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Question: A year and a half ago, when the market was hot, we purchased a home in Virginia which we thought would be ours for a long period of time. However, I have just been transferred to the West Coast, and we are now facing a loss when we sell our home. Fortunately, we do not think we will have to come up with cash to sell it, because we put down a large down payment.

If we had made profit on the house, I understand that the IRS would allow us some partial exclusion of that gain, even if we had not owned it for a full two years.

Can we deduct all or even a part of our loss?

Answer: Unfortunately, the answer is no.

Let's take this example. Your paid $600,000 for your house, and now can only sell it for $550,000. By the time you pay a real estate commission of 5 percent ($27,500) and closing costs (approximately $2,500) your loss will be at least $80,000.

The Internal Revenue Code does not allow losses on personal residences.

According to Julian Block, author of The Home Seller's Guide to Tax Savings, "When Congress and President Clinton agreed in 1997 on a profit exclusion of up to $250,000 for sellers who file single returns ... and up to $500,000 for sellers who are joint filers, they flirted with allowing sellers a limited deduction for losses, but dropped the idea. The 1997 legislation left unchanged the rule that generally bars a deduction for a loss on the sale of something that is considered a personal asset, such as a principal residence."

There are, however, a couple of exceptions to this rule.

Did you use some of your house for business or rental purposes? If so, that portion can be deducted, since it is not a loss related to a personal asset.

Another exception is for principal residences that are converted into rental property. Here is where you may be able to salvage -- or at least limit -- your loss.

Do you need to sell? While many people do not like to own rental property -- especially when they are not physically living nearby so they can monitor the property on a periodic basis -- you should talk with your tax advisors about this possibility.

How does this work? First, you have to remove all evidence that this is still your principal home. Change your drivers license and your voting registration. If you are getting some tax benefit as your main home -- such as the Homestead exemption in the District of Columbia -- advise the DC real estate tax office that you no longer are eligible for this tax reduction.

You now rent out your house. Since you will be living far away, you probably will have to hire a property manager to collect the rent and deal with the tenants. Obviously, this is an additional expense which must be included in your calculations. While you may be willing to have a reasonable yearly negative cash flow, you obviously want to make sure that your income will be able to support this loss.

I believe the market will rebound, but haven't a clue as to when this will happen. Hopefully, within two or three years, the market value of your house will have increased, in which case your overall loss will be less than if you sell it now. And whatever the loss, you may now be able to deduct it on your income tax return.

Mr. Block gives this warning, however:

You actually have to rent out the home before you can take a loss deduction. This limitation has been upheld by the courts.

In other words, it is not sufficient if you just give a real estate agent a listing, or place a "for rent" advertisement in your local newspaper. If you cannot rent the house, you cannot take any deduction for your loss.

The IRS follows what is known as the two year "old and cold" rule. If you rent the house for just one year, the IRS may still consider the house to be your principal residence. However, if you rent for two or more years, your principal residence has now become "old and cold".

Nothing is easy when the IRS is involved. How do you determine the amount of your loss for tax purposes, once you have decided to rent it? According to the IRS, you calculate loss at of the date that you converted the house into rental property. Here is the formula:

· "1. Use the lesser of the property's adjusted basis or fair market value at the time of the change;

· 2. Add to (1) the cost of any improvements and other increases to basis since the change;

· 3. Subtract from (2) depreciation and any other decreases to basis since the change, and

· 4. Subtract the amount you realized on the sale from the result in (3). If the amount is more than the result in (3), treat this result as zero.

The result in (4) is the loss you can deduct."

(For more information, see IRS Publication 544, available on the web at www.irs.gov/publications).

You will need your accountant or tax advisor to assist you in calculating the loss, but the IRS does provide a helpful example:

Five years ago, you changed your principal home to rental property. At the time of the change, the adjusted basis was $75,000, and the fair market value was $70,000. This year, you sold the house for $55,000. Over the years, your depreciation was $12,620. Using the formula spelled above, here is how it works:

Lesser of adjusted basis or fair market value at time of change: $70,000

Plus cost of any improvements: -0-

Minus Depreciation: -12,620

= 57,380

Minus amount realized from sale: 55,000

Your deductible loss: $2,380

To complicate things even more, the law also places limits on the amount of the loss that can be deducted each year. According to Block, you can offset capital losses against capital gains. "But in the absence of capital gains, the yearly cap is $3000 ($1500 for those filing separate tax returns) on the amount of losses they can offset against their 'ordinary income'. The law does, however, allow taxpayers to carry forward unused losses to later years."

This "convert to rental" scenario is food for thought, but before you take any steps -- or sign any contracts -- make sure that you have a complete understanding of the complexities of our tax laws. Expert advice is a necessity.

McLEAN, VA -- Freddie Mac (NYSE:FRE) today released the results of its Primary Mortgage Market Survey (PMMS) in which the 30-year fixed-rate mortgage (FRM) averaged 6.52 percent with an average 0.4 point for the week ending August 23, 2007, down from last week when it averaged 6.62. Last year at this time, the 30-year FRM averaged 6.48 percent.

The 15-year FRM this week averaged 6.18 percent with an average 0.5 point, down from last week when it averaged 6.30 percent. A year ago, the 15-year FRM averaged 6.18 percent.

Five-year Treasury-indexed hybrid adjustable-rate mortgages (ARMs) averaged 6.34 percent this week, with an average 0.6 point, down from last week when it averaged 6.35 percent. A year ago, the 5-year ARM averaged 6.14 percent.

One-year Treasury-indexed ARMs averaged 5.60 percent this week with an average 0.6 point, down from last week when it averaged 5.67 percent. At this time last year, the 1-year ARM averaged 5.60 percent.

"Interest rates on conforming long-term fixed-rate mortgages and one-year adjustable rate mortgages trended down by about one-tenth of a percent in the past week," said Frank Nothaft, Freddie Mac vice president and chief economist. "This is as a result of yields on Treasury securities coming down, and the Fed's decision to cut the discount rate by half a percent to 5.75 percent last Friday."

"Additionally, economic indicators released in the past week reflect slowing housing activity in July. Last month's housing starts dropped to the lowest level since January 1997 at an annualized pace of 1.38 million units, while one-unit housing starts experienced the fourth consecutive month of decline. Building permits also fell to the lowest level in nearly 11 years, and the number of one-unit permits issued was at the lowest since June 1995."

As the subprime crisis deepens and delinquencies and foreclosure filings increase, the lending industry has revved up its efforts find ways to keep the situation from worsening and to prevent it from happening again.

One solution: education.

For example, the Mortgage Bankers Association "has been very active in the area of financial education, working to make the home buying process as transparent as possible," said chairman John M. Robbins, in announcing the latest efforts -- The Simple Facts and The Simple Calculator.

"Helping borrowers understand and evaluate different mortgage choices is a role that our industry must play so that our customers receive the best mortgage information possible to make informed decisions," he said.

The MBA insists that it is committed to helping first- time buyers learn about the mortgage process and is also working to keep current homeowners in their homes.

The lenders' association has enhanced its bilingual consumer education website, HomeLoanLearningCenter.com, with a guide and an accompanying online calculator to help demystify the mortgage process.

The Simple Facts provides information that helps prospective buyers identify the pros and cons of each type of mortgage and choose the best product for their own situation.

One example of the educational offering is titled, "Someone Wants to Give You Money. Help Them," designed to show the buyer what he or she will need to apply for a mortgage:

Provide all your W-2 forms for the past two years and your two most recent pay stubs. (Some lenders may want to see your entire tax return for the past two years.) If you are self-employed, be prepared to provide complete tax returns for the last two years, along with a profit-and-loss statement for the current year.

Don't forget proof of other sources of income such as rental income, social security or disability payments, alimony, child support, etc. Proof of these could be canceled checks, copies of leases, divorce decrees, certification of benefits or other documents.

Finally, if there are any gaps in your employment over the last two years for whatever reasons (illness, layoff and so on) provide a brief written explanation.

Another example, and the sign of the times, is, "How to Live with Your Mortgage, Not for It:"

"The expense of owning a home goes beyond a monthly mortgage and utility payments. Home buyers with minimal cash reserves can often find themselves in financial difficulties," the brochure states, and lists a variety of things that can go wrong -- a furnace needing replacement -- that can stretch the finances of especially first-time buyers who might have been lured into signing up for a larger mortgage than they could readily afford.

Although many consumer advocates maintain that fraud has been a major player in today's troubled mortgage market, the vast majority of borrowers who are behind in payments or have gone as far as facing foreclosure often found so-called "exotic" adjustable-rate loans the only way they could buy a house when median prices skyrocketed.

The problem in many markets is that those same houses have declined in value and are worth less than the mortgages these borrowers took out, and, coupled with tighter lending standards in the wake of the subprime crisis, are unable to refinance to safety.

While the rule of thumb that housing costs should not exceed one third of an individual's annual income, a recent survey by apartments.com found that more than 60 percent of renters responded that they spent more than the recommended percentage on rent.

In fact, 20 percent of survey respondents spending more than half of their annual salary on rent.

The other part of the MBA learning center is "the Simple Calculator," a tool that estimates the payments for each product, not just today but throughout the mortgage, and compares payments under different types of loans.

Mortgage Bankers calls HomeLoanLearningCenter.com its "unbiased" consumer-education information website.

"Clear and understandable information helps consumers become comfortable taking on a mortgage, which is a long-term responsibility," said David Lowman, chief executive officer of Chase Home Lending, the mortgage unit of JPMorgan Chase.

Fannie Mae's chief executive officer Daniel H. Mudd called the MBA website "an important project" to "advance the cause of sound and affordable mortgage lending."

"We at Fannie Mae have long worked for and advocated clear, concise disclosure of mortgage terms to protect borrowers," Mudd said. "Information and education are key parts of providing consumers with a fair path to homeownership."

Freddie Mac's chairman and chief executive officer, Dick Syron, said the site would "help consumers make more informed decisions about their most important investment -- their home."

Which real estate dreams have you abandoned without a fight because money is an issue? Aim to change more than your address when you buy and you may achieve home or cottage ownership seemingly beyond your current means.

Home-buying affordability criteria avoid financial over-extension, but selecting real estate based entirely on current finances and spending patterns may short-change you in the long run. Look beyond what you have to explore what you can do with what you have. Consider which improvements to your debt management and spending habits could extend your financial reach. Credit counseling bureaus offer solid advice in this area at little or no charge.

Balance livable compromise against researched opportunity to reach beyond what finances alone dictate:

• Reign in impulse and discretionary spending, and kick expensive habits like smoking.
• Chip away at "permanent" credit card debt and stop adding to the balance.
• Live to a personal standard instead of chasing the "Jones" to gain some financial "elbow room."
• Shift to a long-term perspective instead of trying to grab everything now.
• Set lifestyle and ownership priorities, and stick to them.

One determined buyer, who we'll call Lee Thompson, is living proof that adapting your finances to achieve your dreams is a powerful alternative to designing your life around a lack of money. Patience and persistence are vital characteristics.

Thompson was almost 50 when the 30-year marriage ended and left her financially vulnerable. Determined to buy her own home and achieve financial stability, Thompson did not let well-meaning, but disparaging friends stand in her way. For a few years, Thompson held down two jobs to make ends meet. Eventually, a move to a small, less-expensive apartment on the outskirts of town allowed her to quit her part-time weekend job.

"Friends and family couldn't understand how I was doing it, but I did it anyway because that is what I wanted to do," said Thompson explaining how she achieved home ownership without the small fortune that pundits say is essential.

Thompson took advantage of her employer's shared contribution program and a loan from a friend to build up her Registered Retirement Savings Plan. Later she withdrew C$20,000 under the Home Buyers' Plan toward her home purchase. She also learned all she could about investing. Meticulous planning and appreciation of the rewards of a simple lifestyle maintained her commitment.

About three years ago, Thompson noticed a newspaper advertisement for a condominium that could be carried for about what she was then paying in rent. Encouraged by her dream of home ownership, Thompson began researching condominiums and this project in particular to learn where value lay:

• When Thompson discovered that prices decreased as square footage dropped and that buying at lower levels saved a thousand dollars a floor, she went after a fifth-floor, 343 square foot unit with a balcony.
• The small building, constructed by a reputable developer, had no swimming pool, elaborate amenities or extensive gardens, so monthly maintenance fees would probably remain affordable.
• Buying one of the last remaining units enabled Thompson to negotiate with the developer who was ready to move on to the next project.
• By selecting a building with a moderate range in unit prices, there was a better chance that owners would have similar long-term financial and management priorities.

By the time the urban river-front building was completed in 2006, Thompson's south-facing unit had already increased in value, as is often the case for purchases made before construction is complete.

Conveniently located for public transit, shopping and pursuit of her interests, Thompson will forego car ownership.

Thompson summed up her real estate decision this way: "It will be tight because it has been since day one, but I'm doing it. It is important not to let anyone put you down or discourage you. When I first found this place, I had been to a real estate seminar and they got me going. Then, I had one family member really put me down. Finally, a friend, who is an accountant, thought it was a good idea and encouraged me, and I thought, 'I can do this.' You must use knowledge to survive. It is very tight, I am not going to kid anyone, but I am still very happy."

Wise choices and strong markets can accelerate your real estate progress and make life enjoyable long the way. What housing dreams are you abandoning without full consideration because money is an issue? Remember, the impossible may just take a little longer.