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Is freeing up capital to pay off equity loan, child's debt worth the risk?

Benny Kass
Inman News®

DEAR BENNY: I am 58 years old and married. My total household income is less than $50,000. I have no mortgage; however, I do have a line of credit with $130,000 owed.

I have a daughter who is a junior away at college. I want to help pay for student loans once she graduates. Do you think I should put my house up for sale and downsize to maybe a condo or townhouse? My home is probably worth about $250,000 in this market. I am worried that I will never be able to retire. What do you think? --Rod

DEAR ROD: I cannot give specific legal or financial advice, but have some general observations. What is the benefit of downsizing? Your house is free and clear, so your only obligation is to pay the yearly insurance premium and the real estate tax. Of course, there is maintenance and upkeep that has to be considered.

Let's assume you can get $250,000 when you sell your house. If you use a real estate agent, you will have to pay a commission, which could range from $12,500 to $15,000. You could try to sell it yourself and save the commission, but you really have to know what you are doing.

Your potential buyer may want concessions from you, such as paying closing costs, or a cash credit at settlement (called escrow in the Western part of the country).

So, bottom line, even if you get the full asking price, after paying off your home equity loan, you will net somewhere in the neighborhood of $100,000. The good news is that if you have lived in the house for two years out of the five years before it is sold, you can exclude up to $250,000 on any gain; or if you are married and file a joint tax return, you can exclude up to $500,000. So, with the price of $250,000, if you meet the use and ownership tests, you will not have to pay any capital gains tax.

Then what? What can you buy that will compare to your present house for $100,000? And actually, with closing costs, you will have to buy something for even less than $100,000.

Bottom line: If you do the math, you will end up worse if you try to downsize. You are blessed with a house that is free and clear. Hopefully, in the years to come, your house will appreciate in value, in which case you may be able to get a higher home equity loan.

Helping your daughter pay her student loans is admirable, but you have to think about your own situation. And besides, Congress is actively looking to curtail student loan interest expenses. Even with its current dysfunctional state, there may be a compromise enacted before the November elections.

My advice: Enjoy your house.

DEAR BENNY: Our two adult children each own a primary residence and now jointly own two rental homes. This places them as holders of three properties each.

They purchased the second rental home last year and we fear that they may not be able to deduct the mortgage payments and other expenses on this property on their federal tax returns. Additionally, if they eventually have to sell it at a loss in the future, the loss may not be deductible either.

Should they place the third property in an LLC or other legal device? --Frank

DEAR FRANK: You really have asked two separate questions: (1) Will they be able to take tax benefits from the third property? and (2) Should they put the property into a limited liability company (LLC)?

As for the first question, I can provide only general information; for specific answers you (or your children) should consult a tax adviser. In general, just because one has several investment properties does not preclude them from taking interest deductions or claiming loss when the property is sold. Of course, if they use one of the properties as a second home, it may lose its status as "investment." Additionally, if this is a vacation home that is rented out for periods of time, the tax laws differ based on how long the rentals are.

Bottom line on this first question: Your children have a number of investment properties and they really should have a tax adviser who can assist and guide them and of course prepare their tax returns at the end of each year. The accountant's fee is, in general, also a tax-deductible expense.

As for the second question -- whether to place the property into an LLC -- it is my personal opinion that investment properties should be in title in a limited liability company. Why? Because if you follow the rules for an LLC (i.e., you do not commingle funds, and all documents are signed in your capacity as member or manager of the LLC and not in your individual name), you insulate all of your other assets.