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Saturday, March 4, 2006 - Page updated at 12:00 AM

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Home Forum

Tax benefits of meeting 2-year test substantial

Seattle Times staff reporter

Q: What exactly is the IRS requirement for selling a rental property that's also been owner-occupied? A friend moved into her rental for several months, then moved out temporarily during a substantial remodel. She moved back in, but now has decided to sell because she's remarrying. She's lived in the house about 16 months total, but if the remodel period is counted, it would be close to 24 months. Would this count, or is it literally 24 months in residence?

A: "You have to have lived in your residence for at least 24 months out of the last five years," said Sue Ann Warren, co-owner of Warren Financial Services in Snohomish.

Warren is an enrolled agent — an income-tax specialist who's passed a Treasury Department test allowing her to represent taxpayers before the IRS. To be on the safe side, she counsels her clients that 24 months and one day is ideal.

Warren said the 24-month rule is open to some interpretation. Also, she said, the months don't have to be consecutive, and the owner doesn't actually have to be there all the time.

If an owner is traveling, in the hospital or living elsewhere temporarily during a remodel, the IRS will still consider it their home as long as it remains their primary residence. Generally that's the place where they're registered to vote and receive mail.

Warren suggests that your friend consider living there the full two years because the tax benefits can be substantial. If the home remains in her name only, she can exclude the first $250,000 in profit from capital-gains tax. If she also puts it in her new husband's name and they live there two more years, they can shield $500,000.

Otherwise, the home will be considered an investment property, and all profit from its sale will be subject to capital gains. Because homes in this area have had a sizable increase in value recently, there could be a fair amount of taxes to pay.

Q: I'm part of a 16-unit condominium homeowners association in Bellevue. We spend about $3,000 a year on earthquake insurance for our wood-frame town houses. The last quake caused us no damage. I think the money can be better spent on other things. How many other associations have earthquake insurance, and how can I persuade our members to drop ours?

A: Jim Comin, president of CDC Management Services, a division of The Management Trust, oversees some 160 condominium and homeowner associations. About half his condo communities have quake insurance. Whether they choose or decline such coverage has less to do with the building's structural characteristics than with the mind-set of the governing board.

"It's how conservative or aggressive people are," Comin said.

He can see pluses and minuses to having quake coverage.

The plus: If there's major structural damage, an earthquake policy will cover it. The condo association's master insurance policy won't.

The minus: The way quake coverage is set up can make it hard for an association to collect unless the damage is substantial. In that case, and in the case where there is no quake coverage, homeowners can face a special assessment to pay for repairs. Potentially, the sky's the limit.

However, there is protection for owners. They can buy individual earthquake coverage, called loss assessment for earthquakes, that will pay for a quake-related special assessment.

As for persuading the membership to drop your coverage, Comin says the decision to carry it usually rests with the board, not the homeowners. He thinks that's wise because earthquake coverage is hard to understand.

"There are nuances with earthquake insurance, so you can't just have everyone chime in without knowing what the value and protections of it are," he said.

If you're really committed to dumping it, Comin suggests you research the topic, then take your findings to the board members. Ultimately, it's in their hands — which is the way many aspects of condominium living work.

Q: I'm a single woman who doesn't want to get scammed hiring a house painter. The ones I've talked to are asking for half the cost of the job up front. Is this legal? Is there any way to check their bonding and insurance when they just work for themselves, not for firms?

A: There's nothing illegal about asking for part of the money up front. That's a contract issue — in other words, whatever payment arrangement you and a painter agree to in the written contract for the work is what applies. So if you don't like the 50 percent plan, negotiate.

Ron Krebs, business representative with Painters District Council 5, said larger firms typically don't ask for such a big deposit — or any deposit. Many simply present a bill when the job is completed.

However, smaller firms or individuals may well require money up front so they can pay for paint.

The state Department of Labor and Industries requires all contractors, not just companies, to be registered (licensed) and bonded. You can check them out on the department's Web site: www.lni.wa.gov. The site also has tips on hiring a contractor.

Finally Krebs suggests you ask painters for references and then check them out by talking to those clients and inspecting their paint jobs. Often, homeowners don't actually take that last step, and it can have dire consequences. Krebs said he's heard from more than one irate homeowner who's made partial payment to a painter and never seen him again.

Home Forum answers readers' real-estate questions. Send questions to Home Forum, Seattle Times, P.O. Box 1845, Seattle, WA 98111, or call 206-464-8510 to leave a question on a recorded line. The e-mail address is erhodes@seattletimes.com. Sorry, no personal replies. More columns at www.seattletimes.com/columnists.

Copyright © 2006 The Seattle Times Company

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