Parents give rental property to son. Son mortgages it, buys home. Help please.

[sandigi]

Parents Quit claim deed rental property to son. Son took mortgage on rental property then used funds towards purchase of his home. I know I have to file Form 709, could you please look over my calculations and see if I'm thinking right or if I'm wa? I have questions on the interest deduction and also the Schedule E reporting.

Here is the financial trail:

· 01/11/16 Mom & Dad gave rental property to son via a Quit Claim Deed for $10 consideration. Parents did not have a mortgage on it.
· Fair Market value per property appraiser on 01/01/16 was $139,834.
· Parent's basis as of 01/11/16 was $134,962

· 08/12/16 Son took out a mortgage on the rental property $118,600

· 11/10/16 Son bought his first home for $295,000
· Home mortgage amount is $245,000

Interest expense question:
Is the interest on the rental even deductible? The mortgage is secured by the rental property and the funds were used to buy his home. Am I looking at this right? Below is a summary I did when i was thinking I had to trace the funds:

Rental Property cost $ 10
Home cost $295,000
total property $295,010

Mortgages:
Rental $118,600
Home $245,000
Total mortgages $363,600


Mortgages less Property = 363,600-295,010 =68,590
Where's the money?
08/12 closing cost $12,002
11/19 closing cash from borrower $57,508
Total $69,510

I'm sure you can tell by my post that I'm so confused and will appreciate any help offered!! Son says he isn't getting the income on the rental property but since parents have no rights to it any more, doesn't son have to report the income and expenses from 1/11/16 forward? And his basis for depreciation is same as parent at time of transfer?

[sandigi]

does depreciation start over year 1?

Parents depreciated the residential rental for 8 years. Does son start over year 1 of 27.5 years?

[taxea]

His basis in the rental is not 10. it is the parents basis at time of gift.

[spanel]

I'm sure you can tell by my post that I'm so confused and will appreciate any help offered!! Son says he isn't getting the income on the rental property but since parents have no rights to it any more, doesn't son have to report the income and expenses from 1/11/16 forward?


Yes. It is his income/expense (assuming he is paying for the insurance/house payment/taxes/etc.

He is gifting the rental income if he doesn't keep it. Might have to file a 709 for him each year/parents if they are paying for said expenses.

Chris

[Kram BergGold]

Mortgage Interest

The mortgage interest is not deductible. Money borrowed against a rental property would only give rise to a interest deduction if the proceeds were used to improve the rental property or could be traced to a business or investment property. You can't trace interest to a personal residence.

[sandigi]

Thanks taxea

His basis in the rental is not 10. it is the parents basis at time of gift.

Thank you for the reply. I understand in this case his basis is $134,962. What about recovery period? Does son start over in year 1 on the depreciation schedules?

· 01/11/16 Mom & Dad gave rental property to son via a Quit Claim Deed for $10 consideration. Parents did not have a mortgage on it.
· Fair Market value per property appraiser on 01/01/16 was $139,834.
· Parent's basis as of 01/11/16 was $134,962

[sandigi]

That's what I thought!

The mortgage interest is not deductible. Money borrowed against a rental property would only give rise to a interest deduction if the proceeds were used to improve the rental property or could be traced to a business or investment property. You can't trace interest to a personal residence.

Thank you, Kram. That is what I found out when I looked into the rules, but thought I might be missing something.

[sandigi]

Thank you Chris

I'm sure you can tell by my post that I'm so confused and will appreciate any help offered!! Son says he isn't getting the income on the rental property but since parents have no rights to it any more, doesn't son have to report the income and expenses from 1/11/16 forward?


Yes. It is his income/expense (assuming he is paying for the insurance/house payment/taxes/etc.

He is gifting the rental income if he doesn't keep it. Might have to file a 709 for him each year/parents if they are paying for said expenses.

Chris

Yes, the son is paying the mortgage payments PITI. Parents gave him the rental property they owned free and clear.

[TaxGuyBill]

Parents depreciated the residential rental for 8 years. Does son start over year 1 of 27.5 years?

Yes. You said the "Parent's basis as of 01/11/16 was $134,962". That is the Adjusted Basis (after depreciation), right? If so, that is what you use for the son's depreciation.

Although not used for the son's depreciation, you need to keep track of the prior depreciation (from the parents) because that may still be factored in when the property is sold.

[Roland Slugg]

These people ... parents and son ... certainly could have benefited from some good tax planning and advice before they did all this.

The son's basis in the rental property may not be the same as his parents' basis. His basis for determining loss on its eventual sale is the lower of their basis or the property's FMV at the time of the gift. (Code §1015(a)) Unless it is abundantly clear that the property's FMV on the date gifted was higher than the parents' basis on that date, he should get an appraisal.

If the son wants to be able to deduct the interest on the $245k he borrowed by buy his own residence, he had better take steps right away to have that loan secured by his new residence and not the rental property.

When he says he's not getting the rental income, does he mean his parents are getting it? Or does he simply mean that there is negative cash flow? If it's the former, maybe there was no gift in the first place.

[Burke]

You say the parents have no rights to the rental income. Are you sure? They could have put a life estate clause in the deed when it was gifted, in order to preserve those rights. Then it is another situation as to treatment of gifting and eventual sale of the property. Even if such clause was not put in writing, it would be implied (courts have held this to be a legitimate life estate) if they are receiving all the income. Roland may be right that it would be treated as an incomplete gift. No 709.

[sandigi]

I hadn't thought about that

Yes. You said the "Parent's basis as of 01/11/16 was $134,962". That is the Adjusted Basis (after depreciation), right? If so, that is what you use for the son's depreciation.

Although not used for the son's depreciation, you need to keep track of the prior depreciation (from the parents) because that may still be factored in when the property is sold.

Yes, TaxGuyBill, the Parent's basis after depreciation is what I used for son's starting basis. Began the duplex on 27.5 year schedule.

I hadn't thought about the parent's depreciation possibly being recaptured when son sells. Thank you!