Refinance home to pay off credit card?

Option would roll $50K debt into tax benefit

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Add Comment Add Comment | Comments: 1 | Posted Nov. 9, 2009

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Option would roll $50K debt into tax benefit

Benny Kass
Inman News

DEAR BENNY: We will soon have our mortgage paid off. Our home is valued at $120,000. Unfortunately, we owe about $50,000 in credit-card debt. I took early Social Security and work part time. My husband will take full Social Security next March and continue to work full time. So we had planned to pay extra on the debt with his Social Security check and the fact that we will no longer have a house payment. This will likely take at least two years. However, we wonder if it would be more beneficial to re-mortgage the house for the $50,000 to pay off all the credit-card debt. Obviously it would be a lower interest rate and would be an income tax deduction. What do you think? --Jean

DEAR JEAN: No one wants to have mortgage debt, but sometimes you have no alternative. On the other hand, no one wants to be "house rich and cash poor."

Interest rates are indeed quite low now, although there is no guarantee how long they will stay this way. While the interest you pay on your credit card is not deductible, mortgage interest up to a $1 million loan limit is. So it definitely makes sense to consider refinancing.

You may also want to consider getting a home equity loan. This is a line of credit, which is why it is referred to as a HELOC (home equity line of credit). With a HELOC, you pay interest only on the amount of money you actually borrow; the rest of the money is available -- all you have to do is write a check.

But many HELOC loans carry a variable interest rate. This means that the rate is not fixed, but will vary (i.e., change) as the money market fluctuates. You should discuss such a loan with your local banker and see if this meets your needs.

One other suggestion: I have consistently maintained that a reverse mortgage should be considered as a last resort, but perhaps this is the time for you to consider such a loan. Talk with a financial advisor to get specific answers to your specific needs.

DEAR BENNY: My family has owned a 200-acre farm for several generations. For some reason, my father, who died in 1981, placed title to 40 acres in our mother's name, and placed title to the remaining 160 acres in the names of my sisters and me, with our mother receiving all profits, use, etc., for the entire farm all these years.

Upon our mother's death, my sisters and I will inherit her 40 acres. I've always heard it is better to inherit property rather than to have it deeded, because you get a "step-up" in the cost basis. If my sisters and I wish to sell the farm after mother's death, am I correct that the 40 acres will be based on the value at the time of her death, resulting in no capital gains taxes, but that the taxes on the 160 acres will be based on its valuation at the time of our father's death in 1981, resulting in huge capital gains?

If this is accurate, then my second question is: Can my sisters and I deed the 160 acres back to our mother now, before her death, so that we "inherit" it from her upon her death? --Connie

DEAR CONNIE: My answer may not be applicable to those readers who live in community property states, such as those in the western part of the U.S. I suspect there were tax reasons your dad did what he did. But now, you and your sisters have to consider your own tax implications.

You are correct that on your mother's death, when you all inherit her 40 acres, your basis for tax purposes will be the value of the property on the date she dies. This is known as the "stepped-up" basis.

Basis is important for tax purposes. It determines what profit you will make when you ultimately sell the property. Oversimplified, you take the purchase price and add any improvements to get the "adjusted basis." Then you take the sales price, and deduct such items as closing costs and real estate commissions to get the "adjusted selling price." The difference between the adjusted basis and the adjusted selling price is your profit, and unless there are exclusions, such as the up to $500,000 exclusion of gain for a principal residence, you will have to pay the IRS 15 percent of this profit.

To qualify for the exclusion, you have to own and live in the house for at least two out of the five years before it is sold. If you are married and file a joint tax return, you can exclude up to $500,000; if you file a single tax return, the exclusion drops to $250,000.

So in your case, on your mother's death, your tax basis for the 40 acres will be the value on the date of her death. As for the remaining acres, you are correct that your tax basis will be based on the value of the property when your father died. However, if you made improvements over the years, that will increase your basis (i.e., the adjusted basis) and your tax obligation will be less.

You want to deed the acres to your mother. That will not only create gift tax consequences for you, but I suspect that the IRS will consider this an improper transaction that was designed only to avoid taxes.

You should discuss your situation with your tax advisor. I can provide only general information, not specific legal or tax advice.

Unless you actually lived on the 160 acres, it most likely can be considered investment property, and you may want to consider doing a 1031 (Starker) exchange and get other property that may be a better investment. Such an exchange will not avoid any capital gains tax, but will defer it to a future date. Again, this is something you should discuss with your tax advisors.

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