Points paid on Rental property

[Bird Legs]

Points were paid on rental property, Home improvement loan. Have been amortizing them
over the life of mortgage, 30 yrs. Client, in Dec. 2004, gives the rent house to daughter
& husband.
Question: what happens to the unamortized points paid on the home improvement loan?
Are they written off? Do they pass on to the daughter & son-in-law?
Or do they just disappear?
Thanks?

[Mark Goldberg]

First a question?

Was the home improvement loan taken out on the rental property to improve the rental property? If not please explain.

[Bird Legs]

Home improvement loan-points

Yes, this loan was taken out to make improvements on the house, which was done before
the hurricane came through. Client wanted to do some remodelling on the house after
it was purchased.

[Mark Goldberg]

Next question

So if your client somehow kept the loan in place after he gave the house away the interest on the loan is no longer deductible. This is because the interest was business interest traced to the rental activity and now it is just a personal loan.
So I would say you can't right off the points either.
Now if the loan was transfered to the children along with the house as part of the gift then they continue amortizing the points until they retire the loan. Upon retiring the loan they claim any unused points as a deduction.
If the taxpayer retired the loan before transfering the property, then he claims any remaining points as a deduction.

[Bird Legs]

Mark-thanks, remaining

answer to your question. The house was quit claimed deeded, by client, to daughter and
husband on Dec. 27, 2004, with the 2 notes, the original note, and the home improvement
loan, remaining in clients name.
In January, 2005, the son in law, daughters husband, refinanced the home in his name, at
the same time retiring the 2 previous notes.
A gift tax return is needing to be filed for 2004 for the gift of house.
A gift tax return, for 2005, is also needing to be filed, for the gift of the $67,000. of
insurance proceeds issued in clients name, but were given to clients daughter, in June, 2005.
This brings up another question. Will the gift of $67,000. in 2005 be reduced by the
amount of the new mortgage? Since my client had debt relief, would this be income to
client, rather than reduction of basis in gift?
Help

[jainen]

too complicated

Trying to get my brain around this, having misread it in the previous thread. House was damaged in September, given to tenants in December, and refinanced in January? I don't think new owners can deduct old points because they didn't pay them, and aren't liable on that loan anyway. Sorry, mother converted to non-rental use prior to payoff so points don't go anywhere. I would include right to receive insurance as part of the December gift. I would still offset the casualty loss by $67K, the "expected" reimbursement so you don't have to report recapture across the gift, too complicated. I would say the loss before insurance was $76K, assuming repairs didn't include upgrades, and attribute all of the speculator's generosity to undamaged land value. (Be sure to tell your clients to only sell high, because calculating gift basis for a loss is too complicated.)

[Mark Goldberg]

the notes

Birdlegs, you say the son in law refinanced and retired the two previous notes which were in your client's name. To me, this says there was a sale componant to this transaction. In 2005 when the client's mortgages were paid off he realized sales proceeds. I think you have to look at this transaction as if it happened in one year rather than two, in order to figure out what % of the property was sold and what was gifted. Then use this to figure out what the 2004 gift tax return should be and the 2005 Form 4797. Hopefully Bees will buzz in here as he is usually very smart about this kind of thing.

[Bird Legs]

Mark-thanks, Have

not considered this to be a sale because of the timing difference between the Quit Claim Deed, in Dec. 2004 and the refinancing in Jan, 2005.
Hopefully, you are correct in that Bees Knees will come in with an idea.

[Bees Knees]

No need for debt relief income. The gift of the house to daughter and husband are contingent on son-in law eventually obtaining his own financing so he can pay off father-in-law’s debt. So the gift in 2004 is the value of the house minus the debt on the house that got paid off a month later, plus the insurance proceeds paid to the father and given to daughter and husband. All three transactions are tied together into one. Intent here is to give the property to the daughter, along with paying off the mortgage and handing over the insurance proceeds. The gift is the net of all three of these, and so the remaining un-amortized points on the home improvement loan are deducted by the father in full in the year the loan is paid off.

[Bird Legs]

Bees Knees-Question

Thank you very much. This was a big help. One other question. The house deeded to daughter and son in law was a rental property, rented to daughter and husband. Depreciation was taken on house and improvements.
If this is treated as a sale to daughter, there will be depreciation recapture, correct?
What else am I overlooking. This is the first time I have had a situation like this.
Also, would the sales price be the balance of the 2 notes refinanced in January, on the house ? Any help is greatly appreciated.

[Bees Knees]

Facts:

Dad owns rental property – $91,569 cost minus $13,425 depreciation = basis of $78,144.

December 27, 2004 – Dad gifts rental house to daughter and her husband.

January 2005 – Daughter and husband reimburse Dad for his mortgages.

June 2005 – $67,000 in insurance proceeds on house paid to Dad but given to daughter.

In a previous post you said FMV before casualty was $125,000, but then it was $150,000 after the casualty.

If FMV went up because of the casualty, then there is no casualty loss deduction.

Dad's gain equals mortgage paid off by Daughter on behalf of Dad minus basis ($78,144). Up to $13,425 of gain is depreciation recapture (25% rate).

Next, the difference between the FMV in January ($150,000) plus the $67,000 insurance proceeds gifted to daughter, minus mortgage paid off for Dad by daughter = Gift.

Daughter and husband’s basis equals cost of mortgage paid off for dad, plus zero basis in excess FMV gift, plus zero basis in $67,000 gift of insurance, plus cost of repairs.

[Bird Legs]

Bees Knees Thanks

ever so much.

[jainen]

Too complicated

Yikes, too complicated.

#1) Casualty loss. There really was $76K loss to building (partly covered by insurance). Yeah, the value of land went up, assuming there was a bona fide offer available, but who can say the property wouldn't have been worth $250K if the home hadn't been damaged?

#2) Gift. That was worth $150K subject to the two liens and a pending insurance settlement, totalling $217K.

#3) Refinance. Just a step transaction in completing the transfer.

#4) Insurance. Previously included in the gift.

#5) Basis. Too complicated.

[Bees Knees]

I agree the FMV of the property should be less after the casualty. But it is possible that a developer would consider the land worth more money when the house is torn down than with it standing. Costs to demolish an unwanted structure are added to the cost of land and cannot be recovered until sold. If the developer has other plans for the property, that could explain the increase in FMV after the casulty.

As to the mortgage being paid off, debt relief is taxable income. You can't avoid paying tax on income by gifting it to someone else. The SBQF has an example on page H-8 of a below market sale where part of the transaction is a sale and the other part is a gift. If you give someone a house but the person receiving the house has to pay off your mortgage, that's not a net gift. It is a below market sale. I don't think you can get away with saying the daughter is gifting the loan proceeds back to the father. I'm sure the father would not have agreed to gift away the rental property if the daughter didn't agree in turn to pay off his mortgage. A gift with strings attached is not a gift to the extent strings are attached.

[Bird Legs]

Bees Knees, you guessed

correctly. The speculators, developers, want the lots to build larger, more expensive,
homes. These lots are right on the coast line. The speculators idea is, hurricanes be
****ed, full speed ahead.
Client said that on Jan 25, 2005, the Martin County tax roll showed a tax appraisal for the property of $206,000.