House deeded to son than sold for huge profit

[BOB W]

I remember reading the the son paid off the parents' existing mortgage on the property that was transferred and sold AT CLOSING??????????

[jainen]

after the tax preparer

>>can anyone doubt that this was a real gift of substance and not just a charade?<<

As an objective outsider, I honestly think the transfer was a sham. The gift was of sales proceeds, not of the property. The sale was arranged while they still owned the property. It was the sale, not the transfer, that gave the parents the economic benefit of reducing debt and improving cash flow. The transfer had no economic purpose other than tax avoidance, which they admit.

The risks of being wrong are high. It is not actually revenue neutral to the IRS, because potential penalties and interest assessed against the parents could exceed 100% of the tax. And every so often some district director decides it's time to make the big career move by cracking down on some defenseless cheat.

If it is ruled to not be a bona fide gift of property, then it was a fraudulent conveyance. You are looking at substantial underpayment, late payment, fraudulent failure to pay, underpayment of estimated tax, and interest for a year or two. And IRS could extort an agreement to all this by threatening criminal charges for the willful attempt to evade. Even conspiracy.

Maybe that's unlikely, I don't know. But if it does happen, both the IRS and the client will then go after the tax preparer.

[erchess]

I see Jainen's point

Where I live, if I decide today to sell my car today I can perhaps complete the sale today by taking it to a dealer. Unless I am very challenged in salesmanship, I can get more money within a couple of weeks by selling the car to its next driver. However, many people do not choose to do the work involved, and I suspect that if this case had involved a car instead of a house there would be less surprise that the son sold it on the first day that it was his.

On the other hand, my parents' house has at least three currently valid firm offers from developers for the house and the 45 acres on which it sits. My parents could contact any of these developers today but I know that they would not officially complete the sale today or receive money today. Despite the fact that I know this, I was reading the post thinking that there was nothing unusual about someone making the decision to sell a house and actually selling it on the same day. This is one of those cases where a tax professional cannot operate without an understanding of economic reality. We would all be skeptical if a client claimed that he had sold five hundred shares of Berkshire Hathoway at a loss to his neighbor, who had given him cash.

I would still like for Jainen to indicate the smallest period of time that the Son could have held the house without arousing Jainen's suspicions that it was a sham transaction. I do hear what Snaggs is saying about their not being a firm answer that we can count on the IRS agreeing with. The line between tax avoidance and tax evasion or even fraud is not always beyond dispute and unfortunately the consequences for us and our clients can be severe if there is even a suggestion from the IRS that we and our clients have crossed that line.

[jainen]

they need something

>>indicate the smallest period of time that the Son could have held the house without arousing Jainen's suspicions<<

It's nice to have two years, which is used many places in the code to overcome problems with related-party transactions. But time is only one of many elements in separating the gift from the sale.

Instead of telling people, "The reason they did it in the first place is so they wouldn't have to pay tax in Maine," they could have sent the son a birthday card saying, we don't want you to have to worry about your retirement. They could have sent their brother a letter saying, we finally got free of all the hassel in being a landlord. They could have added a codicel to their will, identifying the lifetime gift in lieu of a bequest. They could have recorded the transfer at the county assessor's office and submitted whatever is needed for reassessment. They could have closed out their mortgage. They could have filed a gift tax return with a value based on a separate appraisal rather than the sales price.

The son could have renegotiated the leases and opened a new bank account to receive rent and pay taxes, insurance, and maintenance. He could have inked the listing and sales contracts himself instead of just getting them assigned on the day of closing. He could have obtained his own financing, carefully tracking the use of the loan funds. He could have documented the ongoing use of the sales proceeds as well to prove that he didn't rebate anything to his parents. He could have placed the property in his living trust.

I'm not saying they should have done any of these things. Many would not be appropriate for their situation. But they need SOMETHING.

[OldJack]

>>As an objective outsider, I honestly think the transfer was a sham.<<

I have to agree 100% with Jainen. You can twist this case around all you like but the facts still make it an intentional attempt at tax evasion.

[Snaggletooth]

Obvious, yes. Without substance, no.

The stars are aligned against me. When Old Jack and Jainen are tag-team partners, you can usually put money on them.

Was this obvious? Certainly! Was it revenue-neutral for the IRS? Probably not. The son had to take capital gains, and the parents may-or-may-not have to pay estate tax rates on the value of the gift at some point in the future.

What is the difference between this and someone who just-as-obviously gives appreciated stock to a charity and avoids capital gains? Why, then, is this perfectly legal and acceptable?

Is there substance to the transaction? The parents no longer have the land, they no longer have the proceeds, they no longer have ANYTHING associated with the transaction. Why are they obligated to sell the land first and then give their son the proceeds?

[jainen]

get up this early

>>Why are they obligated to sell the land first and then give their son the proceeds?<<

They are not so obligated. As I explained in my horribly early post this morning, they could have given him the property and then he could have sold it. But that isn't what happened. They sold the property using his name, and bragged about how they were beating the system.

What's the difference between this and the charity contribution? The tax code, that's what.

As for Old Jack agreeing me with, I can't explain it. I try as hard as I can to develop unsupportable positions. Frankly, this is embarassing and I might have to go back and edit everything I said. Not just here, either. He did the same thing to me on the "other" board too. Just plain weird. I'm not going to get up this early any more.

[George Boutwell]

I Know Nothing About Many Things

I think what is missing here is whether the "step transaction" "substance over form" arguments have any application when the transaction is revenue neutral for federal taxes.

For all we know, the son paid higher taxes to IRS than his parents would have. Or were they trying to avoid the 25% tax on depreciation recapture? Can you do that with a gift? I would have to look it up. Did the parents qualify for a Section 121 exclusion? We know they moved out in 2004 and sold in 2006, but we don't know if the "3 out of 5" rule was met. The parents might have shot themselves in the foot. I just don't know.

If the federal treasury collects the same amount of tax from the son as it would from the parents, does IRS have a dog in the fight? I would think not. So then it becomes a question of Maine tax law, a subject on which I know nothing. What if it turned out that Maine Revised Statutes Title 43 Section 1408 provides that parents can make gifts of appreciated property to their out-of-state kids, who can then immediately sell without state tax consequences? I just don't know.

[OldJack]

Was this obvious? Certainly! Was it revenue-neutral for the IRS? Probably not. The son had to take capital gains, and the parents may-or-may-not have to pay estate tax rates on the value of the gift at some point in the future.

Probably not obvious as the parents clearly didn't want to pay state tax (tax is due) and probably thought that as a gift the son would not have to pay federal tax, or at least much less than they knew they would have to pay. Also, I'll bet the parents didn't want the asset or money as they are looking to qualify for Medicaid paying for some health care.

Truth is this thing stinks even if treated as a gift. As to Jainen's finally recognizing valid tax concepts that I can agree with... well I can't explain it. If he is going to continue like this I will lose interest in this board.

[Dervis]

State tax

Probably not obvious as the parents clearly didn't want to pay state tax (tax is due) and probably thought that as a gift the son would not have to pay federal tax, or at least much less than they knew they would have to pay.

I'm curious why Maine would tax the sale of property in Florida. Usually the state where the property is located taxes the income (of course no personal income tax in Fla.), not the state of residence. I haven't done a Maine return, so don't know their rules. Are there other states that would tax this gain?

[Lion]

Worldwide Income

CT taxes the worldwide income of its residents. It does give a credit for taxes paid to another jurisdiction (no more than the CT tax would've been), but that wouldn't come into play with a state like FL with no personal income tax. So, CT would've taxed the parents, starting with their federal AGI, if any profits from the sale of their FL home appeared on their federal return. Now, if all profits had been excluded under 121, then....

[jainen]

valid tax concepts

>>As to Jainen's finally recognizing valid tax concepts that I can agree with... <<

Hold it right there, Old Jack! On the "other" board I said you should throw your computer out the window, write down any old number you want, and then fudge the rest to make it fit. Yeah, and even with that you agreed -- you called it "the only way."

Of course, we were talking about 1031 exchanges and I have to admit Form 8824 does require a certain level of extra attention. But still, I take personal offense at having my good name in the same sentence with "valid tax concepts."