Tax Tips Blog

Steve writes: I co-own a house with my domestic partner. We live in California, but are not registered as domestic partners.

The value of the property has dobuled since we purchased it, and it is now worth approximately $1M. All costs related to the house have been split 50/50 (down payment, mortgage, taxes, improvement projects, maintenance). We are both disciplined Quicken users so we can recreate cash flows for the period we have owned the house. We are individually high net worth (over $1M).

The house is bigger than we need, so we may sell it at some point. Both of us are in good health, and hopefully will be so for another 25 years. The problem lies in that only one of our names is on the title and mortgage.

Under California law the property will not be reassessed if a new owner is added to the title (verified by our county tax assessor). We both have excellent credit (800+ FICO) so I don’t think adding a name to the mortgage would be a problem. My biggest concern is federal taxes.

We have met with several local lawyers and accountants, but I think we sometimes get answers they think we want to hear. We want to make sure this is handled properly so that we don’t have to deal with it again. We know this was a mistake, but years later what are our options for fixing the problem?

Thank you for your opinions on our situation.

My response: Hello Steve!

Just to be sure that I answer the question you are looking for I’ll answer several common questions regarding personal residences and the federal law.

First, real estate taxes are generally only deductible by the owner of the property [Regulation Section 1.164]. The owner would be the person who has title to the property; thus, if you add your partner’s name to the title both of you will be able to deduct, assuming you can itemize, the amount you pay for real estate taxes.

Second, mortgage interest payments for acquisition indebtedness after 10-13-1987 are deductible, assuming you can itemize, as long as the loan is less than $1 million.  You can usually use tracing rules to show the payments were made to pay off the mortgage interest and thus be allowed this deduction.

Third, single individuals can exclude up to $250,000 of the gain on the sale of their principal personal residence (IRC §121). If each of you wished to use your $250,000, then each of you must own and use the property as your principal residence for periods totaling at least two years out of the five-year period ending on the date of sale. You do not both have to be on the mortgage, you both just need to live there and own the home. Thus both of your names must be on the title to the house.

The problem with simply adding your partner’s name on the title is that tax law will automatically assume that you gifted your partner half of the house. This is where your impeccable records will be necessary to retain in case you are questioned about this at a later date. You may have to show this to document the fact that both of you actually purchased the house together and that there was just an error with the recording of the original title (at least that is how I read your email - if this is incorrect, so is my response).

If your records are as good as you claim, then although you may face a hassle or two, you should be alright. Adding your partner’s name to the title will make your partner half owner (joint tenancy) and his basis will be the same as yours.

Fourth, if you use your home for business purposes (home office deduction?) you may be able to take advantage of both the home sale-exclusion as well as a like-kind deferral (§1031) if you acquire a similar property. How to go about this is way beyond this medium, but I did write a general article about the tax free exchange of real estate, which you may find useful.

I hope I have satisfactorily answered your question.

Best wishes, Gina http://GLGcpa.com

Emma asks:My husband and I would like a bigger home. The houses we’ve been looking at are either slightly beyond our reach, or affordable but in need of work. My mom would like to loan us $48K to $60K at zero percent interest. (The exact amount is yet to be determined.) Does the IRS consider the forgone interest to be a gift? Any way to avoid it? Possibly relevant facts:

• Mom plans to give my 2 siblings $12K/year for at least the next five years.
• In lieu of giving me $12K, should would reduce my loan balance by $12K until the loan is paid off.
• She and I would prefer that her name not be on the deed.
• The money will be used for down-payment and remodeling (if needed)
• I can qualify for the mortgage on my own, if need be. But the monthly payments would be higher than I’d like.

If the IRS considers the foregone interest a “gift,” and she forgives $12K of the loan, then her total gift to me will exceed $12K and I’ll have to pay gift tax, right? Can Mom “give” the foregone interest to my husband, rather than me? Are there other tax implications we need to consider? Any suggestions will be appreciated. Thank you.

My response: Hello Emma! Thanks for visiting my site.

The IRS does consider forgone interest to be a gift. The interest amount on a zero percent (0%) loan is imputed based on the Applicable Federal Rate (AFR). The IRS revises AFRs monthly. For your purposes you would use one of three AFRs:

• Short Term AFR is used if your loan has a term of three (3) years or less.
• Mid Term AFR is used if your loan has a term greater than three (3) years but less than nine (9) years.
• Long Term AFR is used if your loan has a term greater than nine (9) years.

You can find an index of Applicable Federal Rates on the IRS website.  The best way to avoid the imputed interest would be to charge an interest rate that is at least equal to the appropriate AFR.

If your mother were to give you $12,000 per year in addition to the imputed interest she would be exceeding the annual gift exclusion limit and she would have to file a gift tax return to reduce her lifetime exemption. Most likely no tax would be due, as tax is not due until she exceeded her lifetime exemption.

Even if your mother’s name is not on the deed you should have a signed loan contact with her. It would need to be treated just like any other legitimate business deal.

If both you and your husband sign theses papers documenting the loan, both the interest and the annual gift would be made to both of you, probably 1/2 each. This would solve the gift tax issues for your mother, but it may raise some issues with your siblings since you would be receiving a larger gift than they would.

In addition to gift tax concerns, your mother may also have income tax concerns. The imputed interest is considered income to your mother, even though she’s not receiving cash (because she’s forgiving the interest payments to you). This would increase her income tax.

You may want to consider waiting a couple of years to purchase a house and saving the money that your mother intends on gifting you each year until you have enough money to purchase they house you want without these other issues.

Best wishes,

Gina

Adam asks: I bought a new home last year and moved into it. My previous home, which I owned for over 10 years, is for sale but I don’t expect to sell it very soon. How should I treat the expenses on my previous home? Do I have to treat it as a second home or can I treat it as investment property and then deduct all my utilities, association fees, insurance and depreciation? Is it worth it to treat it as investment property or does the depreciation recapture make it not worthwhile? Thank you, Adam

My response:I’m sorry to have to tell you that you are not allowed to deduct your expenses or depreciate investment property, unless you have placed the property in service as a rental.

I wouldn’t recommend renting your previous home if you believe your home will sell relatively soon, since as of right now you will still qualify for a $250,000 gain exclusion. Thus, if you believe your home will sell, then it would be treated as a second home and you will be able to deduct, as an itemized deduction, subject to limitations, property taxes and interest.

If you believe it will take you several years to sell your home you should investigate the possibility of converting it to a rental.

Best wishes,

Gina

Carol writes:My mom will be closing on the sale of her house next week to move to assisted living. The profit will be split evenly between her, myself, and my two siblings since the house is in all of our names. My siblings and I want to preserve as much of our portions as possible to help with her assisted living costs. Any thoughts would be appreciated.

My response: It’s a shame that you’re asking this question now, thinking about this now, instead of whenever it was that you decided it was wise for you and your siblings to be put on the title of your mother’s home. Since you already made that mistake, unfortunately it’s too late for most tax planning options.

The best advice I can offer at this point is to find the best tax attorney, best elder law attorney and best tax professional possible before you close on the property. You may be able to transfer the property out of your names somehow, but it would need to be done legally and without fraud (the reason it’s so important to have good representation) before the property is sold.

The tax attorney will hopefully be able to help you with a transfer, assuming it’s possible and feasible. The elder law attorney may be able to assist you with your mother’s assisted living. Many assisted living institutions have a graduated charge depending on assets and income. If your mother’s income and assets are limited, you may be able to get some government assistance. In this instance it would be beneficial to her to not have a large gain from the sale of her house. And of course, a good tax professional will be able to help you with the tax consequences of the sale.

Best wishes,

Gina

Lisa from Amarillo, Texas asks: Can capital gains realized on real estate sale be invested in stocks within the 45 day time frame or must the replacement be real estate?

My reply:The net proceeds that you receive (which may be all or part of your taxable capital gain) from the sale of real estate can be invested in anything, with no time limit. However, if you are really asking how to defer the tax that would be associated with the sale of your real estate, then you are really asking about a Section 1031 exchange, which I wrote about last month. In short, a section 1031 exchange is only available for the exchange of business or investment property. You did not state if the real estate you intend on selling is either; therefore, I do not know if this would be available for you or not. Either way, a section 1031 exchange is a complex maneuver and should not be attempted without the help of several professionals. Best wishes, Gina

You can defer capital gains taxes, ordinary income taxes and depreciation recapture taxes when you exchange real estate that you are holding in your trade or business or for investment. This is known as a Section 1031 exchange. You can exchange properties as many times as you like effectively creating almost unlimited tax deferral. You must exchange your property for “like-kind” property. Like kind is defined by how the property is used, not the character of the property. When you exchange your property, you transfer your tax basis and accumulated depreciation from your original property to your new property. By transferring your basis and accumulated depreciation you are deferring the gain, until you ultimately sell your property. You will have to pay taxes immediately (instead of deferring them) if you receive any money (or “boot”). This is why you should purchase a replacement property that costs more than what you’re selling your existing property for and obtain a larger mortgage than what your current mortgage is. The goal is not to take out any cash, and to effectively accomplish this it is usually best to work with a qualified intermediary. This intermediary can arrange the paperwork, hold the sales proceeds, compute the proration of your operating expenses (which would be considered boot if paid through the exchange) such that you know how much additional cash you need to put into the transaction to make sure all taxes are deferred. Properly depreciating your property after the exchange can be somewhat complex, so it is best to have your tax professional help you with this. The basis in your new property that you transferred over from your existing property continues to be depreciated on your old depreciation schedule, using the old life. The increase in basis, due to your new property, is depreciated as a separate asset. When you eventually sell your replacement property, you’ll have to recapture some of your depreciation. You have to recapture some of the depreciation you took, because the property that you sold has actually appreciated in value even though on your tax return you indicated (through the use of depreciation) that it was depreciating.