Any problem with it?

[Questionguy101]

Taxpayer and his parents co-own a rental property. Taxpayer owns 5% of the property and parents owns 95%. Parents have been taking all the rental income and paying for all the rental expenses ever since they purchased the property. So parents have also reported 100% of the rental income and expenses in their tax returns through the years and the taxpayer did not report anything.

They are not trying to shift income because parents have higher tax bracket so pay more tax on the net rental income.

Any problem with it?

[joanmcq]

well, it's really a partnership the way you describe it. Why are they doing it this way? Simplicity?

[Gary2]

Did the taxpayer pay a fair 5% for the 5% interest? Is taxpayer listed on any mortgages or insurance policies? Did all of the owners sign any leases? Is taxpayer actually paying 0% of the costs or 5% of the costs? Is the taxpayer getting any of the income, and if so, is the amount under the annual gift limits (i.e., $26,000 currently, since I'm assuming there are two parents). Or was this done merely to get taxpayer's name onto the title to allow for administration in place of the parents? (I'm also inclined to ask whether it's titled as tenants in common or as joint tenants, but to be honest, I don't know whether that would affect the answer.)

Ordinarily, a simple rental with co-owners doesn't necessarily create a partnership if everything is in proportion to their share of ownership. But Joan raises a good point in this case. I'm not sure if the shifting of income so that it's not proportional to ownership interests necessarily creates a partnership, but it's definitely something to consider. There's probably nothing wrong with this sort of arrangement - except for the requirement to file partnership returns, and keep careful records for basis and gift/estate tax purposes. I'm assuming that there are no losses, so the passive loss rules aren't an issue.

Also, the mere fact that parents are in a higher tax bracket doesn't necessarily mean there's a higher net tax liability among all parties. The taxpayer could, for example, qualify for higher EITC or other credits based on lower income.

[Kram BergGold]

Court case

Once I saw a case about a situation like this. The Court ruled the 5% owner has to report his share. At the very least, the 95% owner can't claim the 5% owners depreciation (you can't depreciate what you do not own). I would say the following:
If before depreciation there is a loss the expenses in excess of income go to whoever paid them. If there is a profit each person gets their share (if all goes to one person it is a taxable gift). Then depreciation is claimed by each person, 95% by one and 5% to the other.

[FEDUKE404]

The question is...

I'm with Joan.

WHY such an arrangement in the first place????

Perhaps seeing the deed, property tax bills, and mortgage details might clear up the picture.

Or is there a creative attorney looking for an end run around an estate tax scenario?

Inquiring minds would like to know!

FE

[Questionguy101]

Did the taxpayer pay a fair 5% for the 5% interest? Is taxpayer listed on any mortgages or insurance policies? Did all of the owners sign any leases? Is taxpayer actually paying 0% of the costs or 5% of the costs? Is the taxpayer getting any of the income, and if so, is the amount under the annual gift limits (i.e., $26,000 currently, since I'm assuming there are two parents). Or was this done merely to get taxpayer's name onto the title to allow for administration in place of the parents? (I'm also inclined to ask whether it's titled as tenants in common or as joint tenants, but to be honest, I don't know whether that would affect the answer.)

Ordinarily, a simple rental with co-owners doesn't necessarily create a partnership if everything is in proportion to their share of ownership. But Joan raises a good point in this case. I'm not sure if the shifting of income so that it's not proportional to ownership interests necessarily creates a partnership, but it's definitely something to consider. There's probably nothing wrong with this sort of arrangement - except for the requirement to file partnership returns, and keep careful records for basis and gift/estate tax purposes. I'm assuming that there are no losses, so the passive loss rules aren't an issue.

Also, the mere fact that parents are in a higher tax bracket doesn't necessarily mean there's a higher net tax liability among all parties. The taxpayer could, for example, qualify for higher EITC or other credits based on lower income.

Did the taxpayer pay a fair 5% for the 5% interest?

No, the parents paid for all the down payment.

Is taxpayer actually paying 0% of the costs or 5% of the costs?

Yes. the taxpayer (the son) paid 0% while the parents paid everything.

Is the taxpayer getting any of the income, and if so, is the amount under the annual gift limits (i.e., $26,000 currently, since I'm assuming there are two parents).

No, the taxpayer (the son) didn't get any income at all.

Or was this done merely to get taxpayer's name onto the title to allow for administration in place of the parents? (I'm also inclined to ask whether it's titled as tenants in common or as joint tenants, but to be honest, I don't know whether that would affect the answer.)

It might be the case but I don't believe anyone can confirm it. The parents have already passed away.

Do the above answers make a difference in the determination?

Thank you for the input of everyone.

[Gary2]

Here are a couple of issues: We know that there are cases where the owners of record don't match the owners for tax purposes (e.g. the "beneficial owner" cases where the taxpayers couldn't qualify for a mortgage, or implied life estates where local law recognizes the life estate without it being on the deed). So one question is whether this is real ownership, given that the taxpayer may not have participated in any of the incidents of ownership.

Another question is whether it's a real partnership. The taxpayer probably had no expectation of current income, and it's conceivable that the circumstances meant that the taxpayer couldn't even expect to profit from appreciation in property values.

But now I'm wondering if this is simply a mental exercise or something worth pursuing. You could proceed treating the taxpayer as a real 5% owner, with penalties for the unfiled 1065s (probably owed jointly and severably by all the owners, possibly waivable) and possibly corrections to the depreciation (owed by the estate, I think). Or you could involve a lawyer to determine whether this 5% ownership wasn't a true ownership under state law.

Keep in mind that your obligation is to your client, and to any return you prepare. You don't have to prepare prior year returns, and if they're not needed to properly proceed the current returns, you can go ahead without them. I think there's little doubt that the taxpayer is entitled to a stepped up basis for at least 95% of the property (unless it's the 2010 special case).

Also keep in mind that I'm just thinking out loud precisely because it's an interesting exercise. Everything above is idle speculation on my part, not tax advice (so the usual 230 disclaimer goes double or triple).

[appelman]

Look at the 1065 instructions.

Shared ownership of rental property does not in itself constitute a partnership.

[Gary2]

Shared ownership of rental property does not in itself constitute a partnership.

It's not that simple, because the income and expenses aren't being allocated in proportion to the ownership. This is one of those areas where you have to look beyond the wording in the publications (which, after all, are not considered authoritative). You may still be right, but I wouldn't rely on either Pub. 541 or the 1065 instructions for this.

[Burke]

Or was this done merely to get taxpayer's name onto the title to allow for administration in place of the parents?
It might be the case but I don't believe anyone can confirm it. The parents have already passed away.
Do the above answers make a difference in the determination?
Thank you for the input of everyone.

Well, now I am confused. Why is this even an issue if the parents have passed away? Did the son inherit the property? Or is their 95% now in the estate where it needs to be accounted for on behalf of other heirs? Did they both die at the same time? Or did one spouse's share pass to the other spouse at the first death?

[Questionguy101]

Well, now I am confused. Why is this even an issue if the parents have passed away? Did the son inherit the property? Or is their 95% now in the estate where it needs to be accounted for on behalf of other heirs? Did they both die at the same time? Or did one spouse's share pass to the other spouse at the first death?

Well, even though the parents have passed away, I think the past returns (at least some of them in recent years) have to be amended. The son wants to correct the mistake as much as possible too.

[Gary2]

Well, even though the parents have passed away, I think the past returns (at least some of them in recent years) have to be amended. The son wants to correct the mistake as much as possible too.

Do you think it's going to make any significant difference in taxes due? Remember that there's may be nothing wrong with the parents keeping and claiming all the income; I'm unsure about the depreciation. So it's possible that the only mistake is the failure to file 1065s. It's also possible that Appleman's view is the correct one, i.e. no real partnership, even with the disproportionate income distribution.

Frankly, I'd suggest trying to consult with someone local to you who has more experience in dealing with implied partnerships. Perhaps a business attorney who also does tax representation, or a CPA or EA that does a fair bit of representation for businesses (as opposed to mere preparation). Get permission to share info, if necessary, so that any opinion you get is fully informed. The recommendation may be to fix or to leave it alone; I wouldn't be surprised either way.