Gift of Rental Property

[geekgirldany]

I've had a client contact me in regards to gifting property to his children.

Client has went to an attorney that handled probate of the will, she told him to go to an accountant on tax matters.
I will still recommend that he and the children go to an estate planning attorney (not sure about his current attorney), I would like to advise them on the tax consequences.
I know everyone is busy and hate to post this now... I greatly appreciate the help.

Client's spouse recently passed. All assets passed to my client. He would like to give the children various property now so he can travel.

Client has principle residence and rental property in one state, vacation home in another state.

It is to my understanding that client can gift the above property to the children in one year. Value of the property would be around 700k to 900K.
There would be a gift tax return that would have to be filed but no gift tax would be owed because of the 5,250,000 exclusion.
Is this correct?

I will warn all parties about basis in the property will be that of the donor.

My concern (among some not tax) is the rental property. My client is currently receiving rental income from the property. Adjusted basis is down to around $180,000.
How would him gifting the rental property to the child be reported as far as Form 1040, Sche E?

Would it be reported as a deemed sale at FMV? Are there related party rules that come in to play?

On the none tax side, I do feel the father should be included on at least one home so if something happened (children get divorced or whatever) he would have a place to live. Again they will have to go to an attorney about that.

[Burke]

If he gifts the rental property, it goes to the child with the father's adj basis. It is not treated as a sale. It depends on what the child does with it. It simply ceases to be rental for the father. If the child wants to continue renting it, it will go on the child's Sche E after the deed transfers and he starts receiving the income. I hope your client gets some advice. It is not prudent to give away all one's property to children. He should at the very least retain a Life Estate.

[TaxGuyBill]

Correct, no gift tax would be due (assuming there hasn't been over $4,500,000 prior gifts).

As you say, an estate attorney is essential. I don't know the legalities, but if it can be set up as an 'imperfect gift' or "retained life estate", then there WILL be a step-up in value at death.

http://www.law.cornell.edu/uscode/text/26/2036

http://taxmama.com/tax-quips/deeded-in-life-or-death/

No, it wouldn't be a sale of the rental property. Just a gift, with no related party rules. I THINK the depreciation would start over for 27.5 years using the current adjusted basis (assuming basis is lower than Fair Market Value). However, I would need to check on that one.

Does the client want to continue to receive the rental income, or is the rental income going to go to the kids? Again, the estate attorney setting up a "retained life estate" could be very important.

[geekgirldany]

Thank you both for responding. I agree that giving it all away is not wise. Spouse just passed away a few months ago and not sure if all of this was discuss prior to her passing. I think some more time needs to pass in making such decisions.

I will look at the links on the retained life estate. I know a little about grantor trusts but do not believe that would fit in this circumstance.

My assumption is that the child will start receiving the rental income... but I will ask.

Now another question, how would the disposition of the rental property be reported on my client's individual tax return? It wasn't sold, so how would it reported?
I know depreciation would have to be recapture section 1250 property. I am thinking this maybe a big tax blow to him.

[TaxGuyBill]

There wouldn't be any effect to take the rental off his return. It's not a sale, so no gain to report of any kind.

The person receiving the gift would also receive the part of the basis due to depreciation, so when the kid sells the property, there will be Unrecaptured Section 1250 gain to report due to the depreciation.

Your software may be different, but in ProSeries you would just 'sell' the rental property for BLANK (NOT $0). That would stop the depreciation on the proper month, but not cause a reportable sale for gain/loss purposes.

[geekgirldany]

Thank you Bill.

It was mentioned about the rent... client says he will still be getting the rental income. So how will that affect his personal tax return?
Will Property still have to be taken off since it will be given to son?

[TaxGuyBill]

That sounds like a classic case of "imperfect gift" or retained life estate.

I think your client would be able to still claim everything on this tax return, because he is "beneficial or equitable owner" because of the imperfect gift/retained life estate. However, that is much more of an argument if audited, and could even go to appeals and/or tax court.

You may want to look at the Tax Court site to look at cases. Be sure to separate your 'keyword' search words with "and". So you may enter something like "beneficial and equitable and rental".

http://ustaxcourt.gov/UstcInOp/asp/HistoricOptions.asp

I can't figure out WHY your client wants to gift all of this away "so he can travel". It seems weird to me.

Would he be willing to ADD the children to the rental house title, and keep himself on it, while still maintaining the imperfect gift/retained life estate? From a tax audit perceptive, it seems less messy that way.

You need to emphasize to the client the importance of going to an estate attorney, to make sure the transfer does qualify as a retained life estate so his children get the 'step up' in basis at death.

[geekgirldany]

Thank you again Bill.

I will do some research on the tax court website.

I agree that putting all the property into the children's names are not wise. I appreciate the information and will make sure he knows.... and he consults a estate planning lawyer.