When it\ncomes to transactions between family members, the tax laws are frequently\noverlooked, if not outright trampled upon. The following are three commonly\nencountered situations and the tax ramifications associated with each.<\/p>\n\n\n\n
Renting to\nA Relative<\/strong> \u2013 When a taxpayer rents a home to a relative for long-term use as\na principal residence, the rental\u2019s tax treatment depends upon whether the\nproperty is rented at fair rental value (the rental value of comparable\nproperties in the area) or at less than the fair rental value.<\/p>\n\n\n\n Rented at\nFair Rental Value<\/em> \u2013 If the home is rented to the relative at a fair rental value, it\nis treated as an ordinary rental reported on Schedule E, and losses are\nallowed, subject to the normal passive loss limitations.<\/p>\n\n\n\n Rented at\nLess Than Fair Rental Value<\/em> \u2013 When a home is rented at less than\nthe fair rental value, it is treated as being used personally by the owner; the\nexpenses associated with the home are not deductible, and no depreciation is\nallowed. The result is that all of the rental income is fully taxable and\nreported as \u201cother income\u201d on the 1040. If the taxpayer were able to itemize\ntheir deductions, the property taxes on the home would be deductible, subject\nto the $10,000 cap on state and local taxes effective starting with 2018. The\ntaxpayer might also be able to deduct the interest on the rental home by\ntreating the home as their second home, up to the debt limits on a first and\nsecond home.<\/p>\n\n\n\n Possible\nGift Tax Issue<\/em> \u2013 There also could be a gift tax issue, depending if the\ndifference between the fair rental value and the rent actually charged to the\ntenant-relative exceeds the annual gift tax exemption, which is $15,000 for\n2018. If the home has more than one occupant, the amount of the difference\nwould be prorated to each occupant, so unless there was a large difference\n($15,000 per occupant, in 2018) between the fair rental value and actual rent,\nor other gifting was also involved, a gift tax return probably wouldn\u2019t be\nneeded in most cases.<\/p>\n\n\n\n Below-Market\nLoans<\/strong> \u2013 It is not uncommon to encounter situations where there are loans\nbetween family members, with no interest being charged or the interest rate\nbeing below market rates.<\/p>\n\n\n\n A\nbelow-market loan is generally a gift or demand loan where the interest rate is\nless than the applicable federal rate (AFR). The tax code defines the term\n\u201cgift loan\u201d as any below-market loan where the forgoing of interest is in the\nnature of a gift, while a \u201cdemand loan\u201d is any loan that is payable in full at\nany time, at the lender\u2019s demand. The AFR is established by the Treasury\nDepartment and posted monthly. As an example, the AFR rates for October 2018\nwere:<\/p>\n\n\n\n Generally,\nfor income tax purposes:<\/p>\n\n\n\n Borrower<\/em> \u2013 Is\ntreated as paying interest at the AFR rate in effect when the loan was made.\nThe interest is deductible for tax purposes if it otherwise qualifies. However,\nif the loan amount is $100,000 or less, the amount of the forgone interest\ndeduction cannot exceed the borrower\u2019s net investment income for the year.<\/p>\n\n\n\n Lender<\/em> \u2013 Is\ntreated as gifting to the borrower the amount of the interest between the\ninterest actually paid, if any, and the AFR rate. Both the interest actually\npaid and the forgone interest are treated as investment interest income.<\/p>\n\n\n\n Exception<\/em> \u2013 The\nbelow-market loan rules do not apply to gift loans directly between individuals\nif the loan amount is $10,000 or less. This exception does not apply to any\ngift loan directly attributable to the purchase or carrying of income-producing\nproperty.<\/p>\n\n\n\n Parent\nTransferring A Home\u2019s Title to A Child<\/strong> \u2013 When an individual passes away,\nthe fair market value (FMV) of all their assets is tallied up. If the value\nexceeds the lifetime estate tax exemption ($11,180,000 in 2018; about half that\namount in 2017), then an estate tax return must be filed, which is rarely the\ncase, given the generous amount of the exclusion. Because the FMV is used in\ndetermining the estate\u2019s value, that same FMV, rather than the decedent\u2019s\nbasis, is the basis assigned to the decedent\u2019s property that is inherited by\nthe beneficiaries. The basis is the value from which gain or loss is measured,\nand if the date-of-death value is higher than the decedent\u2019s basis was, this is\noften referred to as a step-up in basis.<\/p>\n\n\n\n If an individual\ngifts an asset to another person, the recipient generally receives it at the\ndonor\u2019s basis (no step-up in basis).<\/p>\n\n\n\n So, it is\ngenerally better for tax purposes to inherit an asset than to receive it as a\ngift.<\/p>\n\n\n\n Example:<\/em><\/strong> A\nparent owns a home worth (FMV) $350,000 that was originally purchased for\n$75,000. If the parent gifts the home to the child and the child sells the home\nfor $350,000, the child will have a taxable gain of $275,000 ($350,000 \u2212\n$75,000). However, if the child inherits the home, the child\u2019s basis is the FMV\nat the date of the parent\u2019s death. So in this case, if the date-of-death FMV is\n$350,000 and if the home is sold for $350,000, there will be no taxable gain.<\/em><\/p>\n\n\n\n This brings\nus to the issue at hand. A frequently encountered problem is when an elderly\nparent signs the title of his or her home over to a child or other beneficiary\nand continues to reside in the home. Tax law specifies that an individual who\ntransfers a title and retains the right to live in a home for their lifetime\nhas established a de facto life estate. As such, when the individual dies, the\nhome\u2019s value is included in the decedent\u2019s estate, and no gift tax return is\napplicable. As a result, the beneficiary\u2019s basis would be the FMV at the date\nof the decedent\u2019s death.<\/p>\n\n\n\n On the\nother hand, if the elderly parent does not continue to reside in the home after\ntransferring the title, no life estate has been established, and as discussed\nearlier, the transfer becomes a gift, and the child\u2019s (gift recipient\u2019s) basis\nwould be the parent\u2019s basis in the home at the date of the gift. In addition,\nif the child were to sell the home, the home gain exclusion would not apply\nunless the child moves into the home and meets the two-out-of-five-years use\nand ownership tests.<\/p>\n\n\n\n Another\nfrequently encountered situation is when the parent simply adds the child\u2019s\nname to the title, while retaining a partial interest. If the home is\nsubsequently sold, the parent, provided they met the two-out-of-five-years use\nand ownership rules, would be able to exclude $250,000 ($500,000 if the parent\nis married and filing a joint return) of his, her or their portion of the gain.\nA gift tax return would be required for the year the child\u2019s name was included\non the title, and the child\u2019s basis would be the portion of the parent\u2019s\nadjusted basis transferred to the child. As mentioned previously, the child\nwould not be able to use the home gain exclusion unless the child occupied and\nowned the home for two of the five years preceding the sale.<\/p>\n\n\n\n These are\nonly three examples of the tax complications that can occur in family\ntransactions. I highly recommended that you contact this office before\ncompleting any family financial transaction. It is better to structure a\ntransaction within the parameters of tax law in the first place than have to\nsuffer unexpected consequences afterwards.<\/p>\n\n\n\n If you have any questions, please post them directly\non this blog<\/strong>!<\/strong><\/p>\n","protected":false},"excerpt":{"rendered":" When it comes to transactions between family members, the tax laws are frequently overlooked, if not outright trampled upon. The following are three commonly encountered situations and the tax ramifications associated with each. Renting to A Relative \u2013 When a taxpayer rents a home to a relative for long-term use as a principal residence, the rental\u2019s […]<\/p>\n","protected":false},"author":4,"featured_media":6768,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"_et_pb_use_builder":"","_et_pb_old_content":"","_et_gb_content_width":"","_monsterinsights_skip_tracking":false,"_monsterinsights_sitenote_active":false,"_monsterinsights_sitenote_note":"","_monsterinsights_sitenote_category":0,"footnotes":"","_links_to":"","_links_to_target":""},"categories":[25,28,24],"tags":[35,20],"class_list":["post-6767","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-fatca","category-fbar","category-us-tax-return-1040-1040nr","tag-35","tag-irs-2"],"acf":[],"_links":{"self":[{"href":"https:\/\/ustaxconsultants.es\/es\/wp-json\/wp\/v2\/posts\/6767","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/ustaxconsultants.es\/es\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/ustaxconsultants.es\/es\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/ustaxconsultants.es\/es\/wp-json\/wp\/v2\/users\/4"}],"replies":[{"embeddable":true,"href":"https:\/\/ustaxconsultants.es\/es\/wp-json\/wp\/v2\/comments?post=6767"}],"version-history":[{"count":0,"href":"https:\/\/ustaxconsultants.es\/es\/wp-json\/wp\/v2\/posts\/6767\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/ustaxconsultants.es\/es\/wp-json\/wp\/v2\/media\/6768"}],"wp:attachment":[{"href":"https:\/\/ustaxconsultants.es\/es\/wp-json\/wp\/v2\/media?parent=6767"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/ustaxconsultants.es\/es\/wp-json\/wp\/v2\/categories?post=6767"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/ustaxconsultants.es\/es\/wp-json\/wp\/v2\/tags?post=6767"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}\n Term\n <\/td> \n AFR\n (Annual) Oct. 2018\n <\/td><\/tr> \n 3 years\n or less\n <\/td> \n 2.55%\n <\/td><\/tr> \n Over 3\n years but not over 9 years\n <\/td> \n 2.83%\n <\/td><\/tr> \n Over 9\n years\n <\/td> \n 2.99%\n <\/td><\/tr><\/tbody><\/table>\n\n\n\n