Tax Tips Blog

Mike writes:
My wife and I are trying to help our youngest daughter - a single mom - get her own house close to us so we can help with after school care, etc. Advise is needed on gifting, gift splitting, and the best way to handle all this without my daughter having to pay taxes on the money and property we are giving her for this house. Thank you. Mike

My reply:
Hello Mike!

You are allowed to gift your daughter up to $12,000 per year without any current year (and possibly never) tax consequences of the gift. In addition you are allowed to gift your grandchild $12,000 per year without any current year (and possibly never) tax consequences of the gift. If you are married your wife is allowed to do the same thing. This would amount to a total of $48,000 per year in gifts.

You can certainly purchase a second home, keep the home in your name and let your daughter and granddaughter live in it. Depending on your income bracket and the amount of the loan, if any, you may be able to deduct the property taxes and mortgage interest you pay on this second home.

You could also purchase the home and rent it to your daughter. You would have to rent it at FMV and you would have to report any income you receive from the rental, but then you can deduct the property taxes, mortgage interest, utilities, any repairs and depreciation on the second home, which you pay for. And you could gift her the money (as explained above) to help her pay for the rent.

Best wishes,
Gina

Mark writes:My son is no longer a full time student. He lives at home, and the deal is he pays us rent until he either moves out or goes back to school full time. My question is: how is this handled, tax-wise. I assume I declare the rental income, but are there other issues I have to be aware of? Never been a landlord before. Thanks for your help.

My reply: Hello Mark!

If I were your advisor I’d sit down with you and discuss this situation. It seems to me that your son is assisting you and sharing in the home expenses of maintenance (insurance, utilities, etc.) and food. If this is the case then the money you are receiving from his is actually a contribution, not rent, hence no tax consequences.

By the way, I think it’s a great idea that you are charging him rent in this situation, my parents had the same rule for us.  We were required to pay rent if we lived with them after we turned 18 (regardless of whether or not we were still in school). This gave us a safe place to live and study and the opportunity to learn that we were now an adult and adults need to be responsible for paying their own way in the world.

Assuming that you don’t really need the money that your son will be paying you, you may want to consider putting it into a separate account somewhere, or otherwise keep track of how much he gives you. Then when he finally does move out or returns to school, you could consider returning the money to him (as a gift assuming it’s less than or equal to the annual gift tax exclusion that year then there’ll be no tax consequences of this gift either) to use for furniture, a deposit on an apartment or whatever.

Best wishes, Gina

www.GLGcpa.com

Megan asks: I have rental property which I plan on selling. I’m estimating that I’ll have about $100K in profit. How will this affect me taxwise? I would also like to know if I should buy another property or use the money to pay down my mortgage. Any suggestions? Please respond. Thanks in advance, Megan

My response: Hello Megan, thanks for writing. I think it’s excellent that you’re asking these questions BEFORE you sell your rental.

The problem is that these are questions that you should be discussing with your tax professional, because without knowing a lot more information (your age, whether or not you manage the property, your financial situation now and expected in the future, the state you live in, etc.), I really can’t give you any specific advice and my general advice may not be appropriate for your situation.

If you’re like my average client, you’re probably mistaken on what your taxable profit in your rental is likely to be. Most taxpayers forget about adjustments to their basis and simply assume their selling price less what they initially paid for the property is their gain or loss. Not so.

You should ask your tax professional to estimate your estimated tax liability on the sale of your rental. If you’ve made any permanent improvements over the years since you purchased your rental property, these improvements will usually increase your basis.

The largest deduction to your basis is usually depreciation, whether or not you claimed it.

If you live in any of the disaster areas, you may have incurred a casualty loss that modified your basis.

Your property may be subject to depreciation recapture, which would change the character of profit that you will have.

How much tax you will pay on the gain will depend on your particular situation. You may find that this gain has caused you to be in a high tax bracket. Your exemptions and deductions may be phased out. You may be unable to make a deductible IRA contribution. This may even put you in an AMT situation.

The best thing to do is to sit down with your tax professional and have him or her help you plan this out. After your tax professional has helped you figure out your potential profit and related tax liability, then it is time to consider you options.

If you decide to purchase another rental property then the smartest tax method for this is called a 1031 exchange. You have to set this up BEFORE you sell your current rental, but once you do you can postpone paying tax on the gain from the sale. This is a complex transaction and should not be done with professional help.

If you decide to put your net profits into your home or into any other investment which would be considered personal in nature (stock market, savings account, etc.), you will need to make an estimated tax payment to the IRS and your state.

Best wishes,

Gina

Trisha has owned her home for over 20 years. She originally purchased her home for $100,000 and there is not currently a loan on the home. Her home is estimated to be worth $300,000. Trisha wants to move closer to her only grandchild and needs the cash from her current home in order to put money down on her new home. Trisha has strong ties to this area and hopes to move back here in a few years, so she doesn’t want to sell her home. Trisha is thinking of renting her current home instead of selling it. If Trisha simply converts her home to a rental property the property’s basis would be the lower of cost or market value, and in her case this would be $100,000. Trisha should consider forming a wholly owned S corporation and having the S corporation purchase the home from her at fair market value, with the help of a bank loan. Trish should contribute enough cash to the S corporation to make the minimum down payment that would be required by a bank. This way, Trisha would receive $300,000 from the sale of her home to her S corporation (and net $240,000 if she contributed $60,000 to her S corporation), and the $200,000 gain on the sale of her principal home ($300,000 fair market value sales price less $100,000 original purchase price) is excluded from tax (sale of her primary residence). Therefore, this transaction is accomplished at no tax cost. This money could now be used as a down payment of a home near her grandchild. The S corporation can now rent the house and take depreciation deductions on the stepped up fair market value of $300,000 cost allocated to the house (the portion allocated to the land is not depreciable). If the S corporation is able to rent the house in excess of the cash outlay for mortgage payments, insurance, taxes and operating costs, this could provide Trisha some continued cash flow and possible tax benefits associated with residential rental properties. Any gain or loss from the rental activity would be passed through to Trisha, subject to the passive activity rules. If the house was subsequently sold by the S corporation for a gain, the gain would be taxed at capital gains rates (15%) and possibly some depreciation recapture at 25%. However, if she is only going to be gone a couple of years, the gain, will most likely not be that large, due to the step up in basis.