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Although Friday comes every week, Friday Q &A comes around only when someone submits a good question AND I have time to answer it.   Both happened this week, so here we go. Want to ask a question?  Click here for more information or simply email a question.

I plan on buying a  home from my parents that wasn’t their primary residence, it is a rental property. I understand that I wouldn’t be able to get the $8,000 credit because my parents owned the home. What if an unrelated person bought the home from my parents but doesn’t qualify for the First Time Home Buyer Credit, and then I purchased the home from them later to get the $8,000? Is there any restrictions on trying to get the credit this roundabout way?

Thanks,

Paul

Straightforward Answer: Sounds like fraud.

Detailed Explanation:

As you are aware, any home purchased from a close relative, a definiiton that includes a parent, disqualifies you from the first time home buyer tax credit.  Technically, what you are saying – have a parent sell it to someone else and then you buy it from that person – is possible.  There’s nothing remotely illegal about it. But if it’s done solely to get the credit?  Doesn’t pass the smell test?

Transactions that are entered into solely for the purpose of tax avoidance aren’t well-received by the IRS.  Surely, that won’t really surprise anyone. For tax geeks:

Transactions entered into solely for the purpose of tax avoidance, which lack any business purpose, are shams and without effect for Federal income tax purposes. Frank Lyon Co. v. United States, 435 U.S. 561 (1978); Knetsch v. United States, 364 U.S. 361 (1960). The leading case supporting the existence of a “sham transaction doctrine” is Gregory v. Helvering , 293 U.S. 465 (1935).

Furthermore, calculate the transaction costs – real estate commissions, recording fees, etc.  My guess such expenses will cost more than $8,000.  So don’t bother. Want the credit?  Buy a different house. Or buy your folks’ home and forget about the $8,000.

FYI, there are over a thousand comments on my other first time home buyer tax credit posts, many of them are of a Q & A nature.  You can check them out here:

• First Time Home Buyer Tax Credit – 2009 Version
• First Time Home Buyer Tax Credit: When a credit isn’t a credit but it’s still free money
• First Time Home Buyer Credit – Your options if you buy after April 15

Saving for a home or, more precisely, how to save for a home is today’s Q & A.

You: Q & A?

Although Friday comes every week, Friday Q &A comes around only when someone submits a good question AND I have time to answer it.   Both happened this week, so here we go. Want to ask a question?  Click here for more information or simply email a question.

I would like to know what is the most effective way to save for a home? I am currently putting the matching percentage of my employer into my 401(k). Should I open an IRA account or Money Market account to reach my goal of 20% down payment on a home?

I believe my income prevents me from getting a ROTH IRA but I am not sure about a traditional IRA.

Matt C.

I love when people ask questions like Matt’s, because it shows they’re committed to doing the right thing and simply want advice as to the best way to do it.  Contrast Matt’s question with the infinitely more common, “Can I use my emergency fund  (It’s almost $1,000!) to make a down-payment on this new car I want? I’d be getting a great deal!”

For anyone that has a matching program at work, taking advantage of said program is step # 1. Matt’s done that – congrats to him.

Now, Matt wants to know how to save for a home – an appropriate goal for most individuals.  Have you paid off your high interest credit card debts?  Do you have an emergency fund?  If so, great. If not, go there first – those items are more important than the house.  Seriously.

Once you’re ready to save for the home, I believe it makes sense to open a separate account (it can be at the same institution where you already have a relationship) that is earmarked for that purpose.  Doing so makes it much more difficult for you to take the money out for some alternative purpose in the many months (possibly years) before you actually take the plunge into homeownership.

While others will argue that an IRA or a Roth IRA (each of which has some exceptions to taxes and penalties due on a pre-retirement distribution when the money is used to buy a home), I do not support this approach.  Rather, create a regular taxable savings or money market account.  The tax savings, particularly in this pathetic interest rate environment, from using a retirement account to save for a home will be negligible at best. More importantly, I prefer to think as retirement plans as exclusively available for retirement. If you tolerate one exception, why not another later on?

A retirement plan is to used for retirement.  Keep your promise. It’s a promise you’re making to yourself, anyway!

How to Save for a Home – Account Specifications

Don’t put your money in an account that is not FDIC insured. Right now, there’s a $250,000 limit on insurance per account.  There’s no reason to take on any risk with your down payment money.

Choose a bank that pays some freaking interest. While interest rates for savers are disappointing almost everywhere, there is still a meaningful spread between the least and most generous banks, a range that is likely to become more important when rates one day increase across the board.  Internet only banks like ING DIRECT, HSBC, Emigrant Direct and others are great places to start. Bankrate.com lists the highest paying institutions.

Consider CDs.  If you know you’re not going to buy a house for 6 months, a year, or even longer, consider CDs as a way to earn a bit more interest. I don’t suggest going too long, however, as you may not want to lock in your rate for, say five years at a couple of points, since rates may be much higher before your term is done.

Establish a realistic goal. Then achieve it. Do what you can to get a down payment of 20% of your purchase price, saving you the potential significant expense of mortgage insurance.  (Matt’s 20% wasn’t picked out of thin air.  It’s the goal all first time home owners should set for themselves).  If 20% sounds like a ton of money, it probably is.  But you’ll be more financial savvy for achieving that amount, as many home owners (and former home owners) have recently discovered. Banks too have re-learned the importance of a home owner have a financial stake in their home.

Good luck Matt. Stay in touch and let us know what you decide to do.

#     #     #

Anyone else planning on buying a home soon?  My wife and I still are, although we haven’t updated you on our progress (or lack thereof) recently.  More to come.

It’s Friday, so it’s time for this week’s reader-submitted Q & A. (Two covered this week – I am so motivated!)  If you’d like to submit a question, click here for more information or simply email a question.

I purchased a mobile home over 17 years ago for cash and have been paying rent for a space in a trailer park.  Am I considered a home-buyer so am ineligible for the tax incentive?  I am in the process of buying a condo along with a non-relative and she is not eligible for the it.

- Phyllis

Straightforward Answer:  Probably not.

More Detailed Explanation

As I wrote recently on my post First Time Home Buyer Tax Credit – 2009 Version (a post with over 500 comments on it):

For anyone who owns a trailer home, mobile home, or lives in an RV and has been asking or wondering about if they’ll qualify for the first time home buyer tax credit if they purchase a home that is permanently fixed to the land: I just found this link at the IRS web site which seems to suggest that those currently living in RVs will qualify (and presumably, as I have suggested, those living in mobile homes and trailer homes without motors will not.)

Here is the relevant Q & A excerpted:

Q. Can an individual who has lived in an RV qualify for the credit?

A. For purposes of the first-time homebuyer credit, an RV with a built-in motor is personal property that is not affixed to land and does not qualify as a principal residence. Accordingly, someone who has owned and lived in an RV within the past three years may still qualify as a first-time homebuyer.

If we have a purchase agreement signed but we don’t end up closing on the house until after Dec.1,2009 will we still be able to collect the $8,000.00?

- Chenoa B.

Straightforward Answer: Nope.

More Detailed Explanation

You must close before 12/1/09.  (Unless Congress extends the deadline. While I personally believe some form of the credit for the period starting 12/1 will be passed, there can be no assurance and no vote is on the horizon).

It’s Friday, so it’s time for this week’s reader-submitted Q & A. If you’d like to submit a question, click here for more information or simply email a question.

I purchased a home in Nov. of 2008 for $200,000. In July of 2009 I sold it for $265,000. If I am using all of the proceeds from the sale to pay for my new house, will I still have to pay capital gains tax on the profits because I did not live in the house for two years? What rate would the tax on the profits be?

-Rene M., Ventura, CA

Straightforward Answer:  You probably won’t have to pay any capital gains taxes, but not for the reason you think.

More Detailed Explanation

Back in 1997, Congress changed the rules governing the taxation of a gain realized on the sale of a personal residence. Until that time, you could defer your gain (and not pay any capital gains taxes) on your residence as long as you used the proceeds of the home you sold to buy a home that was, roughly speaking, at least as expensive as the home you sold.  I think that may be why Rene mentioned “using all of the proceeds from the sale to pay for my new house.”

Today, that fact is meaningless.  Since 1997, new laws have governed what you can exclude (not just simply defer) from tax as a result of selling your personal residence at a gain.  (Admittedly, there have been a lot less questions about this since the housing crisis began, but it appears something went well for Rene.)  Now, you can exclude up to $250,000 of gain ($500,000 if you’re married) permanently.  The most important criteria to qualify are that you must own and live in the home for at least two of the five previous years before the sale date.  That’s where Rene ran into a problem,  since she only owned the property for about eight months.

If Rene sold her home due to a job change, declining health, or other unforeseen circumstances (as outlined by the IRS), then she may qualify for a reduced exclusion. If she just didn’t like her home anymore and wanted to go across the street, she won’t.  She’d owe tax on her gain of approximately $65,000. Her rate would be the short-term capital gains rate, which is the same as her ordinary tax rate (based on her income).  The preferable lower capital gains tax rates are only applicable for assets held more than one year.

Assuming Renee qualifies for one of the stated reasons, however, her reduced maximum exclusion would be eight divided by 24 (eight months representing the time she actually did own the home,  24  being the number of months she would have had to own the home to get the maximum exclusion). Assuming Rene is unmarried, 8/24 is then multiplied by $250,000. The result is $83,333, which exceeds the $65,000 gross profit on the home.  As such, it’s unlikely she’ll owe capital gains taxes.

Please note that there are some intricacies to the tax law on which I have not gone into great detail (see aforementioned housing crisis for reasons why I’ve decided to spend my time educating you elsewhere at the moment).  For example, less than the full $65,000 might have been taxable had Rene, for example, added a bedroom during the eight months she owned the home. Such details are why, when you have a big event in your life, it’s worth considering hiring a professional tax-preparer.

It’s Friday, so it’s time for this week’s reader-submitted Q & A. If you’d like to submit a question, click here for more information or simply email a question.

Coincidentally, I received the following two questions less than five minutes apart:

You signed my book at the ING DIRECT cafe in Chicago some time ago.  In your book you refer to an 8% savings rate in hypothetical scenarios in several places.  Where/how does one get this rate?  I have a high interest account (under 2%) at ING DIRECT.  I’m considering seeking financial advise/money management at Charles Schwab, but thought I’d check w/you first to get any feedback.  I have $60,000 that I think I should be able to grow at a better rate with little (or no) risk, but not in a cd.  I’d like to buy my first home in 6 months (with most of this money as a down payment) and am wondering what options I have to safely grow this money.  I’m saving maybe $3,000 a month.  I’ve never invested.  Thoughts?

– Becky B., Chicago, Illinois

I’m thinking of buying my first house some time in the next 4-5 years. And I know I should start saving now. But what is the best way of saving? Should I put my money in a High-Interest Savings account such as ING DIRECT, in a 3-year long CD, or invest in a mutual fund with Vanguard? How do I choose which is the best option? Thank you.

– Diana C., Los Angeles, California

Straightforward Answer: Your investment choices must match your time horizon.

More Detailed Explanation:

Whenever you choose save a dollar, you must choose how to invest it.

You: No, I could put it in the bank.

Putting your money in the bank is an investment decision.  It’s called investing in “cash.”  Broadly speaking your investment choices are:

• Cash (includes savings accounts, checking accounts, money in your wallet, and change in the couch).
• Fixed Income (includes savings bonds, municipal bonds, corporate bonds, and the stable value option at your retirement plan)
• Equities (includes stocks)

You: What about mutual funds?

Mutual funds can fall into any of the three categories above.

You: Even cash?

Absolutely. A money market fund is actually just a mutual fund that is invested in ultrasafe assets like “cash and cash equivalents.”  Furthermore, some mutual funds invest in more than one category.

You: They can do that?

Sure. A balanced fund, for example, will often have a large percentage invested in both fixed income and equities.

Your Risk Tolerance, Time Horizon, and Investment Choices

As covered in depth in the investing chapter of Beyond Paycheck to Paycheck, your risk tolerance should drive your investment choices. (Unfortunately, that’s often not how it works since choices are often revealed to having made:

• Out of fear of losing it all and therby keep it all in the bank – also known as the “Depression Mentality”
• Out of fear of missing out on the next good thing and thereby purchasing 17 condos in Miami, putting $1,000 down per unit.

But that’s a post for another day.

Your risk tolerance is based on both your personality and your time horizon.  Both Becky and Diana have shared with us their time horizon as 6 months and 4-5 years respectively.  Let’s first address Becky’s conundrum.

Becky Wants 8% And Has a 6-Month Time Horizon

Turns out Becky isn’t going to be happy.

You: Why?

Because she has two mutually exclusive objectives. The first is to earn an 8% rate of return on her money. The second is extreme safety for her money since she needs it for a home down payment in just 6 months.

You: Why can’t she have these two goals?

She can. Just not at the same time on the same money.  In order to expect to earn about 8%, she’ll need to take the risk of investing her funds in the stock market.  (For those of you skeptical that 8% is achievable or that it dramatically understates today’s opportunity, I say:

I really don’t know what’s going to happen in the near term and neither do you.

However, 8% is the long-term historical return of the stock market (Check out this cool little calculator at  Money Chimp where you can plug in any pair of start and ending years and learn the historical performance of the S&P 500).  Since 1900, we’re at over 9%.  Since 1990, we’re still over 7%.) Indeed, even today 8% seems reasonable for long-term performance.

You: But what’s the big takeaway?

There’s a ton of volatility in the stock market.

You: Well, there’s a newsflash.

First off, to some people it is.  And secondly, when times are good (which they will be again), many people forget about the risk. Or, more precisely, they redefine risk as “not making as much money as someone else did.” All along, in good markets and in bad, you can make money and you can lose money by investing in stocks.

The net impact to Becky is that no matter how aggressive she is (and she’s probably not that aggressive, being that she’s accumulated $60,000 and has “never invested,”) she must keep all of her down payment money in cash.  That’s the only way to ensure she will absolutely have her money available to her when she needs it six months from now.

Only in a savings account or a money market fund can she be assured that she won’t lose her principal. Furthermore, only cash affords her the ability to refrain from timing the market.  After all, where will the stock market be in six months?

You: I don’t know.

Me neither. You wouldn’t want to have to sell if we’re back down at 6,500, would you?

You: No. will it be back to 6,500 again?

I still don’t know.

You: Me neither.

I think you see my point.

You: Right. So Becky can’t get 8% without risking her principal?

Correct – and please don’t comment below about the sure thing in soybeans.

Gary: It’s actually frozen orange juice.

Whatever.

Becky, just keep your money in a high-interest savings account and you’ll be fine. If you’re absolutely certain you won’t need it for six months and you can get a better rate with a CD, feel free, but remember the first time home buyer tax credit. If you’d otherwise buy a house in December, buy it in November and get the free $8,000 (subject to income restrictions).

Diana Has More Time – Can She Take More Risk?

Diana’s time horizon is a bit longer: 4 – 5 years.  But, from reading her letter, her risk is less so from a potential loss of principal than it is from a current lack of savings.  Diana needs to get going on savings for this specific goal (a home) today. It takes along time to get a down payment of 20% of the price of the home in order to avoid costly and utterly unnecessary PMI – especially in California.

You: Why is PMI unnecessary?  I thought it was required if you put down less than 20%.

It is required. It’s unnecessary because no one is putting a gun to your head saying buy a home you can’t afford to pay 20% down on.

You: But–

But nothing.  Save longer or buy a less expensive home. Or, like Diana and Becky, start saving well before you actually go home shopping.

You: When Diana starts saving, where should she put her money she has earmarked for a home?

In the bank.

You: She shouldn’t invest in stocks?

Probably not.

You: Why not?

Because the risk of loss of principal is still too great.

You: But if the next three years prove to be stellar for the stock market, this would prove to be the wrong advice.

No, it would prove to be unlucky.  It’s the right advice for that very reason: we simply don’t know. Many people have advocated investing in stocks for your long-term objectives like retirement. Count me among them. From my vantage point, stocks make sense for my retirement plan as much today as they did 15 years ago when I started investing. I still felt that way earlier this year when the Dow was down in the mid 6,000s.

Don’t get me wrong, it may have periodically caused some lower intestinal distress, but it was and is still the best way to go – for the long-term.

You: What’s long-term?

At least 10 years.  Four or five years is just too short. Diana, put your money in something much safer. A CD (or more than one CD) could be attractive, but you shouldn’t be investing your home money in anything you could actually lose your principal by in.  By definition, this includes stocks.

More aggressive and sophisticated investors could consider bond or other fixed income investing – but given where we are with interest rates at the moment, even those may prove to be overly risky – especially for someone new to the game.

Good News

All of this leads to a wonderful conclusion: savings will be the primary determinant for you getting you your first house someday.  True discipline will give you the opportunity to become a homeowner and in a far different way than the buyers of 2005 and 2006 accomplished the feat.

Remember, however, do not be cheap – be fiscally responsible.

I’m beginning to go through the home buying process myself.  When you call your banker and you tell them you’re going to be putting down 20% (or more) and they pull your impeccable credit history, you will feel rewarded when they tell you what you can afford and at what rate.  This is the future for Becky and Diana.

You: And me?

That’s up to you.

It’s Friday, so it’s time for this week’s reader-submitted Q & A. If you’d like to submit a question, click here for more information or simply email a question. Recently, the questions have been arriving in droves, so get yours in today! As you’ll see from the signature below, they’re also coming in from all over.  (Although nothing from Turkey yet. Istanbul, are you out there?)

Hi Michael,

I own my 2000 Volvo V70 wagon with 140,000 miles outright, but it needs major work to stay on the road –  to the tune of $5,000. I am wondering if I should pay for the repairs or replace the car? The private party sale of the car, once repairs are made, would be $3,000 to $4,000 — less than the cost of the repairs.

Here are a few more details about my situation:

• My general MO with cars is to buy a newer used car in good condition and drive it into the ground. I don’t like to spend money on cars, but I do like reliable and comfortable transportation for my family.

• The mechanic who quoted me the repair estimate is fair and has been working on the car since the beginning. We trust him, as much as you can ever trust a mechanic.

• Also, the 5K estimated for repairs are just the critical repairs. There are other repairs that aren’t critical so we’re ignoring those.

• My husband and I plan to buy our first house later this year and don’t want to spend all of our cash. Even though I would normally tap my savings to buy a good used car outright, this year I am hesitant to do it because we will need the money for our down payment.

• I’m considering financing a car, and I’m wondering if I should consider other options, like a new car where there might be some bargains or great incentives.

What do you suggest?

Many thanks!
Genevive, Maui, Hawaii

Straightforward Answer:  Replace your car with a slightly used car and finance it.

More Detailed Explanation:

I fully realize that my short answer above may draw the ire of some.  Although not for that reason, my response is for Genevive’s facts and others in very similar circumstances. Let’s address each of your issues in turn.  I believe you really have three considerations:

Consideration # 1: Replace the car or fix the car?

It will cost you more to fix the car than it will be worth after completing the repair.  By definition, this means that your car currently, sans repairs, has a negative value.  (This happened to my first car after only seven years and 90K miles.  You’ve benefited from 9 years and 140K since manufacture so you’ve done okay.)

It’s not a good idea to put money into an asset that is worthless.  As you describe your car, your repair needs go well beyond routine and expected maintenance expenses.  Furthermore, there are additional expenses, already known, that are needed in the short-term that go above and beyond the $5K amount.

Still, while your car has a negative value to you, it will have some sort of positive value to someone else.  If you go to trade-in the car, it will have value as a trade, since a reasonable dealer will do what he can to move a car off his lot.  (In this case, the economy will both help and hurt you.  The dealer will be excited at the prospect of moving a car, but he’ll be less excited about the idea of taking your clunker.  (Yet another reason to keep these two negotiations separate.)

Net: replace the car and get what you can for it.  It’s about to become a money-pit.

Consideration # 2:  Replace your car with a new or slightly used car?

This used to be a no-brainer: choose a slightly used car. Doing so enables you to avoid the painful, instant, and dramatic depreciation suffered by any new car buyer.  It is likely still going to be your best strategy.  But it is no longer a no-brainer.  Due to the crazy economy we are now in, new car prices have been punished and, in many cases, severely so.

A brief illustration:

My wife and I finally purchased a second car (Until late April, we’d had just one sedan. However, with two growing kids and my new out-of-the home office, we eventually had to concede to running out of room and flexibility).  We fully intended on purchasing a used mini-van (insert Dad joke here).  But after several weeks of looking for used mini-vans, pricing them and doing just a little bit of negotiating with a new car dealer, the value proposition was notably stronger for the new mini-van.

Because of the economy, certain manufacturers are selling certain model cars at far lower prices than just a few months ago.  Also because of the economy, many people are keeping their cars far longer than they would typically (I’m not talking about financially shrewd people who historically have always kept their cars until they couldn’t run anymore; I’m speaking of the masses who replace their cars every three years or so.)  As a result, it’s possible that, for the make and model of the car you’re looking for, used cars might not be as readily available as during normal times. Supply and demand doing what they do, used car prices for certain models are strong.

Net: do your research.  Depending on your local market conditions, the car model you desire, and your flexibility to consider other car types, you may very well be better off with a new car.  Run the numbers, keeping in mind that you should expect and plan to keep a new car two years longer than a used 2007 model.

Consideration # 3: Lease, Finance, or Purchase for Cash?

I’m hugely against car leasing except in very specific circumstances.  You’re not an ideal candidate for leasing anyway, given your intention to drive your vehicle for a long time and your history of actually doing so.  So the real choice for you is to finance or purchase for cash.  That you are even considering purchasing a car for cash puts you in the great minority.  You are only able to do so because you either have ample savings, a low car budget, or both.

There are huge upsides in paying cash for a car, most notably avoiding interest charges on your car purchase. Furthermore, you won’t be in the monthly payment trap.  Good outcomes to be sure.

But, again, there are other factors at work. You have two primary issues that influence my suggestion to you:

First, there’s the economy again.  If you have the financial strength to be an attractive car buyer (good credit and a job), you will be eligible for significant financing opportunities not available to less credentialed buyers (or even to you, during normal economic times.)  It is financially responsible to consider such low cost financing options. Currently, several new cars are available at low rate or no-interest financing.  While I’m not advocating you sign up for an 8% car loan interest rate, if you can score a 1.9% or 2.9% rate, I’d rather see you with the additional cash in your savings account for emergencies or with the ability to increase your retirement savings.

Your second consideration with regard to financing the automobile is your intended upcoming purchase of your home.  If purchasing the car for cash would push you below the 20% down-payment required to avoid PMI, the car for cash purchase option should be eliminated (or you’ll just need to shop for a less expensive home). Since you don’t seem like a “car person,” you’re better off making sure you are the most attractive home buyer you can be. This will mean bringing a sizable down payment to the table.

Genevive: Good luck with your decisions. Let us know how it all works out or if you have any other questions.

Everyone else: okay, where, and how passionately, do you disagree?  Or do you see it the same way?

It’s Friday, so it’s time for this week’s reader-submitted Q & A. If you’d like to submit a question, click here for more information or simply email a question. The questions about the first time home buyer tax credit keep coming so this week we’re including two on the topic.  If you have your own, feel free to comment at the 2009 First Time Home Buyer Tax Credit.

I am a first time buyer BUT I was married in 2005 and lived with my husband for 3 months; after 3 months I moved back with my mother and have lived there every since which has been almost 4 years now.  My estranged husband owned his house prior to the marriage and I am not on the loan or the deed and he has an FHA loan.  I have been approved for a FHA loan can I take the $8,000 tax credit if he signs away his rights.  We have no intentions on getting back together.

–Requested Anonymity

I have clients who live in another state and would like to purchase a home (in Colorado) for their son while he attends college here.  If they purchase the home in son’s name, would he be able to take advantage of the First Time Homebuyers Credit?  The home could either be a conventional loan or cash purchase.  Your thoughts on the best way to go?

–Carly K., Colorado

Short Answers: A problem and no problem.

More Detailed Explanations: Anonymous hasn’t owned a home in four years.  Since the definition of a first time home buyer is anyone who hasn’t owned a home in the last three years, she’s okay on that front. However, she can’t be married to someone who doesn’t qualify.  She appears to still be married to her husbdand and, since her husband is a homeowner, she is disqualified.  If she were divorced, the answer could be different.

Carly’s clients are considering purchasing a home for their son who has never been a homeowner before and who, we can safely assume, is well underneath the income limits described here. The source of financing is irrelevant (cash vs. mortgage) so long as it is the son who will own the home.  Keep in mind that there may be gift tax implications if the parents are just giving him a huge amount of cash to assist with the down payment. (If less than $26,000, there’s no problem).

It’s Friday, so it’s time for this week’s reader-submitted Q & A. If you’d like to submit a question, click here for more information or simply email a question.

I was wondering if we qualify for a first time home buyer credit. We just bought our first house in Nov 2008. My husband purchased a home with his ex-wife more than 3 yrs ago, (his name is still on that one) but has not lived there in 4 yrs.

Thank you for your help,
Donna

I have been living in a trailer for 11 years.  I co-own the trailer with my spouse.  Can we take the first time homeowner credit?

-TMC

Straightforward Answers: Donna: Yes.  TMC: No.

Detailed Explanation:

Both the 2008 version of the first time home buyer tax credit and the credit for 2009 first time home buyers have raised a ton of interesting questions (By far, they are the most widely read and commented on posts in the history of this blog.)  Let’s take these two questions one at a time.

Impact of A Spouse’s Current of Former Home Ownership

One of the key constraints of this credit is that if either spouse is disqualified for any reason, than both spouses are disqualified. (The same is not true of unmarried taxpayers who jointly purchase a home. This is why engaged couples have an enormous tax planning opportunity.  For example, if one fiancé owns a condo but they both plan to move in together into a home in the suburbs after the wedding, it’s best to buy the home before they get married.  Details available throughout the comment section of the 2009 article.)  In Donna’s case, the question is whether her husband’s previous ownership of a home with his ex-wife disqualified him and his current wife.

If he still owns the home with his ex-wife, you’re Donna and her husband are out of luck. However, if he moved out of that home more than three years ago and it became his ex’s home exclusively at that time, you’re in the clear. Take the credit.

The answer to TMC’s question is less a happy one.  In Congress’ desire to be generous, the credit specifically applies if you are to purchase a trailer home as your first home. As such, a reasonable interpretation of the law says that previous (or current) ownership of a trailer similarly disqualifies you.  So if you’re going to buy your first home and it is a trailer, you’re in good shape to take the credit.  If you currently own a trailer and then seek to buy a first home on a permanent foundation, you’re apparently out of luck.

It’s Friday, so it’s time for this week’s reader-submitted Q & A. If you’d like to submit a question, click here for more information or simply email a question.

My wife and I own one home and the deed is in her name.  We recently formed a Revocable Living Trust and I have been pricing lawyers (lawyers are required to do alter deeds in Pennsylvania) to change over the deed into the name of our trust.  I asked my father who he used and he said that he was told not to put real estate, at least not your primary residence, into the name of the trust.  Do you have any idea why this would be?  This goes against what Suze Orman says and that makes me nervous!

I would love to save the legal fees but I don’t want to save a little now for what could be a big headache later. Do you have an opinion or reason for or against putting your primary residence real estate into a revocable living trust?

Thanks.

Jeff R., Pennsylvania

Straightforward Answer: Suze’s probably right for you, but not 100% of the population.

Detailed Explanation:

By and large, I agree with Suze’s advice on this issue. However, in my opinion, her “trusts for everyone” is not for 100% of the population.  Certain people should have a revocable trust.  For example, people in California, people who own assets in states other than the state in which they live, and people who have a step-family should each make the establishment of a revocable living trust a priority.  However, those 20-somethings out there with no family yet are better served saving their precious dollars for a myriad of higher priorities (including an emergency fund, a Roth IRA, and a down payment for a home) more important than optional legal fees.

The principal advantage of the revocable trust is the avoidance of probate (a potentially expensive, lengthy and complicated court process) and the flexibility it provides those who establish the trust.  However, the probate process (costs and delays) varies significantly by state.  So while California is reported as nightmarish, Texas is apparently not too terrible.  So keep that your resident state in mind when balancing the pros and cons of undertaking the effort and expense.

Another consideration is the fact that, in some states, the transition of your home to certain trusts could eliminate your homestead exemption, a designation that saves you serious cash on your real estate taxes. (This may be what your father’s advisor was referencing, Jeff, but I wasn’t there of course and I am not sure of the state laws applicable in Dad’s case.)

Aside from the legal costs incurred in establishing a revocable livin trust, the negatives are fairly inconsequential, especially since everything about a revocable trust, by definition, can be changed. It’s just not the first place to start financial planning.