Transferring property to heirs

[Alexandra E Aponte]

Hello BP! Love this website, the podcasts, forums, books etc. thank you in advance for the wealth of information. Here's the situation: My father would like to transfer a property to my name, or essentially "gift" it to us since he is well into his golden years and does not wish to deal with management anymore. I will still be giving him the passive income the home generates, however he would like for us to take advantage of the equity in the home. It is owned free and clear, worth approx 140K. My question is what would be the smartest way to do this considering tax implications with passing wealth from one in individual to another. I will be using property as investment as the current tenant has renewed the lease in the property now. Based on some research that I have done I have an idea that a trust may be involved. Can anyone elaborate in layman terms? Thanks again! Alex A.

[Dave Toelkes]

@Alexandra E Aponte

You don't give enough information for anyone to give you an informed opinion.  Brandon already told you that the only way for both you AND your father to avoid capital gains taxes is to have you inherit the property.  Two ways to do this (1) leave you the property in his will, or, (2) establish an inter vivo trust and deed the property to the trust (actually the trustee) and name you as an alternate beneficiary.  

The first option avoids capital gains taxes for both you and your father and preserves the step up in basis, but, does not avoid probate after your father's death.  The second option not only avoids capital gains taxes, preserves the step up in basis, but also avoids probate.

The trust can also name you as a co-trustee and give the trustees power to manage the rental property.  This way you can take over the property management and still give your father the net rental income.  He pays taxes on the rental income until he passes and you inherit.  

If you are just put on the deed, or if your father gifts you a partial interest in the trust every year, you will still have a capital gains impact and will not receive the step up in basis that you would have if you inherit.  Your father may avoid future estate taxes, but we don't really have enough information to tell you anything definite.

Even if your father sells you the house at its current full value, will he have a tax impact?  Perhaps there will be no capital gains tax due to appreciation if his marginal tax bracket is low enough.  Depreciation recapture takes place in full in the year of sale even if you do an installment sale, so the tax impact for capital gains recapture may be the only tax your father has to deal with if you purchased the property.  There are related party rules in play if your father sells to you at a discount, so just buying for what he paid for the property probably won't achieve the tax avoidance you are looking for.

Just how I see it.