Tax implications of sister-in-law on title?

Question

Hi all,

My wife and I are helping her sister to buy a condo so she'll have a place to live when she gets married, which is coming right up. However, she has no established credit, so the loan will go under our names only. We'll get the mortgage on the condo as an investment properly, and she'll pay us rent which will basically cover the mortgage payments (we're putting in the down payment). We're in the process of working out who will get what percentage ownership between us, etc., and that's a question for another day.

My main question is whether or not my sister-in-law should have her name put on the title of the property? Are there any tax advantages for us if her name is on the title from day 1? Does this facilitate one of those 1031 exchanges any easier, or possible at all? Can we somehow avoid or reduce the impact of capital gains taxes made on the future sale of the property?

Any information is greatly appreciated!

Andy in Newark

Bill Exeter · Answer

This is what we refer to as split use property.

First of all, ignoring the complicating factors referred to above, you and your wife would acquire a certain majority percentage of the property and it would be classifed as investment property for you and your wife and you could structure a 1031 exchange upon the sale provide you truly do treat it as investment property.

Your wife's sister (and new husband?) would acquire the remaining percentage as their primary residence. They would qualify for the 121 exclusion ($500,000 tax-free exclusion) for their percentage upon the sale.

You can rent to a related party, but John is right on the money. The IRS could recharacterize the property as a 2nd home and not investment property if you are not careful. You should always charge the related party fair market rent so they can not do so. Charging less than fair market rent could create a problem later under audit, so charge them fair market rent and have them pay you and then you can pay the mortgage to keep it clean.

John is also right in that the lender will probably not permit your wife's sister (and new husband?) to be on title if they are not on the loan documents. You might be able to quit claim them onto title later, but it could trigger a due on sale clause, so be careful. Get the advice of legal counsel before you do so.

Account Closed · Answer

Andy,

Independent of the family motivation this is a messy situation.

1. The title will likely need to show the same folks on the loan when the loan closes. Hence no sister on the title. You could consider putting her on later.

2. The 1031 rules apply to rental property held for investment. Renting to a family member can cause the property to be classified as something other than an investment property.

3. The tax treatment for the property will be an issue unless you can show you are renting at or above the market rent. If she is going to cover the mortgage and that payment is less than the market rent the property is no longer treated as a rental on your tax returns. Think second home in that case.

4. Consider getting legal advice from a tax attorney. A trust might make sense. When the property is sold a rental is subject to capital gains while a primary residence would not. It could be best to wrap the loan you are getting and to sell the property to your sister rather than remain on title as the owner. A land sale contract or a outright sale with a wrap mortgage back to you with the loan you are taking out remaining in place.

5. Your sister it not going to build up credit from the property if she is not paying on a loan that is reporting. Granted it does help a bit if she is on the title.

6. Divorce. Just who gets what if something happens?

7. Interest deduction. As a renter your sister has no deduction. If she is the legal owner then she can deduct the payments made to you as the note holder (see #4 above).

I am not saying to avoid doing the deal. I am saying you need better advice as to what is a real option and the implications.

John Corey

Tax implications of sister-in-law on title?

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