Why is the APPRAISAL important?

On contracts in the State of Texas, we indicate that a home must appraise for at least the loan-to-value (LTV) amount shown on the contract, or the buyer can back out of the deal.

Hypothetical purchase: The buyer and seller sign a contract showing:

a price of $100,000
a down payment of 10% ($10,000)
a loan of 90% ($90,000 – a 90% loan-to-value ratio)
home must appraise for 90% LTV.

Just before final approval of the loan, the buyer’s lender sends an appraiser out to the property.

The appraisal comes in "low", at only $95,000. This is $5,000 below the CONTRACT price. The lender will still give the buyer a loan, but now at 90% of the APPRAISED value, or $85,500! Now the buyer will have to come up with another $4,500 in down-payment, to make up for the difference in what the mortgage company will lend!

The contract, however, stated that the home must appraise for at least 90% LTV ($90,000). Unless the seller is willing the sell the home for the appraised value, the buyer, not wanting to purchase a home valued at less than what he has agreed to pay and not able, perhaps, to come up with the additional down-payment required, can now back out of the contract.

(Note: If the appraisal comes in ABOVE the sales price, the "value" is always the lesser of sales or appraised amounts, so the value will never be above the sales price. The seller is therefore committed to sell at the sales price, even if it is below the appraised value.)

OPTION PERIOD

Hypothetical situation: "The last time we purchased a home in Texas, we agreed to a repair limit (such as $500) when we wrote to contract. We didn’t know what shape the home was in, the seller disclosed no problems, we guessed at the amount of repairs the home might have and put that figure into our offer. After we did our inspections, the amount actually came to $1500. The seller refused to do them, per our contract for $500, but we had to move quickly so we bought the home and have had to do them ourselves."

Texas no longer has an Earnest Money Contract, but rather an "option contract." It does NOT provide for:

1.   An agreed dollar limit on what the seller will spend toward repairs.
2.   Designation of repairs from inspections.
3.   Obtaining repair estimates.
4.   Allowing seller or buyer to back out if repairs run over budget.
5.   Setting time limits to make the choices.
6.   Arranging and completing repairs before closing.

Texas now offers two choices:

Buyer sided - an OPTION to buy, favoring the buyer.
Seller sided - an "as is" sale, favoring the seller.

Almost all offers are now an OPTION offer, giving the buyer an option to purchase the home. The seller agrees to sell, IF the buyer wants to buy. The buyer does not make a firm promise to purchase the home. With a promise on the seller’s side and no commitment on the part of the buyer, this could not be a contract – unless the buyer pays for this option. An option contract requires option money.

The option money is usually in the form of a check made payable to the seller. The seller keeps the money if the buyer decides not to purchase the home. The buyer is purchasing a period of time, during which presumably the buyer will inspect the property, get repair estimates, negotiate any items of major concern with the seller, and then make a decision to buy or not to buy the home. This cannot be done for free, because the seller suffers a loss by keeping the property tied up in contract and not really on the market.

How long is the option period? In practice, about 10 days. Less than this has proven to make it difficult to have inspections scheduled, report received and still leave time to work out any repair problems. More than this amount of time keeps a home off the active market for too long.

How much is the option fee? In practice, about $100 (less if a seller will accept it; more if a buyer wants to strengthen the offer). There is little doubt that the amount should be much greater, but the buyer is seldom willing to pay more than necessary. The option money needs to be enough to make the contract binding and enforceable between the seller and buyer.

The option fee is NOT earnest money. Earnest money is refundable during the option period, then "goes hard" at the end of the period.

How are repairs handled? In practice, the buyer may request that certain repairs identified by the inspector be completed. The seller is under no obligation to complete them, but then the buyer might refuse to buy the home. The seller must disclose the inspection report or repair information to subsequent buyers.

Here’s a likely scenario:

The buyer and seller sign the contract.

The buyer has inspections and (buyer or seller) gets repair estimates.

The buyer writes the seller, requesting certain repairs, at the seller’s expense.

The seller agrees to all (or a portion) or the request. This is put into a new agreement.

The option period is concluded and the sale is closed.

There is no pre-agreed amount of funds the seller is committed in advance to spend on repairs. Therefore, the buyer cannot be too sure the seller will agree to pay for anything at all. The seller may refuse to pay for them. However, the seller will not be able to pay for repairs from a position of know what the buyer’s inspectors say, and based on repair estimates. All of this information will be received during the option period of the contract (usually the first 10 days), which is a much more knowledgeable position from the old days, when the seller and the buyer were just shooting in the dark and guessing what might be needed in repairs. The seller will also be able to see more clearly the disadvantage of not paying for repairs that are really needed, and the seller who refuses to close will be stuck with making these same repairs for the next buyer.

How do we know that the option period is over? IF the buyer does not give WRITTEN NOTICE to kill the option, then the buyer will be deemed to have accepted the property as agreed in writing by   both parties, or "as is."

(Above information by Jim Wiedemer, attorney)

RE-SALE CERTIFICATE ???

Due to the undisclosed financial instability of some subdivisions in Texas, the State of Texas requires that, if requested by a buyer, sellers provide specific subdivision information (re-sale certificate, finances, restrictions, etc.) to a buyer prior to closing.

This is provided by the homeowner's association, at the request of, and a charge to, the homeowner.

If this information is not provided to the buyer in a timely manner, there are large penalties (primarily, it creates another "option period" that may extend almost to closing!) As many homeowners associations are not set up to handle providing information of this type in a timely or economical manner,  it is wise to request this information when the home is listed. 

1997 Tax Provisions Affect the Sale of Your Principal Residence

The tax bill signed by the President on August 5, 1997, provides substantial benefits to taxpayers who sell their principal residence. The Questions and Answers in this document are intended to provide basic guidance to sellers on issues that are covered by the federal statute.  Since becoming law, some issues have received further clarification, so guidance from a competent tax advisor is essential.  The following is taken directly from information provided by the National Association of Realtors.

1.  What is the new $500,000 exclusion?

This new exclusion replaces and greatly expands the old $125,000 one-time exclusion allowed for taxpayers who were age 55 or older.  The amount has been increased to $500,000 for married taxpayers who file a joint return; the exclusion for taxpayers who do not file a joint return is $250,000.  You can now claim this exclusion every 2 years, and you do not have to buy a new residence.

2.  Do I have to be a certain age to claim this exclusion?

NO.   Under old law, you had to be age 55 before the date of sale in order to claim the $125,000 exclusion.  The new exclusion does not impose any age restrictions, so any seller is eligible.

3.  How do I qualify for this exclusion?

You must satisfy three tests, each of which contains a 2-year requirement:

Ownership Test - You must have owned the residence for periods aggregating at least 2 years of the 5-year period, ending on the date of sale.

Use Test - You must have used the property as your principal residence for periods aggregating at least 2 years of the 5-year period ending on the date of sale.

Waiting Period Test - You must not have utilized this exclusion for any sale during the preceding 2-year period.

4.  My spouse and I have not been married long enough to satisfy any of the 2-year tests. Can we qualify for the full $500,000 exclusion?

Maybe, provided you file a joint return for the year of sale and satisy the Ownership, Use and Waiting Period Test, each of which is slightly different for married taxpayers.

Ownership Test - EITHER you or your spouse must satisfy this test, so you still can claim the exclusion even if only one of you owns your residence.

Use Test - BOTH you and your spouse must satisy this test, so each of you must have used the property as your principal residence for 2 years of the 5-year period ending on the date of sale.

Waiting Period Test - You cannot claim this exclusion if EITHER you or your spouse sold a principal residence during the past 2 years that qualified for this exclusion.

5.  I have owned and lived in my residence for over 5 years.  My spouse and I were married only last year, so she has lived in the residence for only a year.  Can we claim the $500,000 exclusion even though she has not used this house as her principal residence for 2 of the last 5 years?

NO. Both of you must meet the 2-year Use Test. There is no exception to this rule for newly-married couples.

6.  Can I still claim the $250,000 exclusion even though my sponse does not satisy the Use Test?

YES.   The law is written so that the exclusion is increased to $500,000 if a married couple files a joint return and satisfies all of the Ownership, Use and Waiting Period Tests.  If either of you fails the Use Test or the Waiting Period Test, you cannot claim the $500,000 exclusion, but would qualify for the $250,000 exclusion.  (Note: As discussed above, only one of you needs to satisfy the Ownership Test.)

7.  I transferred ownership of my principal residence to my revocable living trust over 5 years ago, so technically, I do not satisfy the ownership test. Can I still claim this exclusion?

Maybe. The answer to this question really depends upon the terms of your living trust. The typical "living trust" arrangement allows the grantor to revoke the trust at any time prior to death -- and reclaim the assets.  The Internal Revenue Service generally considers this type of arrangement to be a "grantor trust," and treats the grantor as the owner of the trust property and income. (Please check with your tax advisor for further clarification and guidance.)

8. Do I have to purchase a replacement residence in order to claim this new exclusion?

NO.  YOU ARE NOT REQUIRED TO PURCHASE A REPLACEMENT RESIDENCE! 

9.  Can I claim this exemption more ofter than every 2 years?

MAYBE.   Under very limited circumstances, you are entitled to a percentage of the exclusion even if (a.) you have not owned your residence for 2 years, or (b.) it has been less than 2 years since you sold another principal residence.  These special crcumstances include a change in your place of employment or health.   Also, the new law directs Treasury to issue regulations to provide the same treatment for sales made due to "unforeseen circumstances."

10.  Does the new law allow me to deduct a loss on the sale of my principal residence?

NO.   Losses on the sale of your principal residence remain non-deductible.

11.  If my gain is less than $250,000 ($500,000 for qualifying married taxpayers), can I apply the unused portion to a future sale?

NO.  Any unused portion simply disappears.  However, you will again be eligible for the entire exclusion 2 years after you sell your current residence.

12.  How do the exclusion and the lowered capital gains tax rates related to each other?

If you qualify for the exclusion, the first $250,000 ($500,000 for qualifying married taxpayers) of gain on the sale of you principal residence is not taxable; any gain that exceeds this exclusion is subject to tax at capital gains rates in effect on the date of the sale.

13.  If my gain is taxable, what is the new tax rate?

Effective May 7, 1997, the new rules reduce the capital gains tax rate from 28% to 20% (10% for taxpayers in the 15% tax bracket).  (Please consult with your Tax Advisor for changes in these.)

14.  If I already used the one-time $125,000 exclusion for a residence I sold before May 7, 1997, can I still claim this exclusion?

Yes.  Your eligibility for the new $500,000 exclusion is not affected by whether or not you claimed the old $125,000 exclusion.

15.  My brother and I and one of his friends own a home together that we use as our principal residence.   Each of us is single.  How will the new exclusion affect us when we sell the residence?

Each of you will qualify for an exclusion up to $250,000.  Thus, as much as $750,000 of gain on the sale could be excluded from tax.  Since each of you files your tax return as a single person, each of you will qualify for your own exclusion on your portion of the gain.

16.  My spouse died this year, and now I want to sell our principal residence. Can I claim the $500,000 exclusion?

Maybe, but in order to qualify for the full $500,000 exclusion, you must sell your residence during the same tax year in which your spouse dies.  The reason for this is that you are allowed to claim the $500,000 exclusion only if you file a joint return, and after the death of your spouse, you are permitted to file a joint return only for the year of death.  If you sell in a later year and file a single person return, you qualify only for a $250,000 exclusion.

17.  I bought my house in 1990 and plan to sell it soon.  How do I determine my basis for measuring gain when I sell?

The starting point is your purchase price for the residence when you bought it in 1990.  If you rolled over gain from the sale of a prior residence, you must subtract any gain that you realized and deferred from earlier transactions.  If you did do a rollover, you should review the Form 2119, "Sale of Your Home," that you filed with your tax return for the year you sold your earlier residence. That form will show the adjusted basis of your current residence after rollover of the earlier gain.

Whether you start with the actual purchase price or an adjusted basis as determined in a prior rollover transaction, your basis is increased by adding the cost of major improvements or special tax assessments and subtracting any depreciation (e.g., which you might have taken as a prior home office deduction.) The instructions for Form 2110 include a detailed worksheet to help you determine your correct basis.

18.  I sold my house in 1998 and qualified for the $500,000 exclusion.  I bought a new house for $150,000, and plan to sell it soon as I again qualify for the exclusion. How do I determine my basis for measuring gain when I sell?

Your basis will simply be the purchase price of the $150,000 home plus improvements.  The fact that you claim the $500,000 exclusion does not affect the basis of any residence you later purchase.

19.  What are the record keeping requirements?

For federal purposes, you should maintain records showing the purchase price and any improvements to your residence for as long as you own the property, and then for 3 years after you file your return on which you report the sale.

20.  My spouse and I purchased a residence over 5 years ago, lived in it for awhile, then converted it to a rental property.  If we sell this property today, we will have used it as our principal residence for fewer than 2 of the last 5 years.  Can we still claim a portion of the exclusion?

No.  If you fail any of the tests, you do NOT qualify for any portion of the exclusion except under the special circumstances noted above (i.e., change in your place of employment or health).

21.  My spouse and I purchased a residence over 5 years ago and lived in it until a little over 2 years ago. Can we claim this new exclusion even though we do not now use this property as our principal residence?

Yes.  The property does not have to be your principal residence on the date of sale. The requirement is that you must satisy the Use Test for 2 years of the 5-year period ending on the date of sale.   So, provided all other requirements are satisfied, you will qualify for the $500,000 exclusion.

For further information regarding home office deductons, prior depreciation on rental property you now claim as a residence, exclusion percentages for relocation, etc., please contact a competent tax advisor.