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Patience, Patience, Patience

Q. My father is quite ill and will only live a few more months. I need to help my mom plan for life as a single woman after 47 years of marriage. She will get Social Security, a partial military pension, and healthcare for life. I am trying to come up with a plan to invest her insurance and savings so she will have an adequate income to live on. The house is owned free and clear.

What kind of general advice can you give?

---S.A., by e-mail

  

A. First, remember at all times that being helpful requires patience, care, and more patience. Don't be in a hurry for decisions or changes. Your first task is to help her make certain she has the financial resources to dawdle through a year of indecision and uncertainty. Your second task may be to help her think through a variety of possible changes such as selling the house, moving to a continuing care community, etc. It all depends on her health and hopes.

Investment changes come last because decisions she makes about how and where she intends to live will have a major impact on the income she needs and the investment money available to create the income.

  

Q. I own a condo that I have rented for about 4 years. Due to a recent Homeowner Association special assessment, the rental income received does not entirely cover the combined cost of the mortgage and homeowners dues. I'm left with a $45 monthly shortfall. The condo was purchased off the foreclosure list in 1990 for just over $32,000 and my interest rate is about 8 percent.

I currently live in a townhome that I will eventually also turn into a rental property. I assumed the mortgage in 1996 and it has about a 6.5 percent interest rate. I am in the process of refinancing the townhome. I considered doing a cash-out refinance on the townhome and paying off the condo, but after doing this year's taxes I was reminded of the fact that the condo gives me a loss each year, especially after depreciation.

Questions: Should I pay off the condo? Refinance the condo? Stand-pat with the condo financing and take a loss each year?

---P.C., by e-mail from Dallas

  

A.   In an ideal world you would refinance the condo at a lower interest rate and take out enough cash to pay off the mortgage on your primary residence. This would maximize the expenses on the rental property and generate a loss that could be deducted against your other income. It would make certain that you benefited from the interest payments you would have as a business expense. On your personal return you would also be able to claim the standard deduction, so your income tax bill would be smaller.

If, on the other hand, you refinance your primary residence townhouse and pay off the mortgage on the rental property you could end up with taxable income from the rental property. Worse, the interest on the new mortgage on the townhouse could be less than the standard deduction. As a consequence, you would pay more in income taxes.

So the best course of action is to maximize the debt on the rental property and eliminate the debt on your personal residence.

There are two reasons that scheme probably won't work. First, the rental property probably isn't worth enough to carry the financing you'd like. Second, you'll get a much lower interest rate on your personal residence than on a rental condo refinancing.

A two-step refinancing of your residence is a reasonable second choice, particularly if your residence is worth over $150,000 or so. You would do this by refinancing your 6.5 percent first mortgage to as little as 4.5 percent, possibly less, on a 5/1 adjustable. Then add a cash-out equity loan (second mortgage) to pay off the balance on the rental condo. This will get you a lower cost than a so-called "blended rate" loan. It will also give you more flexibility with future financings.

This will work to your maximum benefit  if you are already itemizing deductions for your tax return and are well above the standard deduction. In any case, much of the income from the rental condo will be tax sheltered by depreciation.

Another alternative would be to sell the rental condo. If you aren't covering your costs 13 years after purchasing a foreclosure, you may never make any income on the property. You might, however, make a capital gain.   

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About scottb

Scott Burns has covered the changing world of personal finance and investments for nearly 40 years. Today, he ranks as one of the five most widely read personal finance writers in the country. Scott began his career as a newspaper columnist at the Boston Herald in 1977 where he was also the financial editor. Nationally syndicated in 1981 and now distributed by Universal Press, the column appears in newspapers from Boston to Seattle. In 1985 he joined the staff of the Dallas Morning News where his column quickly became one of the most widely read features in the paper. He left the Dallas Morning News in 2006 to become one of the founders of AssetBuilder and its Chief Investment Strategist. Burns is a graduate of Massachusetts Institute of Technology (1962). He has written four books, including "The Coming Generational Storm" (MIT Press, 2004) coauthored with economist Laurence J. Kotlikoff. His fourth book, also coauthored with Kotlikoff, will be published this spring by Simon & Schuster. "Spend Til' the End" uses consumption smoothing to demonstrate the errors of conventional financial planning. His business experience includes working as a staffer for a major consulting company and service as a director and audit chairman of a NASDAQ listed manufacturing company. He and his wife divide their time between Dallas and Santa Fe, New Mexico.
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