Lease below fmv

[cpadan]

Retired farmer wants to lease his farm to son-lin-law and daughter at rate below what he has been leasing to 3rd party in past years. He is wondering about tax issues.

The difference here is about $20,000 whcih I believe is a gift which could be offset with the anual exclusions. Are there any other opinions out there?
Thanks
Dan

[jainen]

Change the lease

Change the lease so FMV is 20K less. For example, require road upkeep, retain the right to use part of the property for storage, include restrictions about pesticides or other farming techniques, make the lease period shorter, etc.

Or if it's not a significant difference, just ignore it or call it a poor rental market or something. There some leeway like 20% when rented to a family member, because obviously (well, at least theoretically) the personal relationship will ensure less damage to the property.

[OldJack]

I agree with Jainen there are lots of ways to justify a difference in the rental price and it is much easier to deal with. On the other hand, if the son paid full price he would have a larger farming deduction, less profit, maybe EIC, and the father could gift the money back at Christmas.

[cpadan]

Thanks for your responses Jainen and Jack. They will probably leave the lease agreement the way it is. There should be a comfortable cushion from against a gift tax return since the farm is held jointly and husband and wife could each gift to son-in-law and daughter seperately.

Dan

[jainen]

good advice

>>a comfortable cushion from against a gift tax return<<

That's not the problem. If it is too much below FMV, then their deductions against rental income will be limited. The son might even have taxable income, since the reduced lease is a business matter, not a personal gift. And charging more but then rebating the difference will NOT solve that problem, even if you call it a "gift," because the substance of the transaction is still a below-market lease.

Oh, they will probably get away with it on the theory that such returns are rarely audited, but as far as giving advice, I recommend good advice.

[OldJack]

>> but as far as giving advice, I recommend good advice.<<

Say what????? Oh, of course you recommended good advice from giving good advice.

[cpadan]

Thanks for your second reply Jainen. That is what I was looking for, an issue of unreported income vs gift So what you are saying is that you can gift business property but not the use of business property. I need to research this some more.
Dan

[jainen]

it can bite

>>what you are saying is that you can gift business property but not the use of business property<<

No, that's not what I'm saying. I'm not even sure what it means, but I don't think it is true (not that either of those facts would stop me from saying it!)

First of all, I don't like the idea (often voiced on this forum) that you can pay a little more and then "gift" back the extra. That is a sham transaction. If there is a tax planning problem, why not address it directly?

And there IS a problem here--it's called Section 280A(d)(3). It says renting to a family member is personal use unless FMV is received. At least one court case allowed a 20% discount because the relatives were expected to take extra care of the property. My suggestion is to put that into the lease to strengthen the argument.

In another case, the taxpayers tried to pull off the 20% scheme and failed. Not only was the property considered personal use (no deductions allowed) but they still had to claim all the income! So good advice is to tie down the 20% discount every way possible. Don't mess around with this because it can bite.

[cpadan]

found a court case

>>what you are saying is that you can gift business property but not the use of business property<<

I found a court case that addresses this, ESTATE OF REBECCA A. WINEMAN, filed June 28. 2000, in which the decendent rented her interest in real estate to Coastal Ranches, a corporation owned by her children, at a below-market rate.

The court said "there is no dispute that the below-market rate is a taxable gift under secion 2503."

Jainen I have reviewed Section 280A(d)(3). Even though it is specific to residential property, I can see where it could be applied to this situation. I will address it with the lawyer who contacted me and drafted the lease.

Thanks for your input Jack and Jainen
Dan

[jainen]

there is no dispute

>>there is no dispute that the below-market rate is a taxable gift under secion 2503<<

In Wineman, the kids leased the property for 70% below market value, and paid for it with a cash "gift" from the owner!