Tax Avoidance Strategy - 1031 Exchange & Gift It to my Child - Prove Me Wrong

[Sam Mathew]

Please prove this strategy wrong, but I have not been able to.  

I bought an investment home in Charlotte, NC (I live in FL) when my child was born (14 yrs ago) for $124k that is now worth $340k today.  Because I switched it to a 15 year loan, it is almost paid off in 2 more years (I have been paying much more than the minimum mortgage payment as then yearly rents have increased).  I originally bought the house so one day I could pay my child's college tution and costs (rather than invest in a college 529 plan).

She's in 8th grade this year, so by the time she graduates high school in another 5 years, I'm projecting that it will be worth approx $380-400k, more than enough for college.  

I'm might switch my plans now (and thus why requesting if someone or a tax expert can prove me wrong).  I will still need to seek a tax specialist in the future if laws change. Again, I'm in FL, but she may go to a college out of state.  Boston, Chicago, Ann Arbor, Austin, Raleigh.  No idea yet, but she talks about it.  Whichever city/state she picks, even here in Florida, my new plan is now to 1031 exchange to current investment home to a 4 bedroom property whereever she goes to college.  She can live in it and rent the rooms out to pay her college bills.  But if she lives there for at least 3 out of 5 years, than I am planning to gift the house to her.  You can do a lifetime estate gift to your child up to $13.61M as of 2024 (these limits change).  And then later she can sell it and if it was legally her primary home for at least 3 years, then she will receive all the funds tax free, and I pay no gift tax.  A win-win for her and myself, if legally possible with no issue.

So now my orignially "small" downpayment on the original $124k house, litereally will pay for all her college costs and after I gift the house to her, she will likely receive maybe $550-650k (projections of house in year 2030) tax free once she's done with college and sells the property.  

Do you believe this is possible?  I have researched and it seems completely legal and legit to do.  Again, please prove me otherwise.  Thanks.

[David M.]

@Sam Mathew

Interesting idea... You don't want to pass it to her on your death so she gets the full step in basis?

I think the issues are it may not be tax free, or it really won't.  For one, the sec121 exclusion is $250k if single or $500k if married for the capital gains.  As it stands now, you say there is grossly/roughly $216k in captal gains.  So, by the time she goes to college you've maxed the sec121.

Secondly, the sec121 doesn't apply to the depreciation recapture.  

As I recall, in a gifting situation, the original cost basis transfers...

N.B.  For long range estate planning, people will gift it over time.  For example, if you and your wife (if you have one) can gift some $15k a year.  So, you two can gift $30k a year to your child.  Over time, you can gift out a portion, or all of the property to her.  Just another way to handle the gifting, and it doesn't use any of your lifetime limit.

Yes, @Dave Foster did this already, but just for himself.  Yes, this is a very unique exit strategy for real estate that enables you to take the capital gains tax free, but not the depreciation.

FYI:  the sec121 exclusion is for living in the property 2 out of 5 years...

I assume you'll be able to cover the cash flow of paying for college first, then selling the property after college as I understand your plan.

Good luck.