Tax implications gifting a 1031 property

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Tax implications gifting a 1031 property

Jeremy Lee
Laguna Niguel, CA · Member since 2017 · 125 posts · 7 votes

Hey all,

I was curious about tax implications regarding the condo I live in (primary residence since 2007) that I co-own with my parents (1031 exchange). They had a prior property that they 1031ed into this condo (and also put in some of their own money I believe) and we agreed to 75% (them) /25% (me) co-ownership situation. I put a small downpayment in and took a private loan (for the 25% ownership) from them that I'm paying back w/ interest and somehow we structured it to count as income for them produced by this same property... I don't recall all the details around that.

A couple questions/scenarios to confirm:

1) They are wanting to pass the property on and have encouraged us to look for another place - they would like to transfer their ownership to us, which I assume means gifting. In this case, would the gift of their ownership (mixture of 1031 funds and other) be able to be counted towards both the annual and lifetime gift tax exemptions for them so that they wouldn't be taxed on any of it? 

2) Assuming the first part is OK, and since this presumably counts as our primary residence per section 121 ($500k of home gain exclusions for married couples), when we go to sell (and then buy a new home that's either the same value of the sale proceeds or more), will we have a full exclusion on the capital gains from the sale?

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Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
7y

@Jeremy Lee, the more twists you give this to end up at the same beginning scenario the more it looks like a step transaction - The IRS's favorite.

If your parents can consider their ownership to be investment then they own an investment property that happens to be 75% of an entire property.  You own a primary residence that happens to be 25% of an entire property all as tenants in common.

If that is the case then you could sell the property and your % would fall into the primary residence exclusion.  And their part would be eligible for a 1031 as investment property. They could 1031 into another investment property again with you as a tenant in common.  And then over the next few years use annual gift limits and one times to transfer their % to you.  Or just leave the ownership and when they pass your would get their interests at a step up in basis so the deferred tax goes away.

The key goes back to the beginning.  Have your parents treated their % like an investment.  And would you qualify for the primary residence exclusion on your %.

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  • Christopher Smith
    Investor · brentwood, CA · Member since 2016 · 1k+ posts · 730 votes
    7y

    When would you sell?

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  • Jeremy Lee
    OP
    Laguna Niguel, CA · Member since 2017 · 125 posts · 7 votes
    7y
    Originally posted by @Christopher Smith:

    When would you sell?

    Likely towards the end of this year or sometime in 2020. I believe my parents would also need to "gift" it to us before we sell, as well? 

    0Reply
  • Christopher Smith
    Investor · brentwood, CA · Member since 2016 · 1k+ posts · 730 votes
    7y

    Just thinking out loud, wonder if you would need to bifurcate your interest in the property for testing purposes under 121.

    0Reply
  • Jeremy Lee
    OP
    Laguna Niguel, CA · Member since 2017 · 125 posts · 7 votes
    7y
    Originally posted by @Christopher Smith:

    Just thinking out loud, wonder if you would need to bifurcate your interest in the property for testing purposes under 121.

     Thanks - unfamiliar with "bifurcation" but what exactly does that mean or what implications does it have?

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  • Christopher Smith
    Investor · brentwood, CA · Member since 2016 · 1k+ posts · 730 votes
    7y

    It just means that post gift you would have for tax purposes one interest (the original 25% share), then a second separate interest (the subsequent 75% gifted share) and each share might need to be tested separately under the 121 rules (e.g., holding period, etc.).

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  • Jeremy Lee
    OP
    Laguna Niguel, CA · Member since 2017 · 125 posts · 7 votes
    7y

    Ah, so the 75% gifted share may still be considered "income-generating" property for whatever the holding period is determined to be? How and when would a gifted portion of income-generating property change to "primary residence" though?

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  • Christopher Smith
    Investor · brentwood, CA · Member since 2016 · 1k+ posts · 730 votes
    7y

    I would say the gifted portion might be treated as your primary residence beginning with the date of the gift, so you might need to qualify that portion under the 121 rules (in addition to the original portion that presumably already qualifies). That might mean you could dispose of the property in total only after that gifted element has aged sufficiently to get 121 benefits for the entire sale price. Just to be conservative.

    Just a guess, you should confirm with a competent practioner.

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  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    7y

    @Jeremy Lee, I don't think the 1031 is going to affect you.  It will affect your parents.  But when they gift it to you you're going to have to meet the use and ownership tests if you want to take advantage of sec 121.  Sounds like you've met the use tests for the entirety.  But You haven't met the ownership tests.  So I'm thinking you'd need to stay there until you could meet those.  Where are all our tired CPA brethren out there.  Even my own Turbo Andy is getting tired and cranky as he heads to the wire.  

    You may wan to put a hold on this question for a couple of weeks.

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  • Jeremy Lee
    OP
    Laguna Niguel, CA · Member since 2017 · 125 posts · 7 votes
    7y
    Originally posted by @Christopher Smith:

    I would say the gifted portion might be treated as your primary residence beginning with the date of the gift, so you might need to qualify that portion under the 121 rules (in addition to the original portion that presumably already qualifies). That might mean you could dispose of the property in total only after that gifted element has aged sufficiently to get 121 benefits for the entire sale price. Just to be conservative.

    Just a guess, you should confirm with a competent practioner.


    Originally posted by @Dave Foster:

    @Jeremy Lee, I don't think the 1031 is going to affect you. It will affect your parents. But when they gift it to you you're going to have to meet the use and ownership tests if you want to take advantage of sec 121. Sounds like you've met the use tests for the entirety. But You haven't met the ownership tests. So I'm thinking you'd need to stay there until you could meet those. Where are all our tired CPA brethren out there. Even my own Turbo Andy is getting tired and cranky as he heads to the wire.

    You may wan to put a hold on this question for a couple of weeks.

    Thanks guys - good points... So it may not work out as planned. 

    What if I were to relinquish (gift) my portion ownership to my parents, then they 1031 the entire thing into another property and gift it back to us after X years? 

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  • Christopher Smith
    Investor · brentwood, CA · Member since 2016 · 1k+ posts · 730 votes
    7y

    To be more direct I think what we are suggesting is let the parents gift you what ever you don't currently own, sit on it for 2 years (or whatever it requires for 121 benefits that will cover the entire merged ownership interests), then sell and claim full exemption.

    Just as an aside, if the amounts at issue are significant enough, you could also "consider" submitting to the Service a Private Letter Ruling request. If they accepted your ruling request then you would at least have certainty. They might agree with this treatment and they might not - your risk.

    Only you can decide to make a ruling request with the assistance of sound professional guidance which this is NOT. If a ruling request is a viable option (and assuming this is an area the Service will rule on), you would need to pay a fee for the Ruling and professional fees to draft the request.

    Remember this is all merely conjecture on my part, all of this needs to be fully reviewed by a competent practioner before you decide to do anything. 

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  • Jeremy Lee
    OP
    Laguna Niguel, CA · Member since 2017 · 125 posts · 7 votes
    7y
    Originally posted by @Christopher Smith:

    To be more direct I think what we are suggesting is let the parents gift you what ever you don't currently own, sit on it for 2 years (or whatever it requires for 121 benefits that will cover the entire merged ownership interests), then sell and claim full exemption.

    Just as an aside, if the amounts at issue are significant enough, you could also "consider" submitting to the Service a Private Letter Ruling request. If they accepted your ruling request then you would at least have certainty. They might agree with this treatment and they might not - your risk.

    Only you can decide to make a ruling request with the assistance of sound professional guidance which this is NOT. If a ruling request is a viable option (and assuming this is an area the Service will rule on), you would need to pay a fee for the Ruling and professional fees to draft the request.

    Remember this is all merely conjecture on my part, all of this needs to be fully reviewed by a competent practioner before you decide to do anything. 

    Thanks, we are considering moving *before* 2 years for one major reason: possibly getting our kid enrolled in a dual-immersion program at a specific school district when he first enters Kindergarten (which would be next year 2020).

    Anyway, the appreciation on the current place actually wouldn't be all that significant relatively speaking. I calculated capital gains taxes to be somewhere in the ballpark of $8k - by no means is that a *small* amount but it's not significantly huge either. So I guess the other option would be to suck it up and pay the $8k at the end of the day and if we need to move before 2 years. But as I had mentioned initially, preferably it would be great to avoid the taxation all together. 

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  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    7y

    @Jeremy Lee, the more twists you give this to end up at the same beginning scenario the more it looks like a step transaction - The IRS's favorite.

    If your parents can consider their ownership to be investment then they own an investment property that happens to be 75% of an entire property.  You own a primary residence that happens to be 25% of an entire property all as tenants in common.

    If that is the case then you could sell the property and your % would fall into the primary residence exclusion.  And their part would be eligible for a 1031 as investment property. They could 1031 into another investment property again with you as a tenant in common.  And then over the next few years use annual gift limits and one times to transfer their % to you.  Or just leave the ownership and when they pass your would get their interests at a step up in basis so the deferred tax goes away.

    The key goes back to the beginning.  Have your parents treated their % like an investment.  And would you qualify for the primary residence exclusion on your %.

    The 1031 Investor5137 Reviews
    WebsiteView Page
    2Reply
  • Jeremy Lee
    OP
    Laguna Niguel, CA · Member since 2017 · 125 posts · 7 votes
    7y
    Originally posted by @Dave Foster:

    @Jeremy Lee, the more twists you give this to end up at the same beginning scenario the more it looks like a step transaction - The IRS's favorite.

    If your parents can consider their ownership to be investment then they own an investment property that happens to be 75% of an entire property.  You own a primary residence that happens to be 25% of an entire property all as tenants in common.

    If that is the case then you could sell the property and your % would fall into the primary residence exclusion.  And their part would be eligible for a 1031 as investment property. They could 1031 into another investment property again with you as a tenant in common.  And then over the next few years use annual gift limits and one times to transfer their % to you.  Or just leave the ownership and when they pass your would get their interests at a step up in basis so the deferred tax goes away.

    The key goes back to the beginning.  Have your parents treated their % like an investment.  And would you qualify for the primary residence exclusion on your %.

    Thanks Dave! So are you suggesting that they could do another 1031 exchange of their portion into another property and that I would sell my portion ownership and apply it towards that same property where we are TIC (same as current situation)? In doing so they would maintain their ownership in the property as being "investment" (and thus tax deferred) while it would still be considered primary residence for myself and thus qualifying for the home gain exclusion per section 121?

    Sort of a 'rinse and repeat' scenario in terms of what we did originally with the current condo? I believe my dad is reporting everything as income (thus as an "investment"), and we have certainly lived here for at least 2 years.

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  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    7y

    @Jeremy Lee exactamundo.  If that's the scenario then you are absolutely great rinse and repeat clients.  What a country!!!  You'll just want to pay attention to the % and values associated so they take title to as much as they sell.

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  • Jeremy Lee
    OP
    Laguna Niguel, CA · Member since 2017 · 125 posts · 7 votes
    7y
    Originally posted by @Dave Foster:

    @Jeremy Lee exactamundo.  If that's the scenario then you are absolutely great rinse and repeat clients.  What a country!!!  You'll just want to pay attention to the % and values associated so they take title to as much as they sell.

     Thanks! And so it sounds like if we wanted to continue with the "buy more of their ownership plus whatever interest is charged" concept we are currently running with,  and it would continue to qualify as "investment" for them since they are generating the interest. Then they could just use the annual gift exemption, as I think you suggested, to gift us back as an 'indirect' means to slowly gift us the ownership.

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  • Joe SplitrockPro Member
    Moderator
    Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes
    7y

    @Jeremy Lee is your parents portion an investment? What I mean is are you paying fair market rent to them? Are they receiving checks from you and depositing in their account? Are they claiming that income and claiming 75% of property expenses on their taxes? I am asking because it almost sounds like this property is personal use and not rental property. 

    0Reply
  • Jeremy Lee
    OP
    Laguna Niguel, CA · Member since 2017 · 125 posts · 7 votes
    7y

    I believe so but not sure regarding "fair market rent" - if I'm considered a co-owner would "fair market rent" still apply? In this case, I've taken a private loan from them for 25% ownership of the place and am paying them back monthly + interest for it... would that still be considered an "investment" on their part particularly since they are receiving interest on it? For property taxes, I think in the past couple years my dad has asked me to pay property taxes but years prior he was primarily paying. Will that cause issues?

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  • Jeremy Lee
    OP
    Laguna Niguel, CA · Member since 2017 · 125 posts · 7 votes
    7y

    Quick update: I asked a friend who specialized in commercial real estate, and she thinks what most here are thinking as well in that if they gifted the property to us, we would have to sit on it for at least another 2 years before selling if we wanted to avoid capital gains.

    I'm also checking and inquiring with my CPA as well as an enrolled agent on this as well. Just wanted to see if anyone else has thoughts on the matter in the meantime. 

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  • Jeremy Lee
    OP
    Laguna Niguel, CA · Member since 2017 · 125 posts · 7 votes
    7y

    The EA Just got back to me after looking into it... Beyond the ownership/use qualification issue, there could also be potential issues with recaptured depreciation as well as the gain incurred not only from the date we bought the current property but all the gain that would have been incurred from the date my parents purchased the original property they 1031ed (which they purchased for $121k). So hypothetically, even if we did qualify for use and ownership, if we were to sell at an estimated $600k we would be fast-approaching the $500k exclusion limit. 

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