Based on the info provided, I agree with Phil that the transfer would be a gift. As Phil alluded to in his initial response, other fact patterns could lead to different conclusions.And I'd add that it's quite possible to change those facts today - at least assuming that it's still a few years until Junior has paid enough money.Junior and Senior could talk to a CPA about how to do this best to minimize taxes - and they have a couple of options that I can see.1> Keep on renting house to Junior, and in N years gift it to him.2> sell the house to Junior now with an installment loan held by Senior. Senior can sell it for less than the current fair-market value, but that portion would be a gift.2a> sell it for current fair market value (dead of sale, etc), but gift $13K worth of the interest and principle to Junior each year. (or potentially $26k - Mr. Senior and Mrs. Senior each gifting Junior $13K)Why $13k each year? Go read up on gift tax limit.If Senior is sure he won't use up his lifetime gift tax exemption of $1M, and is OK with filling out a gift tax form to show how much over $13K he gave, then that's an option too - using up some of the exemption... But I'd probably go with $26K/year and avoid the extra paperwork if Junior was willing to go with it.3> talk to a lawyer about what would be required to have the sale dated as of some previous date - whether you can simply put into writing the verbal agreement that had been reached and date it as of the date of that agreement. Of course as of the date of sale, the tax treatment changes, so if it was during 2011 then Senior *AND* Junior need to redo their taxes for 2011.BTW: I'd *guess* that when it is sold and Senior is carrying the note, that if the note is recorded (like all mortgages should be) Junior gets to claim the mortgage interest deduction. Even if Senior gifts him the $ to pay it. (OTOH, I think it's income for Senior, even if he gifts Junior the money to pay it)And when the note is written, they'll have to make sure that the interest is more than what the minimum interest would have to be - they'd have to use this table to make sure it's more: http://www.irs.gov/taxpros/lists/0,,id=98042,00.html(And I don't know how to read that table - but the CPA should be able to use it to give advice on making sure the interest rate is above the minimum required)BTW: to the OP: Good luck telling Senior that he needs to get this squared away.
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