Moseley Flint Schools of Real Estate 1. 4 Elective Credits - $25

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1 Moseley Flint Schools of Real Estate, Inc. Professional Education Since Elective Credits - $25 STEP 1 - Study the book at your own pace and complete the Section Reviews. Compare your answers with the Section Review Answer Key at the end of this book. Section Reviews are not graded but they must be completed. STEP 2 - Complete the open-book Final Test. Use the Final Test Answer-Form in back of this book to fill in the answers to each question. A passing grade of 75% or higher is required. STEP 3 - Return your completed Answer-Form by mail, fax or online. 3-a. *ONLINE COMPLETION instant grading, no charge Go to Click on Virginia Real Estate, CE Self-Study, Online Exams, and follow the instructions. Be sure to print your affidavit when prompted to do so and have it notarized. (See * below) If you have pre-paid, check the appropriate box. If you have not paid you may pay by credit card at time of submission. Your course completion date is the date you submit your successful online exam results. 3-b. MAIL OR FAX COMPLETION If you have not pre-paid, you may pay by credit card when you fax or mail your Answer- Form to our office. If you have pre-paid, check the ʺI have paidʺ box on the Answer-Form. Your Course Pledge signature on the Answer-Form must be notarized. Your course completion date is the date your successful, completed Answer-Form is notarized. REGULAR SERVICE mail or fax your Answer-Form to Our CE Processing Center; we process it in 5 business days and mail your Course Certificate to you by first class mail. SAME DAY SERVICE (optional) available for an additional $10.00 fee. Please refer to the Course Instructions at the end of this book for details. YOUR CERTIFICATE is for your records, and will be sent to you after we process your record. DO NOT SEND TO REB. We report your successful course completion to the Real Estate Board (REB). Please keep your certificate in your permanent records. There may be a charge for duplicate certificates. *Virginia law requires the licensee to retain on file the notarized affidavit certifying compliance with the course requirements. All real estate continuing education courses are not created equal. Our schools have provided quality education since Our family-owned business takes pride in developing its own course materials for you the real estate professional. We hope you agree with us, and decide to try our course. Questions?? Call Moseley Flint Schools of Real Estate 1

2 SECTION 1 ENVIRONMENTAL HAZARDS... 3 INTRODUCTION... 3 TOXIC MOLD... 3 ELECTRIC AND MAGNETIC FIELDS... 6 ASBESTOS... 8 SECTION 2 CONSTRUCTION & INSURANCE ISSUES INTRODUCTION POLYBUTYLENE PIPING ENERGY-EFFICIENCY INSURANCE ISSUES SECTION 3 HOME OWNERSHIP & INCOME TAX DEDUCTIONS INTRODUCTION DEDUCTIONS FOR HOMEOWNERS SELLING A PRIMARY RESIDENCE CAPITAL GAIN TAX AVOIDANCE INSTALLMENT SALES Moseley Flint Schools of Real Estate 2

3 SECTION 1 ENVIRONMENTAL HAZARDS LEARNING OBJECTIVES After completing this section, students should be able to: 1. Describe the origins and potential health hazards attributed to toxic mold. 2. Define and describe electric and magnetic fields (EMFs) and the potential health hazards associated with exposure to them. 3. Describe asbestos-related problems and identify potential health hazards associated with exposure. 4. Evaluate the role of the licensee in providing information to consumers about environmental issues. L E 2 INTRODUCTION Brokerage firms today deal with real property problems that were not considered or were overlooked twenty years ago. Environmental hazards such as toxic mold, electric and magnetic fields (EMFs), leadbased paint, asbestos, and radon gas have significant implications for property owners and real estate brokers. Every real estate licensee should be familiar with the complex and important effects these potential hazards have on the everyday practice of real estate. TOXIC MOLD Mold is an often fuzzy-looking fungus that grows on the surface of organic materials in damp locations both indoors and outdoors, digesting that surface in order to survive. A natural part of the environment, molds thrive in warm, humid climates. They may be gray, black, green, yellow, orange, or other various colors and may have a velvety or wooly texture. Mold spores will grow wherever there is excessive moisture, such as where leakage may have occurred in roofs, pipes, walls, or plant pots, or where there has been flooding, particularly if the moisture problem remains undiscovered or not addressed. Indoors, mold can grow on wood, paper, fabric, carpet, food, and other organic materials. Many building materials provide nutrients that encourage mold to grow. Wet cellulose materials, including paper and paper products, cardboard, ceiling tiles, wood, and wood products, are particularly conducive to the growth of some molds. Other materials such as dust, paint, wallpaper, insulation material, drywall, carpet, fabric, and upholstery commonly support mold growth. Changes in home construction since World War II that may have contributed to the increased frequency of mold problems are insulation of the building envelope, addition of forced-air systems, new building products, creation of condensation on surfaces now made cold by air conditioning, and the introduction of more processed organic materials. Health Risks In the early 1990s, the Environmental Protection Agency (EPA) began studying problems associated with exposure to mold. Studies indicated that poorly maintained offices and homes with water damage or moisture problems can accelerate the growth of certain types of mold, such as Stachybotrys atra (S. Atra). A greenish-black mold, S. Atra can grow on material with a high cellulose and low nitrogen content, such as fiberboard, gypsum board, paper, dust, and lint. It requires constant moisture for growth. Humans often come in contact with molds in moist areas in or around their homes or when mold spores become airborne. Airborne mold spores can come into contact with humans either through the skin or through ingestion. While individuals react differently to exposure, the following are common adverse health effects of toxic mold: watery, reddened, burning eyes; sinus congestion; breathing difficulty; dry, hacking cough; shortness of breath; chronic fatigue; Moseley Flint Schools of Real Estate 3

4 diarrhea; headaches; aches and pains; skin irritation; and sore throat. The health effects depend on the type of mold involved and the metabolic byproduct of the mold, as well as how much contact there is and for how long. A final factor level of susceptibility is especially important for children and the elderly, who can be affected much more easily than adults. Litigation An estimated 9,000 toxic mold lawsuits alleging bodily injury and/or property damage were filed in the United States since Suits are pending in Delaware, Illinois, New York, Florida, and California as well as in Canada. Lawyers are taking on more mold cases as more clients come to them with mold-infested houses and physical symptoms. These cases have the potential for large financial awards or settlements. Two key examples have involved courthouses in Polk and Martin counties in Florida. The Polk County courthouse was constructed in 1987 for $37 million. Due to the presence of toxic mold, the building had to be evacuated in The building s contractor settled the case by paying $4 million to the county, but the litigation did not stop there. An insurance company paid the county over $50 million for building repairs, litigation expenses, relocation, and worker health claims. The 1996 case of the Martin County courthouse is known as a landmark case in mold lawsuits. In one of the first sick building cases involving mold, Martin County sued the construction company after employees became sick. The county claimed construction defects caused moisture problems in the courthouse, which resulted in mold growth. The construction company paid the county more than $17 million (Kathryn Quigley, Deadly Toxic Mold Brings Woes, Lawsuit. Palm Beach Post [May 5, 2002] Website: A family s personal injury suit against an apartment complex in Sacramento, California, concluded in early 2002 with a jury award of $2.7 million. The family stated that they became seriously ill after living in their apartment for six months and consequently incurred nearly $125,000 in medical bills ( Judge Finalizes Largest Award for Toxic Mold. The ApartMentor. [February 2002]: 1). Multimillion-dollar suits and more recent cases involving celebrities Erin Brockovich and Ed McMahon are likely to elicit more public interest and concern about toxic mold and health hazards. Insurance issues In addition to worrying about acts of terrorism, insurance companies have recently had to focus on the expensive results of insuring builders, building owners, and contractors against toxic mold issues. For example, approximately 50 commercial and residential property insurance carriers have either filed for exclusions or attempted to work with Florida insurance regulators to protect themselves against toxic mold problems. Insurance carriers have asked the Florida Department of Insurance (DOI) to specify when they would and would not be required to cover mold claims. Most of the insurers exclusions seek to clarify that a basic policy covers mold damage under certain circumstances. Some want to apply financial limits to existing coverage, even when mold is covered. Homeowners policies in Florida cover mold under limited circumstances and exclude it under others. If a covered peril such as a hurricane or a windstorm causes water damage that results in mold, insurers must cover it. But if the mold resulted from a maintenance issue or building-construction flaw, it is not covered. The DOI is working with the Insurance Services Office and the National Association of Insurance Commissioners to develop a nationwide, uniform response to the mold issue ( Carriers File for Mold Exclusions in Florida. Insurance Journal [December 5, 2001] Website: Moseley Flint Schools of Real Estate 4

5 Florida insurance regulators hope to avoid the problem faced by property owners in California, where insurance companies throughout the state have steadily raised their rates for the past two years, in part because of the growing number of lawsuits over mold caused by water damage to homes. California insurance carriers are already writing policies that stipulate a property owner can receive no more than $5,000 on each mold claim. Prevention According to the experts, the easiest way to prevent mold from gaining a foothold is to control dampness. When water is left to sit for even for a few hours, common molds begin to take hold. Homeowners can slow mold growth by keeping humidity levels below 60% and ventilating showers and cooking areas. The Centers for Disease Control (CDC) offer these additional recommendations: 1. Check the exterior of your property regularly for accumulation of ground water. 2. If a wall appears damp, have it opened to see what is causing the dampness. 3. If the structure sits above a foundation and there is a heavy rain, put electric fans under the structure to dry the ground. 4. Fix leaky faucets, pipes, and other leaks as soon as they are found. 5. Have heating and air conditioning systems serviced each year. 6. Clean and dry out wet or damp areas within 48 hours. 7. Keep indoor humidity below 60% by venting bathrooms and dryers to the outside; using air conditioners and dehumidifiers; using exhaust fans or opening windows when cooking, washing dishes or cleaning; and increasing ventilation. 8. If a leak saturates carpet, ceiling tiles, or upholstery, remove the wet material. 9. Use paint that has an EPA-approved mold inhibitor. 10. Clean kitchens and bathrooms with mold-killing cleaners. 11. Do not carpet bathrooms. 12. Do not use vinyl wallpaper on walls that are at risk of sustaining water damage. ( Questions and Answers on Stachybotrys chartarum and other molds. ) Website: Remediation Although any visible mold can be sampled by an environmental consultant and/or analyzed by a laboratory specializing in microbiology, these tests can cost from hundreds to thousands of dollars. There is no simple and cheap way to sample the air in a structure to find out what types of mold are present and whether they are airborne. Even if a structure is tested, it is difficult to say at what levels of exposure health effects would occur. Therefore, it is more important to get rid of the mold than to find out more about it. The most effective way to treat mold is to correct underlying water damage and clean the affected area. Mold should be cleaned as soon as it appears. Persons cleaning mold should be free of symptoms and allergies. Small areas of mold should be cleaned using a detergent/soapy solution or an appropriate household cleaner. Gloves should be worn during cleaning. The area should then be thoroughly dried. Any sponges or rags used to clean mold should be disposed of properly. If the mold returns quickly or spreads, it may indicate an underlying problem such as a leak. Any underlying water problems must be fixed to eliminate mold problems. If mold contamination is extensive, a professional abatement company may need to be consulted. Individuals with symptoms possibly caused by exposure to mold should see a physician. For more information about the health effects of mold exposure and the safe removal of mold, contact your local Health Department. Moseley Flint Schools of Real Estate 5

6 Section 1: Review Exercises - Part I Complete these review exercises as they are intended to help prepare you for the final exam. Answers are found at the back of this text. 1. Mold is an often fuzzy-looking. 2. Molds thrive in, climate. 3. Wet cellulose materials, including,,, and, are particularly conducive to the growth of some molds. 4. Changes in home construction may be contributing to the frequency of mold growth. 5. The easiest way to prevent mold from gaining a foothold is to dampness. ELECTRIC AND MAGNETIC FIELDS Power lines, electrical wiring, and appliances all produce electric and magnetic fields (EMFs), invisible lines of force that surround any electrical device. Electric and magnetic fields have different properties and possibly different ways of causing biological effects. While electric fields are easily shielded or weakened by conducting objects (e.g., trees, buildings, and human skin), magnetic fields weaken only with increasing distance from the source. Magnetic fields pass easily through almost anything, including buildings and the human body. The alternate electric current delivered by the American power system goes though a complete cycle 60 times per second, a rate known as 60 hertz (Hz). The associated magnetic field changes direction twice every cycle, or 120 times per second. Even though both electric and magnetic fields exist around appliances and power lines, more recent interest and research have focused on the potential health effects of magnetic fields. This is because epidemiological studies have found associations between increased cancer risk and power line configurations that are thought to be surrogates for magnetic fields. No such associations have been found with measured electric fields. Homes in the United States typically have EMF levels ranging from 0.1 to 2 milligaus (mg), the standard unit of measurement for magnetic fields. One source of household magnetic fields is nearby power lines and neighborhood distribution lines. Although fields directly under large transmission lines can be more than 50 mg, they diminish rapidly with distance. Neighborhood lines may look less threatening than big transmission lines, but neighborhood lines pass closer to houses and can sometimes produce indoor fields of 2 mg or greater. The scope of the potential problem is underscored by the fact that 642,000 miles of power lines dangle across the United States (Linda J. Orel, Perceived Risks of EMFs and Landowner Compensation. ) Website: Another source of magnetic fields is the grounding system that protects residents from lightening and from electric shock delivered by a faulty appliance. Health Risks Nancy Wertheimer and Ed Leeper conducted the first study to report an association between power lines and cancer in 1979 in Denver. They found that children who had died from cancer were two to three times more likely to have lived within 40 meters (131 feet) of a high-current power line than were the other children studied. Exposure to magnetic fields was identified as a possible factor in this finding. Magnetic fields were not measured in the homes. A second Denver study in 1988 and a 1991 study in Los Angeles also found significant associations between proximity to high-current power lines and incidence of childhood cancer. The L.A. study found an association with leukemia but did not look at all cancers; the 1988 Denver study found an association with the incidence of all cancers. When leukemia was analyzed separately, the risk was elevated but not by a statistically significant amount. In neither of these studies was the association found to be statistically significant when magnetic fields were measured in the home and used in the analysis. Studies in Sweden (1992) and Mexico (1993) have found increased leukemia incidence among children living near Moseley Flint Schools of Real Estate 6

7 transmission lines. A 1993 Danish study, like the 1988 Denver study, found an association with incidence of all childhood cancers but not specifically leukemia. A 1993 Finnish study found an association with central nervous system tumors in boys. Eight studies have examined the risk of cancer for adults living near power lines. Of these, two found significant incidence of cancer among people living near power lines. Although the studies are contradictory and confusing, property owners are struggling with their implications. Appraisers indicate that, whether or not there are health risks associated with exposure to EMFs, property near power lines often suffers devaluation. Real estate brokers report that houses next to power lines sell more slowly than others and for lower prices. Parents with children in schools near power lines demand that the lines or the school be moved. Utility companies have had to delay or end their plans to build or expand high-voltage transmission lines. One engineering policy analysis suggested that fear of EMFs causes the United States approximately $1 billion a year in reduced property values, higher electricity rates, and litigation costs ( Electromagnetic Fields. Consumer Reports [May 1994]: 358). A survey administered in 1990 suggests that proximity to high-voltage power lines is capitalized into lower values for residential properties. Respondents who had appraised such properties report that power lines can affect residential property value to varying degrees under certain circumstances and that the market value of these properties is, on average, approximately 10% lower than the market value for comparable properties not subject to the influence of high-voltage power lines (Charles J. Delaney and Douglas Timmons, Abstract of High Voltage Power Lines: Do They Affect Residential Property Value? Journal of Real Estate Research 7, no. 3 [1992]). About 200 epidemiologic, laboratory, environmental, and engineering studies involving electric and/or magnetic fields are under way or planned. Many involve some aspect of cancer development. These studies are sponsored by federal and local government agencies and private organizations, including electric utilities and appliance manufacturers. The Energy Policy Act of 1992 included a provision for a $65-million program of EMF research and public information dissemination program (42 U.S.C ). Under this research program, studies on possible health effects (cancer, reproductive, and neurological impacts), exposure assessment and field management, and risk assessment continue. The electric power industry has provided major financial support for EMF research, primarily through the Electric Power Research Institute. At least 22 countries are conducting EMF research ( Questions and Answers About EMF Electric and Magnetic Fields Associated with the Use of Electrical Power [January 12, 2000]) Website: infoventures.com/private/federal/q&a/qa-gact3.html Standards The United States has no federal health standards specifically for 60-Hz EMFs. At least six states have set standards for transmission-line electric fields; two also have standards for magnetic fields. The magneticfield standards for these two states, New York and Florida, are basically the maximum fields that existing lines in those states produce under maximum load-carrying conditions. In other words, their purpose is to ensure that future power lines do not exceed current EMF levels. Prevention The EPA suggests a number of ways to reduce exposures to EMFs. Some are as easy as standing back from an appliance when it is in use. Remember that magnetic fields from appliances drop off dramatically in strength with increased distance from the source. Other EMF reduction steps, such as correcting a household-wiring problem, are worth doing anyway for safety reasons. What about more costly actions, such as burying power lines or moving out of a home? Because scientists are still debating whether EMFs are a hazard to health, it is unclear how much should be done at this time to reduce exposure. Some EMF reduction measures may create other problems. For instance, compacting power lines to reduce EMFs can increase the danger of accidental electrocution for line workers. Instead, take simple precautions such as the following: Moseley Flint Schools of Real Estate 7

8 Increase the distance between yourself and the EMF source. Sit at arm s length from your computer terminal and from your television. Avoid unnecessary proximity to high-emf sources. Do not let children play directly under power lines or on top of power transformers for underground lines. Reduce time spent in an EMF. Turn off your computer monitor and other electrical appliances when you are not using them. Do not linger near a microwave oven when it is in operation. Purchase a new electric blanket with low EMFs. Older blankets have higher EMF readings. Limit the time spent on a cell phone, and use one that has a safer EMF rating. ( Electromagnetic Fields. Consumer Reports [May 1994]:360). Section 1: Review Exercises Part II Complete the following True or False review exercises as they are intended to help prepare you for the final exam. Answers are found at the back of the book. Circle (T)rue or (F)alse for each question below. 1. EMFs are invisible lines of force that surround any electrical device. T F 2. Magnetic fields weaken with increasing distance from the source. T F 3. Magnetic fields pass easily through almost anything, including buildings and the human body. T F 4. Power lines do not affect residential property value. T F 5. In Florida, the Department of Environmental Protection (DEP) monitors compliance by companies (primarily utilities) that construct or operate transmission lines. T F 6. There is no way to limit exposure to EMFs. T F ASBESTOS Asbestos is a mineral first mined in the 1870s in Canada and later in South Africa. A strong, flexible, corrosion-resistant material, asbestos will not burn. Few other potential building materials have the same combination of qualities. At one time, approximately 3,000 types of commercial products contained asbestos, with the amount of the mineral varying from one to 100%. Many older construction products contain asbestos, including sealants, cement pipe, cement sheets, ceiling tile, flooring, and insulation. After World War II, and for the next thirty years, asbestos and asbestos-containing materials (ACMs) were used extensively in the construction and renovation of schools and other public buildings, primarily to fireproof, insulate, and soundproof. In 1990, the EPA estimated that there were ACMs in most of the nation s approximately 107,000 primary and secondary schools and 733,000 public and commercial buildings. Unlike most minerals, which turn into dust particles when crushed, asbestos breaks up into fine microscopic fibers that can stay in the air for a long time. In a 1984 study, the EPA found that approximately 66% percent of the buildings with asbestos contained damaged ACMs. Damaged ACMs may contain friable asbestos, a form of asbestos that is dry and crumbling. Friable asbestos is more likely to release fibers than nonfriable asbestos. Fireproofing material is generally considered friable, whereas vinyl asbestos floor tile generally is not friable unless it is sanded, sawed, or otherwise aggressively disturbed. When buildings are demolished, renovated, or repaired or when the ACM is in a heavy-traffic area, asbestos fibers may be released. Health Risks People may inhale airborne asbestos fibers. Workers who rehabilitate buildings with asbestos may suffer from occupational exposure. Workers families may inhale asbestos fibers released by clothes that have been in contact with ACM, and residents who live or work near asbestos-related operations may inhale asbestos fibers that have been released. Once inhaled, asbestos fibers can easily penetrate body tissues and affect airways and lung tissue. Asbestos fibers remain in the body; thus, with each exposure, the chances increase of developing an asbestos-related disease. Diseases caused by asbestos exposure are difficult to trace because asbestos-related diseases may not appear until years after exposure. Nor have researchers developed a safe threshold level for exposure to airborne asbestos as they have for EMFs and other environmental hazards. Moseley Flint Schools of Real Estate 8

9 The most commonly described illness related to asbestos exposure is asbestosis, a serious, chronic, noncancerous respiratory disease. Inhaled asbestos fibers aggravate lung tissues, and cause them to scar. Symptoms of asbestosis include shortness of breath and a dry crackling sound in the lungs while inhaling. In its advanced stages, the disease may cause cardiac failure. Asbestosis can be fatal and is typically disabling. Workers who renovate buildings with asbestos are at high risk, whereas those who experience secondary exposure are usually at low risk, depending on the precautions taken. Asbestos exposure may also contribute to the incidence of lung cancer in people who are directly involved in the mining, milling, manufacture, and use of asbestos. People who have been exposed to asbestos and another carcinogen, such as cigarette smoke, have a significantly greater risk of developing lung cancer than do people who have only been exposed to asbestos. Almost all cases of mesothelioma, a rare form of cancer that occurs most often in the thin membrane lining of the lungs, are linked with asbestos exposure. Millworkers, miners, shipyard workers, and insulation installers and manufacturers have an increased risk of mesothelioma, as do those who live with asbestos workers, near asbestos mining areas, near asbestos product factories, or near shipyards where use of asbestos has produced large quantities of airborne asbestos fibers. Younger people are at a higher risk of developing mesothelioma when exposed to asbestos fibers, which is why so many schools are rehabilitating their buildings. Litigation The first asbestos lawsuits, which were filed in the 1970s, continued for the next 20 years and forced 50 asbestos-products companies into bankruptcy. Some companies only marginally connected to asbestos have also been sued. Over 1.4 million claimants have filed suit; the final toll for these cases may be in excess of $200 billion (Eric Roston, The Asbestos Pit. Time [March 2002], Y9). Regulation The EPA and OSHA are responsible for regulating environmental exposure and protecting workers from asbestos exposure. OSHA is responsible for the health and safety of workers who may be exposed to asbestos in the workplace or in connection with their jobs. The EPA is responsible for developing and enforcing regulations to protect the general public from exposure to airborne contaminants known to be hazardous to human health. Individuals who renovate or remove asbestos from a building of a certain size or who plan to demolish any building are required to notify the appropriate federal, state, and local agencies and to follow all federal, state, and local requirements for removal and disposal of regulated ACM. The EPA s Worker Protection Rule (40 CFR Part 763, sec. G) extends the OSHA standards to state and local employees who perform asbestos work and are not covered by the OSHA Asbestos Standards or a state OSHA plan. The Worker Protection Rule parallels OSHA requirements and covers medical examinations, air monitoring and reporting, protective equipment, work practices, and record keeping. In addition, many state and local agencies have more stringent standards than those required by the federal government. In 1979, under the Toxic Substances Control Act (TSCA; 15 U.S.C et seq.), EPA began an asbestos technical assistance program for building owners, environmental groups, contractors, and industry. Known as the Asbestos-in-Schools Rule (40 C.F.R. 763E), the first regulation intended to control asbestos in schools was issued by the EPA under the authority of TSCA in May Starting in 1985, loans and grants have been given each year to conduct asbestos abatement projects under the Asbestos School Hazard Abatement Act (ASHAA; 20 U.S.C et seq.). In 1989, the EPA published the Asbestos Ban and Phaseout Rule (40 C.F.R. 763, sec. I), which by 1997 effectively banned asbestos use in the United States. The Clean Air Act Amendments (CAA; 42 U.S.C et seq.) of 1970 require the EPA to develop and enforce regulations to protect the general public from exposure to airborne contaminants known to be hazardous to human health. The EPA requires that the asbestos content of suspect materials be determined by collecting and analyzing bulk samples. EPA Moseley Flint Schools of Real Estate 9

10 regional offices can provide information about laboratories that test for asbestos. The EPA also regulates the appropriate disposal of ACM. Remediation The EPA s advice is neither to remove asbestos nor to ignore the problem under a false presumption that asbestos is risk free. Rather, the EPA recommends a practical approach that protects public health by emphasizing that asbestos material in buildings should be located, that it should be appropriately managed, and that those workers who may disturb it should be properly trained and protected. The EPA s policy is based on the following observations: Although asbestos is hazardous, human risk of asbestos disease depends upon exposure. Prevailing asbestos levels in buildings seem to be very low, based upon available data. Accordingly, the health risk we face as building occupants also appears to be very low. Removal is often not a school district s or other building owner s best course of action to reduce asbestos exposure. An improper removal can create a dangerous situation where none previously existed. The EPA only requires asbestos removal in order to prevent significant public exposure to asbestos, such as during building renovation or demolition. The EPA does recommend in-place management whenever asbestos is discovered. Instead of removal, a conscientious in-place management program will usually control fiber releases, particularly when the materials are not significantly damaged and are not likely to be disturbed. According to the EPA, the best way to reduce the asbestos hazard is to repair friable ACM, spraying it with sealants, enclosing it, removing it, or keeping it in good condition so that it does not release fibers ( The Asbestos Informer. ) Website: Section 1: Review Exercises Part III Complete the following review matching exercise as they are intended to help prepare you for the final exam. Answers are found at the back of this book. Fill in the letter of the correct definition in Column II that matches the word(s) in Column I. Column I 1. asbestos 2. asbestosis 3. mesothelioma 4. asbestos-containing material (ACM) 5. friable asbestos 6. OSHA 7. EPA Column II a. a serious, chronic, noncancerous respiratory disease b. responsible for the health and safety of workers who may be exposed to asbestos in the workplace or in connection with their jobs c. asbestos that is dry and crumbly, a condition more likely to release fibers d. responsible for developing and enforcing regulations to protect the general public from exposure to airborne contaminants known to be hazardous to human health e. a rare form of cancer that occurs most often in the thin membrane lining of the lungs, linked with asbestos exposure f. used primarily to fireproof, insulate, and soundproof g. strong, flexible, corrosion-resistant material that will not burn Moseley Flint Schools of Real Estate 10

11 A FINAL NOTE Ever since the federal government closed down the Love Canal neighborhood near Buffalo, New York, because of the dangers of toxic dumping, the public has become increasingly aware of the risks of exposure to environmental contaminants. Popular books and movies such as Erin Brockovich and Civil Action have publicized these dangers and heightened public awareness, perhaps adding to the significant number of lawsuits being filed against companies that do not take proper precautions in manufacturing or handling dangerous materials. Public interest and litigation are unlikely to diminish in the next decade. Real estate agents must remain vigilant and knowledgeable about building materials and environmental hazards so that they may respond to consumers legitimate concerns about how these issues may affect potential property values and individual health matters. SUGGESTED READING AND RESOURCES Websites: EMFs EMFs in Your Environment: Magnetic Field Measurements of Everyday Electrical Devices, U.S. Environmental Protection Agency (EPA), pp. Available free from the US EPA Public Information Center, 401 M Street, SW, Washington, DC National Institute of Environmental Health Sciences (NIEHS), EMF Rapid Electric and Magnetic Fields Research and Public Information Dissemination Program Website: Asbestos There are ten EPA regional offices around the country. The one for Virginia, Region 3, can be reached at: Environmental Protection Agency, 1650 Arch Street, Philadelphia, PA Its main phone numbers are (215) and toll-free (800) The EPA Public Docket Center, Public Reading Room will send information on EPA regulations. They caan be reached at (202) The EPA has an asbestos ombudsman to provide information on the handling and abatement of asbestos in schools, the workplace, and the home. The EPA asbestos ombudsman can also help citizens with asbestosin-school complaints. The ombudsman can be reached toll-free at (800) GLOSSARY Asbestos-containing materials (ACMs) - Materials used primarily to fireproof, insulate, and soundproof. Asbestosis - A serious, chronic, noncancerous respiratory disease caused by exposure to asbestos fibers. Friable asbestos - Dry, crumbling asbestos, a condition more likely to release fibers. Mesothelioma - A rare form of cancer that occurs most often in the thin membrane lining of the lungs, linked with asbestos exposure. Moseley Flint Schools of Real Estate 11

12 SECTION 2 CONSTRUCTION & INSURANCE ISSUES LEARNING OBJECTIVES After completing this section, students should be able to: 1. Identify and describe polybutylene (PB) piping and its use in residential property. 2. Discuss litigation regarding PB piping and the problems associated with the use of this material. 3. Define the term R-value and describe how it is determined. 4. Evaluate the impact of Hurricane Andrew on the insurance industry. 5. Evaluate the impact of September 11, 2001, on insurance exclusions and property insurance coverage. 6. Describe some of the current issues regarding homeowner s insurance. INTRODUCTION In many regards, Virginia s real estate market differs from those of most states. This difference can be attributed largely to the Commonwealth s diverse climate. While the scenic Blue Ridge Mountains and balmy summer coastal weather continue to attract visitors and residents, these two attributes also create some very special building and insurance issues unique from other states. Hurricane Isabel drove these issues home for builders, real estate licensees, and consumers in Consumer concern about building materials such as polybutylene (PB) piping and insulation has also influenced construction decisions, building code change, and in some cases, federal regulation. It is imperative that real estate practitioners are familiar with these issues and are able to find appropriate resources for additional information. POLYBUTYLENE PIPING Polybutylene piping is a flexible, easy-to-cut gray, silver, or black plastic piping that was used because it was relatively inexpensive, easy to use, and could reduce the time required for an average plumbing job thanks to its simple crimp connectors. Introduced in the late 1970s, PB has been used to pipe approximately six million homes in the United States ("Leaks Plague Polybutylene Plumbing," Arizona Water Resource 3, no. 6 [1994]) Website: It is most commonly found in the Sun Belt, where residential construction was heavy through the 1980s and into the mid-1990s, but it is also common in the Mid-Atlantic and Pacific Northwest. Unfortunately, there have been numerous reports of the failure of plumbing systems that used PB piping. Apparently, the pressure used to secure the plastic fittings stresses and cracks them, leaving the material vulnerable to attack by chlorine and other water-supply chemicals. Brass fittings also increase the rate of oxidation, thereby making the PB piping brittle. On top of that, the metal fittings and plastic piping have different expansion rates, which cause the pipes to sprout leaks or rupture. Litigation The use of PB has been the subject of numerous lawsuits and settlements across the United States. More than $1 billion has been paid out for claims regarding leaks and subsequent damage. The best-known lawsuit, Cox v. Shell Oil Co., required Shell to commit a minimum of $950 million to a settlement fund. Claimants who presently own or have previously owned a home plumbed with PB, whose pipes have or have had a qualifying leak, and who file a claim within an appropriate time period may be eligible to recover property damages, repair costs, and a complete re-plumbing of the property. A qualifying leak is not easy to define, but generally: the leak must have occurred after the first year following installation; the leak is not covered under another warranty; and the PB plumbing system must have been installed between January 1, 1978, and July 31, Moseley Flint Schools of Real Estate 12

13 Consumers who believe they have grounds to file a claim can access a website set up for this purpose at Because the stubs to sinks and toilets generally use poly-to-copper connectors, homeowners often cannot determine by inspection what type of plumbing they have. PB pipes are seldom visible in slab homes. Some real estate agents suggest using a wiggle test to identify concealed piping materials. Wiggling involves grabbing the wall stub-out pipe; if it moves freely, chances are PB is attached in the wall. However, wiggling pipes can be risky. It may be advisable to look at the washing machine utility box instead. Plumbers often connected the PB piping directly to the service valves, threaded the pipe through the valve hole at the washing machine box, and used a locknut to secure the valve. Plumbing contractors state that 90% of leaks are at joints in the piping and estimate that about 30% of the problems at leaking joints are due to installation errors. Leaks that occur inside a line are almost always in hot water lines, sometimes in areas with no stress (Kenny Hart, More on PB Piping, ASHI Reporter 18, no. 11 [December 2001]:1). Manufacturers and other defenders of PB piping insist that the product on the market today does not deserve its bad reputation. Shell Oil, Hoechst Celanese Corp., DuPont de Nemours, and other manufacturers of raw PB blame the majority of leaks and ruptures on improper installation. Polybutylene pipe manufacturers have addressed joint problems with a new type of manifold design, which eliminates the need for T-joints and other traditional fittings used with copper and chlorinated polyvinyl chloride (C-PVC) pipes. The new design runs flexible 3/8-inch PB pipes from one common source to each fixture. Pipes are joined with a copper tube secured by two crimped copper bands to seal the connection. Real Estate Agents and PB Piping Because real estate agents are not expert in the subject of PB piping or in locating it, a home inspector or professional engineer should be employed to determine whether or not a home has PB piping or damage from its use. Inspectors will note obvious leaks, poorly supported piping, noticeably bad crimps, loose hose bibs, improperly installed fittings, and related problems. Polybutylene piping remains popular among homebuilders because it offers savings of $200 to $600 per home compared to C-PVC and copper piping. The PB itself is about half the cost of copper, but somewhat more expensive than C-PVC. Major cost savings come from lower installation costs: polybutylene piping can be installed quickly by semiskilled labor. The plumbing in inexpensive tract houses and mobile homes is almost exclusively PB. Real estate agents should provide prospective buyers with information about PB piping so that they can focus on concerns they may have about the home they wish to buy, obtain expert opinions, and determine necessary remedies, if any. Section 2: Review Exercises Part I Complete the following true or false review questions as they are intended to help prepare you for the final exam. Answers are found at the back of this text. 1. PB piping is flexible. T F 2. PB piping is easy to cut. T F 3. PB piping is gray, silver, or black in color. T F 4. PB piping is relatively inexpensive plastic. T F 5. PB piping is easy to use. T F 6. PB piping reduces the time required for an average plumbing job. T F 7. PB piping is rarely used in homes in the United States. T F 8. PB piping is reported to have failed numerous times. T F ENERGY-EFFICIENCY Virginia property owners should have a special interest in energy-efficient construction because the state s climate subjects structures to extremes of temperature and humidity. Heat flows naturally from warmer to cooler spaces. Heat enters a home from outdoors in hot weather, and in cold weather it moves out of the Moseley Flint Schools of Real Estate 13

14 home to unheated areas such as garages. A home s heater or air conditioner works to keep the house comfortable as it loses heat in winter and gains it in the summer. Insulation installed in attics and walls provides resistance to this flow of heat. The term R-value refers to the measure of thermal resistance provided by insulation. The higher the R- value, the greater the insulating effectiveness. R-value is cumulative; therefore, the R-value of insulation installed on top of insulation is the sum of the two R-values. R-value is determined by (1) the insulation material itself the type of insulation, its thickness and density; and (2) where and how the insulation is installed. For example, squeezing insulation into a space, thereby compressing it to a smaller size, reduces its R-value. Manufacturers of insulation products print the R-values of their products on either the bags or the labels. In most cases, R-values are also printed on the facings of fiberglass batts and rolls. Insulation is not just for attics and outside walls. Insulation should also be installed in areas such as ceilings with unheated spaces; basement walls; floors above vented crawl spaces; cathedral ceilings; floors over unheated garages or porches; knee walls; and between interior walls, ceilings, or floors for extra sound control. The Department of Energy provides the chart on the following page to guide property owners in choosing the appropriate R-values for the different areas of a structure. This chart is also available at <www.ornl.gov/roofs+walls/insulation> 1. In unfinished attic spaces, insulate between and over the floor joists to seal off living spaces below. * 1A attic access door. 2. In finished attic rooms with or without dormer, insulate... 2A between the studs of "knee" walls; 2B between the studs and rafters of exterior walls and roof; 2C ceilings with cold spaces above; 2D extend insulation into joist space to reduce air flows. 3. All exterior walls, including... 3A walls between living spaces and unheated garages, shed roofs, or storage areas; 3B foundation walls above ground level; 3C foundation walls in heated basements, full wall either interior or exterior. 4. Floors above cold spaces, such as vented craw spaces and unheated garages. Also insulate... 4A any portion of the floor in a room that is cantilevered beyond the exterior wall below; 4B slab floors built directly on the ground; ** 4C as an alternative to floor insulation, foundation walls of unvented crawl spaces; 4D extend insulation into joist space to reduce air flows. 5. Band joists. 6. Replacement or storm windows and caulk and seal around all windows and doors. * Well-insulated attics, crawl spaces, storage areas, and other enclosed cavities should be ventilated to prevent excess moisture build-up. ** For new construction, slab on grade insulation should be installed to the extent required by building codes, or greater. Moseley Flint Schools of Real Estate 14

15 Energy-efficient systems such as solar hot water systems and dedicated heat pumps can reduce energy consumption. Proper shading of windows by roofing overhangs, particularly on the east and west exposures, glazing, or landscaping can prevent heat from entering and reduce cooling bills. Repair of leaky ducts can also reduce energy consumption significantly. INSURANCE ISSUES The following section features examples that have greatly influenced the insurance industry in construction and for homeowners. Hurricane Andrew in Florida The population in storm-prone Florida grew steadily from 1970 to 1990: a nearly 75% increase in population density along the southeast Atlantic coast coincided with a 20-year lull in the occurrence of intense hurricanes. To say that Floridians were unprepared for 1992's devastating Hurricane Andrew is an understatement. The most costly natural disaster ever experienced in the United States, Andrew caused over $25 billion in damage. Of that total, $15 billion in insurance settlements were paid out, with $10 billion going to residential settlements alone. In the wake of these massive payouts, a number of insurance companies declared bankruptcy some within days of Hurricane Andrew. The experience sent shock waves through the entire insurance industry. With the approach of the 1993 hurricane season, many insurers sought to adjust their risks by canceling policies and, in whole or in part, pulling out of Florida. Before the apparently imminent mass exodus of insurers, the State declared a moratorium and curtailed the companies ability to withdraw from the market. To cover homeowners whose policies had been canceled or could not find homeowners insurance, the State also established a Joint Underwriting Association (JUA). Today the JUA is the third largest insurer in Florida holding in excess of 120,000 policies. (Florida Residential Property and Casualty Joint Underwriting Association.) Website: Insurers also responded to Andrew by controlling costs and making affordable coverage available by changing policy forms and coverages. Raising deductible charges, limiting coverage, and capping guaranteed replacement coverage were some of the changes made. A decade after Hurricane Andrew, Florida's homeowners insurance policies remain with a small number of insurers. Insurance companies have reduced their risk by placing coastal homes into a state windstorm insurance pool (see next section) and backing the passage of a tougher statewide building code. They have also raised premiums, in some cases more than doubling them. One source indicates premiums have gone up by 250% in Miami and by 110% in all of Florida (Jeff Ostrowski, Insurance Rates Double Since Andrew, Palm Beach Post [July 12, 2001]) Website: See also Nanette Byrnes, A Ruinous Day for Insurers, Business Week (September 24, 2001). Website: Terrorism The insurance industry was financially devastated by the terrorist attacks of September 2001, with estimates of claims in excess of $70 billion. Months later, the insurance industry re-evaluated its property insurance policies and began to reduce its exposure particularly in commercial and government properties by eliminating coverage for terrorist attacks. The Florida Department of Insurance has stopped Florida insurance companies from eliminating such coverage, despite the fact that insurers in other states have done so successfully. California, Texas, and Georgia have also rejected the industry's request. Moseley Flint Schools of Real Estate 15

16 Some industry experts suggest that it will be difficult to find coverage for acts of terrorism, even if companies cannot eliminate the coverage. Furthermore, premiums will be extremely expensive. As an example, one of the most famous landmarks in the West, the Golden Gate Bridge, was formerly insured for $125 million in coverage that included terrorist attacks. The Premium was $500,000 yearly. The Bridge is staying with its insurance company, but its premium is now $1.1 million, with coverage limited to $25 million in physical damage to the span and $25 million in loss of toll revenue. Major hotel chains have also reported difficulty in finding insurance. Perhaps the most significant impact is for those developers who wish to obtain financing for large projects. Lenders refuse to provide financing unless buildings are covered by insurance that includes acts of terrorism, but it is difficult to find adequate coverage. In some cases, construction of commercial projects has been postponed indefinitely (Coalition to Insure Against Terrorism [CIAT], Examples Illustrating the Need for Terrorism Insurance ). Website: The federal government is likely to create a fund to help cover losses due to terrorist attacks. A week after the September 11 attacks, the Senate Banking Subcommittee said it was drafting legislation that would make the federal government an insurer of last resort on insurance claims stemming from terrorist attacks. Government insurance would be taxpayer funded (Patrick L. Thimangu, Insurance May Take Hit in War on Terrorism: Future Acts of Terror May Not Be Covered, Dayton Business Journal [October 12, 2001]:8). Homeowner s Insurance In mid-2002, the Wall Street Journal reported that several major insurance companies were implementing policies that would penalize property owners who filed two claims within three years ( You re Cancelled: How to Hang on to Your Home Insurance, [May 14, 2002], D1). Generally, insurance companies forgive one claim in five years. These stricter nonrenewal standards are a direct result of tremendous losses suffered by insurance companies due to the terrorist attacks in New York and Washington, D.C., as well as losses due to weather conditions Homebuyers purchasing older homes may find it difficult to obtain insurance, even if they have no history of filing claims. If the industry databases indicate that the property itself is catastrophe-prone, insurance companies may refuse to insure the property. Without insurance, buyers may be unable to obtain loans. Property history once available only to insurance companies is now available to home sellers. By calling (800) to access the Comprehensive Loss Underwriting Exchange (CLUE) or by contacting sellers can obtain their CLUE reports regarding past claims. There is a fee to access the database. Individuals dropped or denied coverage have the right to get a copy of their claim history by visiting: (Jeff D. Opdyke, Is Your House Insurable? Wall Street Journal [May 23, 2002], D1). Section 2: Review Exercises Part II 1. Insurance companies have reduced their risk by placing coastal homes into a state windstorm insurance pool and backing the passage of a tougher statewide building code. T F 2. Stricter insurance nonrenewal standards are a direct result of tremendous losses suffered by insurance companies due to the terrorist attacks in New York and Washington, D.C., as well as losses due to weather conditions. T F 3. Hurricane Andrew was a relatively inexpensive natural disaster for insurance companies. T F 4. Insurance experts claim that it will be easy to find coverage for acts of terrorism. T F 5. Individuals dropped or denied coverage have the right to get a copy of their claim history. T F Moseley Flint Schools of Real Estate 16

17 SECTION 3 HOME OWNERSHIP & INCOME TAX DEDUCTIONS LEARNING OBJECTIVES After completing this section, students should be able to: 1. Describe the various tax deductions available to homeowners. 2. Define the terms acquisition financing, adjusted sales price, basis, capital gain, consumer interest, distance test, equity financing, improvements, installment sales, once-in-a-lifetime exemption, points, prepayment penalties, rollover rule, and work test. 3. Explain the various methods available to avoid capital gain tax on the sale of a principal residence. 4. Calculate capital gain on a residence. 5. Compare and contrast the changes in the tax deductions permitted homeowners before and after the Taxpayer Relief Act of Describe the rules regarding deduction of moving expenses. INTRODUCTION For a number of reasons, real estate practitioners should be familiar with the basics of tax law as it affects the sale or purchase of a residence. An understanding of tax law can (1) help the practitioner structure the transaction in a way more favorable to the buyer and/or the seller; (2) help practitioners recognize potential liabilities for their principals; and (3) keep a sales transaction together and increase earning potential for the practitioner. While real estate professionals should not give tax advice, they are expected to recognize red flags and suggest that their clients or customers obtain professional tax advice. DEDUCTIONS FOR HOMEOWNERS Two deductions are permitted for owners of primary and secondary residences: property taxes and mortgage interest. For many citizens, the opportunity to deduct property tax and mortgage interest is the sole remaining reason to itemize miscellaneous deductions on their tax returns. With the last few tax reform acts, Congress virtually eliminated all other deductions for most citizens. Property tax deductions are simple and straightforward; the more complex rules regarding deduction of mortgage interest are the primary focus here. Mortgage Interest Since passage of the Tax Reform Act of 1986 (effective in 1987), consumer interest is no longer deductible. Car loans and boat loans accrue consumer interest. Interest paid on credit card charges for nonbusiness expenses is also not deductible. In contrast, mortgage interest on primary and secondary residences is still tax deductible; however, limits on the amount of interest that can be deducted depend on the type of financing used. Acquisition Financing and Equity The IRS recognizes two types of financing: acquisition and equity. Acquisition financing is used to acquire, construct, or substantially improve a primary or secondary residence. To qualify as an acquisition loan, either the mortgage has to be in place or paperwork for the mortgage must be in progress at closing. The interest on only the first $1 million of acquisition financing is deductible. This limitation does not pose a problem for most Americans because few taxpayers borrow over $1 million to finance the purchase of their homes. However, for affluent taxpayers whose residence(s) may cost several million dollars, any interest paid on the loan amount above $1 million cannot be deducted from income. Around election time, congressional candidates sometimes propose lowering the limits of deductible interest to loans of $250,000 or less, but real estate advocates and lobbyists rarely support such measures. Moseley Flint Schools of Real Estate 17

18 Taxpayers should be reminded that paying off an initial (acquisition) loan leaves no acquisition financing on the home. Any subsequent loans on the property are then considered equity financing. Equity financing is any type of loan that does not qualify as acquisition financing. If a mortgage is not in place at closing or the paperwork for the mortgage is not in progress at closing, then the IRS considers the loan to be equity financing. Equity financing can be a first, second, or third mortgage. Whether an equity loan is recorded as a first or second mortgage is not relevant. Equity loans can take the form of a checkbook, credit line, or credit card. Regardless of the form or the purpose of the loan, only the interest on the first $100,000 of equity financing is deductible. If taxpayers wish to use an equity loan to finance a child's college education, purchase a car, pay medical bills, or for any other purpose, they may not deduct more than the interest paid on a loan up to $100,000. For owners of a primary residence and a vacation home, the total mortgage indebtedness on both homes cannot exceed $1,100,000 for tax deduction purposes. Points Buyers and sellers may deduct points (also called discount points), a form of prepaid interest, under some circumstances. Buyers can deduct points in the year they are paid if the following conditions are met: The loan is made for the purchase of a principal residence and is secured by the residence. Charging of discount points is an established business practice in the area in which the loan is made. The number of discount points charged does not exceed the amount generally charged in the area. The amount claimed as discount points is equal to or exceeded by the amount of the cash paid by the buyer (including any earnest money deposit applied at the closing, down payment, escrow deposits, and funds actually paid at the closing). The points are not paid for with funds received from a lender. If sellers pay or are charged points in connection with the buyer's loan for the purchase of their residence, the sellers can deduct those points in the year of the sale. Points paid to refinance a mortgage must be prorated over the life of the loan. When refinancing for a second or third time, taxpayers should consult their tax advisors about any unused portion of deductible points. Prepayment Penalties Prepayment penalties charged to owners who sell their home before amortizing the mortgage are treated as additional interest and can be deducted in the year they are paid. Section 3: Review Exercises Part I Complete these true or false and matching review exercises as they are intended to help prepare you for the final exam. Answers are found at the back of this text. 1. Mortgage interest is tax deductible for a homeowner. T F 2. Points are tax deductible for a homeowner. T F 3. Prepayment penalties are tax deductible for a homeowner. T F 4. Credit card interest is tax deductible for a homeowner. T F Column I Column II 1. Consumer interest a. treated as additional interest 2. Equity financing b. acquisition loan limit for interest deduction 3. Acquisition financing c. car or boat loan; credit card loan 4. Prepayment penalties d. any type of loan that does not qualify as acquisition financing 5. The first $1 million e. any loan used to acquire, construct, or substantially improve a primary or secondary residence Moseley Flint Schools of Real Estate 18

19 SELLING A PRIMARY RESIDENCE Sometimes homeowners are unable to realize a profit or capital gain from the sale of their homes. Capital gain is the difference between the cost or the adjusted basis of an asset, and the net proceeds from the sale. For those taxpayers, the loss on the sale of their personal residence hurts twice: first, when they sustain the actual loss; second, when they discover that the loss is not tax deductible. Selling a Home at a Profit For those home sellers fortunate enough to sell their homes at a profit, it is essential to calculate the amount of capital gain for tax-planning purposes. However, depending on the taxpayer's strategy, taxes may be avoided. Taxes are assessed on the amount of capital gain from the sale of a primary residence. Familiarity with the following key terms is essential for an understanding of how capital gain is calculated: Expenses of sale of old home. Expenses include sales commissions, advertising expenses, attorney and legal fees, and similar expenses incurred in selling the old home. Basis. The basis includes the original cost of the home to the taxpayer, commissions and other expenses incurred in its purchase, the cost of any improvements, and the postponed gain (if any) from the sale of a previous home. Adjusted sales price. The adjusted sales price of the old home is the actual sales price less the expenses of the sale and the fix-up expenses. Cost of the new home. The cost of the new home includes (1) the purchase price plus the cost of all capital improvements or the cost of construction completed and (2) expenses of acquiring the home, such as title insurance, appraisal, survey, and attorney s fees. Improvements. An improvement is any new item made a permanent part of the real estate or any item that is an actual improvement over an old item. Examples include a new kitchen, new plumbing fixtures, a new pool, or new flooring. Example of Capital Gain Calculation Assume that sellers have sold their home for $165,000. They incurred $15,000 in expenses of the sale, including real estate commissions. Their home originally cost $90,000, but they added a $10,000 swimming pool three years ago. What is the capital gain on this home? $165,000 Actual sales price -$15,000 Commissions and other expenses of sale $150,000 Realized sales price -$100,000 Original cost of home + any improvements (basis) ($90,000 + $10,000) $ 50,000 Profit or capital gain If owed, tax would be based on the amount of capital gain. As of 2003, the current maximum tax on capital gain is 18% or 8%, depending on the taxpayer s marginal tax bracket (the level of income tax of a given individual, as indicated by the amount of taxes he/she pays on his/her final dollar of taxable income; also called tax rate), so the taxpayers may owe $9,000 ($50,000 x 18%). Section 3: Review Exercises Part II Complete the following matching review exercises as they are intended to help prepare you for the final exam. Answers are found at the back of this text. Column I 1. Capital gain 2. Expenses of sale of old home 3. Basis of the old home 4. Adjusted sales price of old home Column II a. the original cost of the home plus expenses incurred in its purchase and the cost of any improvements b. the purchase price plus the cost of all capital improvements and expenses of acquiring the home c. the actual sales price less the expenses of the sale and the fix-up expenses d. profit Moseley Flint Schools of Real Estate 19

20 5. Cost of the new home 6. Improvements e. a new kitchen, new plumbing fixtures, or new flooring, for example f. sales commissions, advertising expenses, attorney and legal fees, for example CAPITAL GAIN TAX AVOIDANCE Taxpayers have a number of methods by which they can avoid capital gain tax on the sale of their homes. Prior to May 1997, qualified taxpayers may have used the rollover rule, or elected to take the once-in-alifetime exemption. However, rules in effect since May 7, 1997, have simplified capital gain rules on primary residences. Old Rollover Rule If a taxpayer purchased a replacement home 24 months before or after the sale of the old residence at a price equal to or greater than the adjusted price of the old home, the rollover rule was met. As a result, the taxpayer would not be responsible for any capital gain tax. If taxpayers did not meet the rollover rule, that is, purchase a replacement home within 24 months; another method could be employed to avoid capital gain tax. Eligible taxpayers could have elected to take the once-in-a-lifetime exemption and thereby avoided paying tax on up to $125,000 of capital gain. In order to qualify, two requirements must have been met: (1.) The taxpayer must have been 55 or older on the day of closing. If the taxpayers were married, only one of them had to be 55. And (2.) the taxpayer must have lived in the home as a primary residence for three of the five years prior to the sale. Current Rules A single person that has owned and lived in the primary residence two of the last five years has an exemption from capital gain tax on up to $250,000 of capital gain. A married couple that has owned and lived in the primary residence two of the last five years has an exemption on up to $500,000 of capital gain in the home. The gain does not have to be reinvested in another home, nor does the taxpayer need to meet a minimum age requirement. Moreover, the taxpayer(s) can use this rule over and over again; it is not a once-in-a-lifetime exemption. The Taxpayer Relief Act of 1997 reduced capital gain tax rates from a maximum of 28% to 20%. For sales after 2000, the maximum capital gain tax rate is 18%, or 8% for sellers, depending on their marginal tax bracket. Certain holding periods are required for these lowered rates. Under certain circumstances, taxpayers may still be exempt from capital gain tax even if they have not owned and occupied the property for two years. For example, the taxpayer may have had an "unforeseen personal circumstance," such as a job-related move. Also, the taxpayer may be eligible for a partial exemption under new rules. Taxpayers should consult with their tax preparer for more details. Section 3: Review Exercises Part III Complete the following true or false exercises as they are intended to help prepare you for the final exam. Answers are found at the back of this text. 1. Today taxpayers must be 55 years old to avoid capital gain tax on the sale of their homes. T F 2. A single person who has lived in the primary residence for two of the last five years is exempt from capital gain tax on up to $250,000 of capital gain from the sale of the primary residence. T F 3. A married couple that has lived in the primary residence for two of the last five years is exempt from capital gain tax on up to $1 million of capital gain from the sale of the home. T F 4. Capital gain must be reinvested in another home to avoid capital gain tax. T F 5. Taxpayers can only avoid capital gain taxes on their homes once. T F Moseley Flint Schools of Real Estate 20

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