I recently had a call from a real estate agent who was in a panic. She had an 82 year old client who had called her in tears. Here is what had happened.
The client (I'll call her Susan Seller) had engaged the real estate agent (Rita Realtor) to sell an investment property for her in the Spring of 2006. Rita did exactly this and collected her commission without asking any questions about what Susan would do with the proceeds. Susan had approximately 280K in gains.
Susan took the check from escrow and placed it in a 6 month CD. She had never sold property before and was unaware of the tax consequences.
When the 6 months were nearing an end, Susan called Rita back and asked her to look for another investment property for her that was in the price range of her last sale.
Rita found a property for her in early 2007 and collected another commission, still not ever discussing the funds involved. Susan used the entire amount from the last sale, plus the interest from the CD and about 10K of her savings and purchased the property outright.
The second week of April Susan went to her accountant to do her 2006 tax return. The accountant told Susan she would owe upwards of 80K in capital gains tax, recaptured depreciation and extra income tax from the CD earnings.
Susan didn't believe that was possible because she hadn't spent a penny of the earnings except on the new property. Since she had employed Rita for both the sale and the new purchase, she believed that Rita would have mentioned the tax problems since Rita was aware of what she was doing.
So, Susan was furious and called Rita to see if there was some sort of mistake. Susan no longer had the money to pay the 80K tax bill. It never crossed Rita's mind to talk to her clients about what effect their sales and purchases could have on their taxes. Rita didn't know herself.
I gave Rita the bad news that Susan didn't have any choice but to pay her taxes. She will have to take out a loan either against her personal residence or the rental. This means the rental income that she was counting on to support herself will be used in good part to make payments on the new loan.
The extremely sad part of this story was that all of this could have been totally avoided by either doing a 1031 exchange or structuring the sale to minimize the tax burden. At the very least, Susan could have kept the proceeds in an account until the tax return and paid her tax consequences with the cash on hand.
Rita Realtor just lost herself a client and you can bet Susan Seller will be telling everyone who will listen about her bad experience.
All Rita would have had to do was ask a simple question when helping Susan with her first sale. She could have asked Susan what her plans were after the sale, informed her that she should talk to someone who could explain the tax consequences and options available because they may be significant if not handled properly, and given her the name of someone who could help.
Real estate sales persons and brokers don't have to be tax experts, but if they take that one extra step to show they have their client's best interest at heart, they will earn the respect and appreciation of their clients and never put themselves in the position of having to explain why they never disclosed the tax consequences on a sale.
I guarantee this is a lesson Rita Realtor won't soon forget!
Paula Straub
760-917-0858
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