How to swap ownership with a sibling?

Question

Hi I own two properties of roughly equal value with my sibling. Each of us own 50% / 50% of each property. What's the best way to swap ownership so that in the end each of us own 100% of one of the propertys? Is there a better way than 1031 exchange because we are siblings? Are they any tax consequences? Thank you!

Account Closed · Answer

To start you want to get appraisals for the two properties. You have to be able to document value to the IRS if that ever becomes an issue. You order a title report for each property. You have a lawyer or escrow company prepare deeds that properly transfer 1/2 ownership off of one and onto the other in each direction, so each of you ends up with 100% ownership of only one property. That gets recorded. This assumes the properties are free and clear, no liens, no set backs and no easements you can't live with. You notify the insurance company to change insurance. Some counties have a transfer tax and you have to see if there is an exception for intra-family transfers. If there is financing on the property(ies) you could be in violation of the Due on Sale clause and should seek local legal advice.

There is a simpler way that may or may not suit your future needs: Get comps of the properties from a real estate agent and file quit claims deeds. You still need to change insurance. It's possible sometime in the future, an heir or an interested party could cloud title over a "fraudulent transfer" but that's rare. If an owner is within 5 years of receiving medicare, medicare may have a clawback. There are these obscure items to be aware of so talk to an attorney before getting too wild.

Dave Foster · Answer

@Calvin L., To swap deeds and complete a 1031 you do not have to use a qualified intermediary if your accountant is comfortable with the situation.  But because this is between related parties it will be fraught with peril from the IRS who will assume it was done to swap basis in an inappropriate way.

Using a QI to set it up with property 1031 documentation will create a more professional optic and if your accountant is very meticulous in the documentation and reporting of the 1031s you might be OK.  But if audited it would be questionable.

The regular course of gifting is a sure thing.

Frank Chin · Answer

@Calvin Lo

Yes, you can do gifting.

Some years back, in our family's estate planning, we transferred ownership of properties, and used an estate attorney to do so. You can use "gifting", where there is an annual limit and a lifetime limit where you can do it tax free. For a property or two, among family, in your situation, it's simpler than a 1031.

The annual gifting limit is currently $15K per person per year, and the lifetime limit is over $11 million. My attorney, being a bit conservative, have us use the annual limit to transfer properties gift tax free. Being married, we can transfer $30K/year gift free to someone else, so if I want to transfer a property worth $90K gift tax free, he'll create a note, and have $30K forgiven each year, and it's done over a 3 year period. For efficiency, he create the note to be executed on Dec 30 of year one, forgiven right away, another third on Jan 1, two days later, and then the remaining third the following year. There is imputed interest required, If it's too much trouble, do it in one shot and use the lifetime limit.

We had the properties appraised to make it legitimate. When we hired appraisers, we discussed the purpose, and they asked whether we want a high appraisal (for loans) or a low one (for gifting).

Finally, there are some reporting requirements for gifting, and as I mentioned imputed interest if there are notes. Other than that, it's pretty simple.

Frank Chin · Answer

It's difficult to answer your questions because we don't know all the details. What is the equity of the properties, how many, how much they appreciated, whether the siblings are married or not, so that you can double your gifting. These are issues that go into estate planning.

It's true that when we did it years ago, when the lifetime limit was even lower, our attorney did it so that the lifetime limit was not used at all, using only our annual limits. Compared to a 1031, the parts that's gifted will in the future have a higher basis, mitigated by the gifting, thus saving you a bundle in future capital gains. With 1031's the basis is carried over. Back then we were able to transfer ownership of a duplex that's owned for a dozen years, half the property with equity of $60K for the half, via a note for that amount, forgiven over 3 years, but actually a little over a year with 3 installments dating the note for Dec 30 for the 1st installment as I described earlier. When we did it, the annual personal limit was $10K/person, $20K per couple.

I don't know what your total portfolio looks like, but when my mother in law passed, she transferred a number of properties to 3 children of hers, all using the annual limits, and the lifetime limit was never used. And the time to prepare and execute the paperwork is only a matter of months, though you can have notes that runs over a few years.

Now I'm talking about doing things by the book. There's an audit done some years back where they found people simply quit claiming among relatives, transferring properties and not filing the required tax forms. But that's a whole another story. At least their looking into it.

Currently, the lifetime limit will stay at $11.8 million per person, sunsetting in 2026, and may revert back to $3.5 million. But even if you used only $4 million of the lifetime limit, you can reduce the capital gains by several million is you sell the properties in your lifetime because of the higher basis. If you hold on to it till you pass, the lifetime limit becomes irrelevant, it passes with the stepped up basis on death.

Just to add I'm not an attorney but went through these issues when my parents and in laws in their latter tears till they passed.

Calvin L. · Answer

Thank you Account Closed

Frank Chin · Answer

There's only three major methods of transferring title on real estate, namely via sale, gifting or 1031 exchange. Each method are used in different situations, and subject to different methods of taxation. Sale of real estate are subject to capital gains, gifting subject to gift tax regulations, and 1031 subject to maintaining records of transfer of tax basis from one property to another as well as QI's to handle transfer of funds. I don't know of "another way to do something similar".

Properties held in LLC was not mentioned by OP, but not an issue in any of the methods mentioned and only needs owners of can easily quit claim out of the LLC if needed.

Each of these methods include careful document preparation by attorneys conforming to requirement of the laws. If not by sale, 1031, or gifting, I never heard of another way to transfer title. As @Dave Foster mentioned, swapping between siblings could be done either via gifting or by 1031 via simultaneous exchange without a QI. In the case of gifting, property gifted is appraised and valued at current value with gains, though through annual gift limits, lifetime gift limits when used mitigates the affects of taxes. And many people doing quit claim transfers are ignorant of gains involved, assumes none exists, and don't file tax forms required.

I've seen transfer of title situations in estate situations, and most are handled via gifting. Mutual gifting is the best solution in OP's case.

Bob E. · Answer

It seems like you should not have to do gifting.  Neither one of you has a gain in this.  Seems like you should be able to dissolve the LLC and distribute the assets based on value.  If not held in an LLC there should be a way to do something similar.  Talk to a tax person, since there is not gain thee should be a way to do this.

How to swap ownership with a sibling?

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