Tax Avoidance Strategy - 1031 Exchange & Gift It to my Child - Prove Me Wrong

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Tax Avoidance Strategy - 1031 Exchange & Gift It to my Child - Prove Me Wrong

Sam Mathew
Real Estate Investor · Pembroke Pines, FL · Member since 2017 · 80 posts · 34 votes

Please prove this strategy wrong, but I have not been able to.  

I bought an investment home in Charlotte, NC (I live in FL) when my child was born (14 yrs ago) for $124k that is now worth $340k today.  Because I switched it to a 15 year loan, it is almost paid off in 2 more years (I have been paying much more than the minimum mortgage payment as then yearly rents have increased).  I originally bought the house so one day I could pay my child's college tution and costs (rather than invest in a college 529 plan).

She's in 8th grade this year, so by the time she graduates high school in another 5 years, I'm projecting that it will be worth approx $380-400k, more than enough for college.  

I'm might switch my plans now (and thus why requesting if someone or a tax expert can prove me wrong).  I will still need to seek a tax specialist in the future if laws change. Again, I'm in FL, but she may go to a college out of state.  Boston, Chicago, Ann Arbor, Austin, Raleigh.  No idea yet, but she talks about it.  Whichever city/state she picks, even here in Florida, my new plan is now to 1031 exchange to current investment home to a 4 bedroom property whereever she goes to college.  She can live in it and rent the rooms out to pay her college bills.  But if she lives there for at least 3 out of 5 years, than I am planning to gift the house to her.  You can do a lifetime estate gift to your child up to $13.61M as of 2024 (these limits change).  And then later she can sell it and if it was legally her primary home for at least 3 years, then she will receive all the funds tax free, and I pay no gift tax.  A win-win for her and myself, if legally possible with no issue.

So now my orignially "small" downpayment on the original $124k house, litereally will pay for all her college costs and after I gift the house to her, she will likely receive maybe $550-650k (projections of house in year 2030) tax free once she's done with college and sells the property.  

Do you believe this is possible?  I have researched and it seems completely legal and legit to do.  Again, please prove me otherwise.  Thanks.

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David M.
Morris County, NJ · Member since 2020 · 5k+ posts · 2k+ votes
2y

@Sam Mathew

Interesting idea... You don't want to pass it to her on your death so she gets the full step in basis?

I think the issues are it may not be tax free, or it really won't.  For one, the sec121 exclusion is $250k if single or $500k if married for the capital gains.  As it stands now, you say there is grossly/roughly $216k in captal gains.  So, by the time she goes to college you've maxed the sec121.

Secondly, the sec121 doesn't apply to the depreciation recapture.  

As I recall, in a gifting situation, the original cost basis transfers...

N.B.  For long range estate planning, people will gift it over time.  For example, if you and your wife (if you have one) can gift some $15k a year.  So, you two can gift $30k a year to your child.  Over time, you can gift out a portion, or all of the property to her.  Just another way to handle the gifting, and it doesn't use any of your lifetime limit.

Yes, @Dave Foster did this already, but just for himself.  Yes, this is a very unique exit strategy for real estate that enables you to take the capital gains tax free, but not the depreciation.

FYI:  the sec121 exclusion is for living in the property 2 out of 5 years...

I assume you'll be able to cover the cash flow of paying for college first, then selling the property after college as I understand your plan.

Good luck.

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  • Melanie P.Pro Member
    Rental Property Investor · Member since 2023 · 1k+ posts · 922 votes
    2y

    She would owe gift taxes on a gift that large in a single year. The best thing you can do for the taxes on the property is die and let her inherit it. She will receive a stepped up basis to the present day value as of the time of the inheritance. In the meantime you can still 1031 exchange and pay her a salary to do your leases and collect your rents or give her the maximum allowed tax free gift each year - 2023 that is $17k. The tuition you pay for her incurs no tax liability but you don't want to lose the real estate to do that. 

    Important to consider is that if you sell the house after the 1031 exchange you will have to pay all of the depreciation recapture (25%) tax that you avoided in the 1031 plus if you added money to the new property whatever depreciation has occurred there. The lifetime exemption is a combination of the yearly gift exemptions and whatever is left when you die. You can't hit that number and be there to see it.

    2Reply
  • David M.
    Morris County, NJ · Member since 2020 · 5k+ posts · 2k+ votes
    2y

    @Sam Mathew

    Interesting idea... You don't want to pass it to her on your death so she gets the full step in basis?

    I think the issues are it may not be tax free, or it really won't.  For one, the sec121 exclusion is $250k if single or $500k if married for the capital gains.  As it stands now, you say there is grossly/roughly $216k in captal gains.  So, by the time she goes to college you've maxed the sec121.

    Secondly, the sec121 doesn't apply to the depreciation recapture.  

    As I recall, in a gifting situation, the original cost basis transfers...

    N.B.  For long range estate planning, people will gift it over time.  For example, if you and your wife (if you have one) can gift some $15k a year.  So, you two can gift $30k a year to your child.  Over time, you can gift out a portion, or all of the property to her.  Just another way to handle the gifting, and it doesn't use any of your lifetime limit.

    Yes, @Dave Foster did this already, but just for himself.  Yes, this is a very unique exit strategy for real estate that enables you to take the capital gains tax free, but not the depreciation.

    FYI:  the sec121 exclusion is for living in the property 2 out of 5 years...

    I assume you'll be able to cover the cash flow of paying for college first, then selling the property after college as I understand your plan.

    Good luck.

    3Reply
  • John McDonald
    Member since 2023 · 158 posts · 96 votes
    2y

    @Melanie P.

    >  The best thing you can do for the taxes on the property is die and let her inherit it.

    Hahahaha.  I love these forums more every day. 

    1Reply
  • Chris Martin
    Investor · Willow Spring, NC · Member since 2009 · 5k+ posts · 3k+ votes
    2y

    Regarding "She would owe gift taxes on a gift that large in a single year...", I believe the OP will use the form 709 exclusion - see https://www.irs.gov/forms-pubs/about-form-709, the form and instructions. My understanding is that the recipient of a gift is not responsible for the tax, the giver of the gift is. Specifically, the exclusion amount is on Part 2 - Tax Computation (Page 1 of Form 709), Line 7:

    The applicable credit (formerly unified credit) amount is the tentative tax on the applicable exclusion amount. For gifts made in 2023, the applicable exclusion amount equals:

    The basic exclusion amount of $12,920,000...

    1Reply
  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    2y

    @Sam Mathew,

    Kiddie Condo's for college are an awesome way to help pay for college as well as teaching your child real world investing lessons they don't get in the class.  Your plan to 1031 into something she can live in and rent is solid.  I'm with @Melanie P. and @David M.. If you keep that property in your name and when she leaves college sell it and 1031 again into another investment property she can manage while you own it - you'll have the opportunity to keep all of the gain and depreciation deferred.

    And when you die it goes to her tax free.  Depreciation alone on that house will be approaching $100K plus by the time she graduates.   Plus what we found is that going forward it's kind of fun and a unique point of contact and relational growth to invest with our children. The asset may be in our name (although as we buy bigger we put our children on the deed for any amount not needed for a 1031).  A very fun way to connect with your child until you die.  And then a much larger benefit to your heir.

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  • Melanie P.Pro Member
    Rental Property Investor · Member since 2023 · 1k+ posts · 922 votes
    2y
    Quote from @Chris Martin:

    Regarding "She would owe gift taxes on a gift that large in a single year...", I believe the OP will use the form 709 exclusion - see https://www.irs.gov/forms-pubs/about-form-709, the form and instructions. My understanding is that the recipient of a gift is not responsible for the tax, the giver of the gift is. Specifically, the exclusion amount is on Part 2 - Tax Computation (Page 1 of Form 709), Line 7:

    The applicable credit (formerly unified credit) amount is the tentative tax on the applicable exclusion amount. For gifts made in 2023, the applicable exclusion amount equals:

    The basic exclusion amount of $12,920,000...


     I think the instructions are fairly clear:

    All of the gifts made during the calendar year to a donee are fully excluded under the annual exclusion if they are all gifts of present interest and they total $17,000 or less.

    The basic exclusion amount is lifetime - what you can give away under the annual cap each year together with what you leave upon death.

    The IRS keeps its options open: If the donor doesn't pay they can collect the gift tax from the donee.

    I think that addresses all of your concerns.

    1Reply
  • Bill B.
    Investor · Las Vegas, NV · Member since 2013 · 8k+ posts · 10k+ votes
    2y

    A few problems. 

    If you “gift it to her” your cost basis becomes her cost basis. So she’d owe taxes on all the gains. And all the depreciation. 

    I don’t know these people from Adam, but they say if you gift it the receiver has to use it as an investment for at least 2 years. If she does that then she would only get a 60% sec 121 deduction if she rented it out for 2 then lived in it for 3 because  the disqualified use will come before the qualified use. Plus owing the depreciation recapture. 


    Can you gift a 1031 exchange property to a family member?

    Yes, it is possible to gift a 1031 exchange property to a family member. However, there are some requirements you should follow. The property must be transferred to a related party, a lineal descendant or ascendant of the transferor, or a spouse or a former spouse as a result of a divorce. Additionally, the property must be held for investment or use in a trade or business for the related party for at least two years from the date of the transfer.

    https://learn.valur.io/1031-related-party-rule/#:~:text=Yes%....


    wasn’t selling the home to pay for college the plan?  

    you could just as easily 1031 in to a rental that became new primary for yourself and sell your current home to pay for her college skipping the gifting and income shifting  

      lastly, would owning the home or having the rental income mess up an scholarship/grant opportunities?

    1Reply
  • Sam Mathew
    OP
    Real Estate Investor · Pembroke Pines, FL · Member since 2017 · 80 posts · 34 votes
    2y

    @Bill Brandt

    Great thoughts. I never considered selling my primary and taking 1031 investment to become my new primary.

    1Reply
  • Bill B.
    Investor · Las Vegas, NV · Member since 2013 · 8k+ posts · 10k+ votes
    2y

    Same rules, the exchange has to be for a new investment property until it no longer makes sense and THEN you decide to make it a primary home. 

    The big advantage besides getting to choose the property is resetting the disqualified use clock. If it was a rental for 18 years and then your primary for 2. It’s 90% disqualified. Instead you exchange it and rent out for 2 and then live in for 2 it’s 50%. 

    1Reply
  • Chris SeveneyBusiness Member
    Moderator
    Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes
    2y

    @Sam Mathew

    Why not have a living trust where the trust owns the property and she can live in it and be the beneficiary so then it will automatically transfer to her?

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  • David M.
    Morris County, NJ · Member since 2020 · 5k+ posts · 2k+ votes
    2y

    @Melanie P.

    I think you need to do some more research / consultation.

    The annual amounts gifted (<$17k) do NOT go towards the lifetime limit.  If one wants/needs to use the lifetime limit, thats when they file the form to declare.  The uber wealthy do that.  They over and over gift the ~$12mil to trusts.  So, some 100 trusts would move ~$1.2bil.  Yup, these uber wealth generate close to 1000 trusts at once to move their wealth off, and the IRS can't tax any of it on the transfer... (sheesh)

    2Reply
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