1031 vs Gift vs Sale

[Thomas F Blaskey]

Seeking informed opinions on the best tax avoidance strategy...

I own a SFR in NoDak. I purchased it ($265,000) in 04/2022 for #2 son to live in while he attends college. I have been deliberately managing it as a rental (ie, contract, collecting rent, etc.). I plan on selling it ($300,000) in mid-2025 after he graduates. I am now thinking about different tax strategies and would appreciate insight as all my experience in real estate has been on (my) primary residences.

The options I see:

1) Sell outright and pay Capital Gains tax (15%), depreciation recapture, etc.  Since I will have owned it only 3 years, the property value increase is minimal ($35K) and closer to $15K once I pay a listing agent and closing fees.

2) Gift it to #2 son now and let him pay the Capital Gains tax at his rate (0%) when we sell next year.  If we sell it inside a year (short-term), his regular tax rate is still low because he has no regular income.  I figured he can't claim as a primary residence as a renter even though that's been his only address for 3 years? I am aware that I would have to claim a large gift tax exclusion but $300K is relatively small.

3) Use a 1031 exchange to sell this property and buy an equal/greater one in AZ, where #1 son lives.  I would then make him my renter and kick the can down the road to figure out how to gift it to him.

It seems as if the 1031 exchange fees might be a wash with the taxes?  Thoughts?  Any other scenarios or details I'm not thinking about?

[Bill B.]

Check with your CPA if you instantly owe the depreciation recapture if you gift it to your son. Even if not immediately then your son would owe it when he sells, so no advantage to this strategy. 

I believe you were right he would inherit your cost basis, so he would owe capital gains. Did you pay cash for this house so there’s no loan to pay off when you gift him the house?

This seems like a lot of work to save 15% of $35k in taxes (Less than $5k.) especially if you have transfer taxes or title insurance, or you convert your long term 15% rate in to your son’s regular income tax bracket.

I hate paying taxes as much as the next guy but this lemon isn’t worth squeezing. Just consider the rent you saved buying the place as part of the profit plus any/all the write offs you’ve had for 3 years. 

[Ashish Acharya]

@Thomas F BlaskeyIf your gain after expenses is minimal (~$15K), selling outright is straightforward, with modest taxes on the gain (15%) and depreciation recapture (25%). After operational expenses, there might be minimal tax.

Gifting the property to your son transfers your basis ($265K) to him, allowing him to sell at his lower tax rate (0%-12%), but requires using part of your lifetime gift tax exclusion. A 1031 exchange defers all taxes by reinvesting in a like-kind property, preserving capital for long-term investments but adds complexity and future tax obligations. If simplicity is key, selling outright is best; if deferral or family planning is the goal, consider gifting or a 1031 exchange.

This post does not create a CPA-Client relationship. The information contained in this post is not to be relied upon. Readers should seek professional advice.