Question. We are retired and have two children older than 21. We have some investment properties we do not want to sell at this time. However, we do not want to continue to be involved in the rental aspect of these properties and would like to know what alternatives we have in solving our problem.
Answer. You could consider hiring your children to be the property managers and pay them a fee for their services. This may relieve some of the property management burden which you are facing. And of course you can always hire a professional property manager to relieve you of the day-to-day operational burdens of ownership.
You might also want to consider gifting a portion of the property each year to each of your children. Under the tax laws, an individual may exclude from the total amount of gift subject to tax the first $14,000 in value of gifts to each donee during a calendar year. For several years, the tax stayed the same, but the IRS recently announced that as of January, 2018, it will be increased to $15,000.
Thus, next year, you and your wife can give gifts of $30,000 ($15,000 each) to each of your children, and then (depending on whether this amount will be increased) another $30,000 to each of your children the following years. And, assuming that Congress does not change these tax laws, this could go on for ever on a yearly basis.
The gift does not have to be in the form of cash. It could also be property or a portion of your property.
Let us assume that you both own one rental property worth $300,000. If my math is correct, a total of $30,000 is the equivalent of 1/10th of the property. You can deed to each of your children 1/10th of the property this year, and then another 1/10th of the property to each child next year — depending on the then-current market value of the property.
Under this approach, by deeding a portion of the property each year to your children, they obtain the tax benefits, if any, on their portion of the property, and they can also collect their proportionate percentage of the rents.
Unfortunately, your children’s basis for tax purposes will be the same as your basis in the property. When a person gives a gift, the tax basis of the giver becomes the tax basis of the receiver. Accordingly, depending on how and what the kids do with the property, they may have tax consequences when they ultimately sell. If you have significantly depreciated the property over the past several years, then your children’s basis will also be significantly reduced. This can be a problem, since when they sell the property, they will have to pay a large capital gains.
However, If they purchased the property from you, their basis would be their cost. But you would have to pay capital gains tax on your profit.
You could, of course, wait until you both die, in which case your children would inherit the property at the stepped-up basis, which is the market value on the date of your death. However, this requires probate proceedings in most cases, which can be complicated, time-consuming and expensive.
In many jurisdictions throughout the United States, if there is a transfer of property between parent and child, the county and state will impose no transfer or recordation tax. All you would have to pay is the nominal fee for actually recording the deed among the Land Records in the county or city where the property is located.
Many people have indicated they would prefer not to transfer the property, but rather just give a gift letter to the children indicating that a portion of the property has been transferred to them.
I cannot recommend this approach, since you have not physically conveyed legal title to your children. The IRS may want to challenge this approach. Thus, in my opinion, it makes greater sense to actually physically convey a portion of the property to your children each and every year, if this is the approach you intend to take.
The advantages are simple. Your children will gradually become the owners of your property, and will be able to take whatever tax benefits may be available for their interest in that property.
However, the disadvantages must also be explored. First, by actually deeding property to your children, you both have no more interest in that portion of the conveyed property.
If, down the road, you face the need for cash, you no longer own that portion of the property, and thus do not have any control over it.
Second, you are giving up your right to a percentage of the rental income stream. This means you are going to receive less cash from the rental property than you were getting while you owned the entire property.
As I have indicated, there are serious and complicated tax issues that must be explored, and thus you should check with your own tax advisor before finalizing any arrangement with your children. You could also consider doing a like-kind (tax-free) exchange, and swap your current rental property for other investment property which will not take as much personal involvement of your time. For example, if you find some rural land which has long-term future appreciation value, you certainly have the right to exchange your current rental property for that land.
But Congress is trying to pass a major tax reform law, and tax-free exchanges may be on the chopping block. So if that’s of interest, talk to your attorney immediately to get the ball rolling.