightly different facts may produce different results.  Accordingly, parties should consult a professional tax advisor if advice is needed in connection with a particular transaction.

I. Taxation on Sale of Principal Residence

Q 1.   What happens if I sell my principal residence?

A  Individuals are generally permitted to exclude from income up to $250,000 ($500,000, in general, for married couples filing a joint return) realized on the sale or exchange of their principal residence (26 U.S.C. § 121 also cited as IRC § 121).

Q 2.    May I use this exclusion more than once? 

A  Yes, but generally not more than once every two years.  In order to qualify, you must have owned and used the property as your principal residence for at least two years during the five-year period ending on the date of the sale or exchange.  In addition, the two-year periods do not have to be continuous. (IRC § 121.)

Q 3.    May I use this exclusion in connection with Internal Revenue Code ("IRC") section 1034 "rollover" of gain on the sale of my principal residence if I purchase a home of equal or greater value?

A  No.  The IRC § 1034 provision allowing a delay in the recognition of gain when purchasing a replacement residence of equal or greater value was repealed by the 1997 Act (IRC § 121).

Q 4.    May I still take a one-time  exclusion of $125,000 of gain from the sale of my principal residence if I am age 55 years or older?

A  No.  This exclusion was also repealed by the 1997 Act.

Q 5.    If I have previously used the $125,000 exclusion of gain, am I prohibited from using the new $250,000 ($500,000 for married couples filing jointly) exclusion of gain?

A  Generally no.   Even if you have previously taken the one-time $125,000 exclusion, if you are otherwise eligible for the exclusion you can take advantage of the $250,000 exclusion ($500,000 for married couples filing jointly) as often as you meet the requirements.  (IRC § 121.)

Q 6.    How does the exclusion apply to married couples?

A  The $500,000 exclusion applies to married couples filing jointly when all of the following conditions are met:

• Either spouse meets the ownership requirement;
• Both spouses meet the use requirement; and
• Neither spouse has had a sale of their principal residence in the preceding two years subject to the exclusion.
  
  (IRC § 121.)

Q 7.    What if I marry someone who has used the exclusion within two years prior to our marriage?

A  Even though your spouse has used the exclusion within two years prior to your marriage, you would still be allowed a $250,000 exclusion.  Once both spouses satisfy the eligibility requirements and two years have passed since the last exclusion was allowed to either spouse, a full $500,000 exclusion would be allowed for the next sale or exchange of a principal residence.  (IRC § 121.)

Q 8.    If my spouse dies, must I sell our principal residence within the year of my spouse's death in order to take advantage of the $500,000 exclusion from gain?

A  No.  The 2007 Act amends IRC § 121(b) to allow the exclusion of $500,000 in capital gains tax if the principal residence is sold within two years of the spouse's death (but this applies only for sales after December 31, 2007).

Q 9.    What if I move before I have occupied my residence for two years or before two years have elapsed since the last time I sold or exchanged my principal residence?

A  If you fail to meet either two-year requirement, you will still be entitled to a pro-rata amount of the exclusion as long as the failure to meet the requirement is because the sale or exchange is by reason of a change in place of employment, health or other unforeseen circumstances. 

The 1998 Act provides that this ratio is that portion of the $250,000/$500,000 exclusion equal to the fraction of the two years that the ownership and use requirement is met.  Therefore, an unmarried taxpayer who owns and uses a principle residence for one year and then sells because of a job transfer may exclude up to $125,000 of gain (one-half of the regular $250,000 exclusion).

Example:
Ms. Seller purchased and occupied her principal residence in 1998.  One year later, she is transferred by her employer to another city and sells her house for a $100,000 gain.  Because she occupied her residence for one-half of the required two years, Ms. Seller is entitled to exclude up to one-half of the $250,000 otherwise allowed, thereby covering her entire $100,000 gain.  This is a change from the IRS’s previous position allowing her to exclude only one-half of her gain, or $50,000.

Q 10.    Are there clarifications to the permissible reasons for sale or exchange allowing a pro-rata exclusion?

A  Yes.  Treasury regulations provide clarifications and safe harbors for the exemptions from the two-year period.  Treasury Regulation 1.121-3(b) provides that a sale or exchange is by reason of a change in employment, health, or unforeseen circumstances only if the primary reason for the sale or exchange is a change in place of employment, health or unforeseen circumstances. The regulation provides the following guidelines and safe harbors:

Place of Employment

Generally, a sale or exchange is deemed to be a change in employment if the primary reason for the sale or exchange is a change in the location of a qualified individual’s place of employment.  (See Question 11 for a definition of  qualified individual.)

The regulation provides a distance safe harbor if (i) the change of employment occurs during the period of the taxpayer’s ownership and use of the property as the taxpayer’s principal residence, and (ii) the individual’s new place of employment is at least 50 miles further from the residence sold or exchanged than was the former place of employment, or, if there was no former place of employment, the distance between the individual’s new place of employment and the residence sold or exchanged is a least 50 miles.

For purposes of the regulation, employment includes starting a job with a new employer, continuing employment with the same employer, and starting or continuing self-employment.

Health

A sale or exchange is by reason of health if the primary reason for the sale or exchange is to obtain, provide, or facilitate the diagnosis, cure, mitigation, or treatment of disease, illness, or injury of a qualified individual, or to obtain or provide medical or personal care for a qualified individual suffering from a disease, illness or injury.  A sale or exchange that is merely beneficial to the general health or well-being of the individual is not a sale or exchange by reason of health.

The regulations provide a safe harbor if a physician recommends a change of residence for reasons of health.  (See Question 11 for a definition of qualified individual.)

Unforeseen Circumstances

A sale or exchange is by reason of unforeseen circumstances if the primary reason for the sale or exchange is the occurrence of an event that the taxpayer does not anticipate before purchasing and occupying the residence.

The regulations provide a safe harbor for any of the following events occurring during the taxpayer’s ownership and use of the residence as the taxpayer’s principal residence:

1.  The involuntary conversion of the residence;

2.  Natural or man-made disasters or acts of war or terrorism resulting in a casualty to the residence;

3.  In the case of a qualified individual:

a.  Death;

b.  The cessation of employment as a result of which the individual is eligible for unemployment compensation;

c.  A change in employment or self-employment that results in the taxpayer’s inability to pay housing costs and reasonable basic living expenses for the taxpayer’s household (including amounts for food, clothing, medical expenses, taxes, transportation, court-ordered payments, and expenses reasonably necessary to the production or income, but not for the maintenance of an affluent or luxurious standard of living);

d.   Divorce or legal separation under a decree of divorce or separate maintenance;

e.   Multiple births resulting from the same pregnancy; or

4.   An event determined by the Commissioner to be an unforeseen circumstance to the extent provided in published guidance of general applicability or in a ruling directed to a specific taxpayer.

(See Question 11 for a definition of  qualified individual.)

(26 C.F.R. § 1.121-3.)

Q 11.  Who is a “qualified individual”?

A   Qualified individual is defined in the regulations as the taxpayer, the taxpayer’s spouse, a co-owner of the residence, or a person whose principal place of abode is in the same household as the taxpayer.  For purposes of the pro-rata exclusion of gain for a sale or exchange due to health only, a qualified individual also includes (i) an individual with a relationship described as a dependent in IRC § 152(a)(1) through (8), without regard to whether they are actually a dependent, or (ii) a descendent of the taxpayer’s grandparent. (26 C.F.R. § 1.121-3(f).)

Q 12.  What if I do not qualify for a safe harbor?

A  The regulations provide the following factors, which may be relevant in determining the taxpayer’s primary reason for the sale or exchange:

1.      The sale or exchange and the circumstances giving rise to the sale or exchange are proximate in time;

2.      The suitability of the property as the taxpayer’s principal residence materially changes;

3.      The taxpayer’s financial ability to maintain the property materially changes;

4.      The taxpayer uses the property as the taxpayer’s residence during the taxpayer’s ownership of the property;

5.      The circumstances giving rise to the sale or exchange are not reasonably foreseeable when the taxpayer begins using the property as the taxpayer’s principal residence; and

6.      The circumstances giving rise to the sale or exchange occur during the period of the taxpayer’s ownership and use of the property as the taxpayer’s principal residence.   

(26 C.F.R. § 1.121-3(b).)          

Q 13.  May I deduct a loss on the sale of my principal residence?

A  No.  Although there were discussions about allowing homeowners to deduct losses on the sale of their principal residence, this provision did not become law.

Q 14.  If I have gains from the sale of my principal residence above the $250,000/$500,000 exclusion limits, what tax rate will I pay?

A  Depending on the length of time you owned your principal residence, your gain may be taxed at the more favorable capital gain rates discussed below.  See Section II, below.

Q 15.  Are there more special rules?

A  Yes, including, among others, the following:

• A taxpayer can elect not to have the exclusion apply to any sale or exchange.
  
• Certain periods an individual resides in a nursing home on account of physical or mental incapacity are included as part of the two-year use requirement if certain other rules apply.
  
• An individual whose spouse is deceased on the date of the sale of the property can include the period the deceased spouse owned and used the property before death.
  
• An individual is treated as using the property as his or her principal residence during any period of ownership while the individual's spouse or former spouse is granted use of the property under a divorce or separation instrument.

Q 16.  What happens if I transfer my principal residence into a revocable living trust?

A  IRC § 676 provides that a grantor (the person who creates and funds the trust) is treated as the owner of the property when the grantor retains the power to revoke the trust and revest title in him or herself.  The 2003 Act does not change this provision.  This means that the $250,000 exclusion ($500,000 if married filing jointly) applies to a sale or exchange by a revocable living trust so long as the grantor of the trust and owner of the property before it was conveyed to the trust are the same person and that person, either as owner or grantor, has owned and used the property as his or her principal residence for two of the previous five years.  In other words, because the grantor is still treated as the owner of the property, the transfer into the trust is not a taxable event.

Q 17.  May I utilize an IRC 1031 ("like kind" tax-deferred exchange) in connection with an owner-occupied residence?

A  No.  However, individuals sometimes exchange one rental property for another planning to move into the acquired property and, after living in it for two years, sell it and take advantage of the capital gains exclusion. This sometimes occurred as soon as three or four years after the acquisition.  As of October 22, 2004, this was no longer possible. Pursuant to the American Jobs Creation Act of 2004, a property acquired in a 1031 exchange and later converted to a principal residence must by owned for five years from the date of the exchange before the owner can claim the capital gains exclusion. Therefore, in order to take advantage of a 1031 exchange and the capital gains exclusion, the owner must both have used the acquired property as a principal residence for two years and owned it for five years.

Q 18.  What are the basic capital gains tax rates?

A  The 2003 Act reduced the maximum rate on the net capital gains rate of an individual (net long-term capital gains less net short-term capital losses) from 20 percent to 15 percent.  Net capital gains previously taxed at 10 percent were reduced to 5 percent.

Q 19.  Has the holding period for long-term capital gains changed?

A  In order to qualify for long-term capital gains treatment, property must be held for more than 12 months.

Q 20.  Are there further capital gains tax rate reductions?

A  In 2008, the capital gains tax rate for gains taxed in the lowest tax bracket (5 percent) will be reduced to zero.

Q 21. When did the reductions in capital gains take effect?

A  The 2003 Act took effect May 6, 2003 and applies to taxable years ending on or after May 6, 2003. 

Q 22.  Do these capital gains rates expire?

A    Unless the U.S. Congress extends them, under Section 102 of the 2007 Act the capital gains rate reductions will sunset December 31, 2010, at which time the rates will revert to 20 percent and 10 percent.

Q 23.  Are there any changes to depreciation recapture rules?

A  No.  Generally, when selling investment real property, a tax is imposed on all amounts previously taken as depreciation.  Under prior law, these amounts were taxed as ordinary income and not capital gains.

The 1997 Act provides for a 25 percent maximum tax rate on any gain attributable to depreciation already claimed on the property in the case of real property for which the maximum tax rate is reduced to 15 and 5 percent.  Although there was an effort to reduce the recapture rate, no reduction materialized.

Example: 
Ms. Seller purchases a triplex for $200,000 after January 1, 2001, and takes depreciation deductions of $50,000 over the six years she owns it.  She sells the duplex for $300,000.  Her basis in this property is reduced to $150,000 because of her deductions for depreciation, and she would have a $150,000 gain.

Under the 2003 Act, she would be taxed at a 15 percent (or 5 percent) rate on the $100,000 portion of gain over her original $200,000 basis and at a 25 percent rate on the $50,000 portion of gain attributable to her depreciation deduction.

Q 24.  Can you provide a summary of the capital gains tax rates?

A  Yes. Sales of assets held more than 12 months and sold on or after May 6, 2003 qualify for the 15 percent capital gains rate (5 percent for lowest income taxpayers and zero percent beginning in 2008).  The capital gains rate reverts to 20 and 10 percent for assets held for more than 12 months and sold after December 31, 2010.

Q 25.  Can I still take advantage of an IRC 1031 ("like kind" tax-deferred) exchange?

A  Yes.  The tax-free exchange of  "like-kind" property used in a trade or business is not affected by the 1997, 1998, 2003 or 2007 Acts.

Q 26.  Where can I obtain additional information?


A   Readers who require specific advice should consult an attorney.