Selling rental to children for 1031 exchange

1031 Exchanges
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Selling rental to children for 1031 exchange

Derwin VillanuevaPro Member
Rental Property Investor · HI · Member since 2018 · 19 posts · 3 votes

Aloha BP'rs,

My wife and I have our son and his family in our rental, which he wants to stay in, and we want to do a 1031 exchange into higher performing assets. The home here on O'ahu has a FMV of about $900k~, a $405k mortgage @5.3%. They had the rent covered up until our oldest son that shared rent, his brother, passed away in August. They have never owned a home. He wants to stay in the house and we, of course as doting parents, do not want to sell to him at the market rate. We are thinking to sell it to them at $650k.

What ideas/considerations do any of you with your collective base recommend to make this happen? Are there better alternatives to conduct the 1031?

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Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
7y

@Derwin Villanueva, As far as the 1031 goes its fairly well accepted that you can sell to a related party as long as you both keep your properties for at least two years.  However the IRS will still be on the lookout for basis shifting.  And selling to them for a discount might feel an awful lot like that.  I'd like some CPA folks to chime in here.  

I get that you're wanting to help your children.  And the partial gifting ideas from everyone are great.  You could also simply hang on to that property and rent it to them at just enough to cover the mortgage.  Then when you pass it could go to them but at a stepped up basis so the tax and depreciation recapture over all the years would disappear for them.  That's truly a magnificent gift.

In any event if your accountants weren't worried about the gift/basis shifting issue then you would be selling an asset for $650K and after paying off the note in the sale you would have around $250K in cash.  So you're requirements then for the 1031 would be to purchase at least $650K of real estate using the $250K in cash (plus whatever cash/mortgage you chose).

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  • Jaysen Medhurst
    Rental Property Investor · Greenwich, CT · Member since 2015 · 4k+ posts · 2k+ votes
    7y

    @Derwin Villanueva, I'm curious to hear from some of the 1031 experts and CPAs on BP. My understanding is that by selling to your son at a discount you expose him to a tax liability. Namely the difference between the FMV and the $650k discount price is a "gift" and would be subject to gift tax.

    I think there are probably better strategies for this. I'm sure there is a lot of emotion and attachment to the property, but is it really worth foregoing ~$250k? Personally, I'd rather use tax-advantaged instruments to transition that money over time, 529s for example. Assuming your son's family is 4 people, you could transition that amount in just a couple of years. I believe gifts are capped at $15k/person/year, so you and your wife could each gift $60k/year.

    *I'm not a CPA*

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  • Clayton MobleyPro Member
    Birmingham, AL · Member since 2014 · 875 posts · 947 votes
    7y

    @Derwin Villanueva I will defer to @Dave Foster here, but my understanding is that there are stricter rules with regard to 1031 exchanges involving a 'related party' (which would include your children).

    Fairly certain the primary stipulation is that both you and the receiving party (your son) hold the property for at least 2 years. So if you've owned it for more than 2 years, and you sell to your son, he needs to them keep the property for at least 2 years as well.

    http://www.exeter1031.com/1031_exchange_related_pa...

    As for the selling below market value aspect, I'll let Dave weigh in on that. It sounds like something the IRS wouldn't be keen on, but I don't know the specifics.

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  • Clayton MobleyPro Member
    Birmingham, AL · Member since 2014 · 875 posts · 947 votes
    7y

    @Jaysen Medhurst makes a very good point re: the tax liability transferred to your son. If you sell at $650k but it's worth $900k, he's already got a tax basis way below his (eventual) sales value, unless the market takes a serious dip before he sells... 

    Interested to see what CPAs have to say about the gifting aspect as well.

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  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    7y

    @Derwin Villanueva, As far as the 1031 goes its fairly well accepted that you can sell to a related party as long as you both keep your properties for at least two years.  However the IRS will still be on the lookout for basis shifting.  And selling to them for a discount might feel an awful lot like that.  I'd like some CPA folks to chime in here.  

    I get that you're wanting to help your children.  And the partial gifting ideas from everyone are great.  You could also simply hang on to that property and rent it to them at just enough to cover the mortgage.  Then when you pass it could go to them but at a stepped up basis so the tax and depreciation recapture over all the years would disappear for them.  That's truly a magnificent gift.

    In any event if your accountants weren't worried about the gift/basis shifting issue then you would be selling an asset for $650K and after paying off the note in the sale you would have around $250K in cash.  So you're requirements then for the 1031 would be to purchase at least $650K of real estate using the $250K in cash (plus whatever cash/mortgage you chose).

    The 1031 Investor5137 Reviews
    WebsiteView Page
    2Reply
  • Duc Ong
    Real Estate Agent · Honolulu, HI · Member since 2015 · 450 posts · 196 votes
    7y

    @Derwin Villanueva

    I agree with @Dave Foster in that you should continue to rent it to him, so that when he inherits it, it will be at the stepped up basis. If you need the liquidity, you could take a HELOC or refinance. There are some nice intro rates for HELOCs still from local banks and credit unions.

    1Reply
  • Derwin VillanuevaPro Member
    OP
    Rental Property Investor · HI · Member since 2018 · 19 posts · 3 votes
    7y

    @Clayton Mobley, @Jaysen Medhurst, @Duc Ong, @Dave Foster Thanks for your insight and wisdom and gentlemen. I most certainly am the better for it.

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  • Daniel DietzPro Member
    Rental Property Investor · Reedsburg, WI · Member since 2011 · 1k+ posts · 857 votes
    7y

    I just wanted to chime in that 'gifts about 15K are subject to Gift Tax'. To my knowledge, that is NOT accurate. From my experience, the amount ABOVE 15K is RE-PORTABLE as Gift Tax, but it is only for 'tacking purposes' in regards to the Lift Time Exclusion that is now in the area of about 10 million per person. 

    In the example that I am familiar with, it was a 50K gift, that 15K is exempt from reporting, and then the remaining 35K is reports and comes off of the 10M exclusion. So now there is only 9,965,000 left of gifting room on the Life Time limit :-)

    Dan Dietz

    [email protected]608-524-4899
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