Sec 121 - Gifting Issue

[trevor1991]

I am located in CALIFORNIA. Scenario is below and pertains to a family friend.

This adult friend has lived in a home owned by his parents for the last 8 years. His parents gifted 1% of the home to him back in 2010 when they moved out and even had it recorded. He has lived there since as his primary residence. His parents (who own 99%) have decided they would like to sell the home.

The parents apparently are going to gift the son an extremely large sum after the home sells, but they want to their son to maximize his 121 deduction. The plan is to gift an additional 49% in interest before they sell the home so that the son can take the full $250,000 deduction because he satisfies all the requirements of 121 (use and ownership)

He approached me because he's concerned that the IRS might view this additional gifted interest as "shady" or that it might disallow him to use 121 at all. Any thoughts on this? I can't seem to find anything on Sec 121 issues relating to limited interest transfers....Wouldn't the ownership requirement "reset" once he is gifted the additional 49%?

Would love it if someone can help me with some case law or a revenue ruling on this. Cannot find anything...

 

[xylene]

People pondering EXTREMELY LARGE gifts should get all parties involved in a sit down.

This sounds convoluted. How much could the gains on 1% of the house in 8 years be?

 

[Taxing Matters]

Would love it if someone can help me with some case law or a revenue ruling on this. Cannot find anything...

If they make a gift of 49% of the property to him and then promptly sell the property he'll only be able to exclude from income the gain on the 1% interest that he has held for the last 8-9 years. He would recognize all the gain he realizes on the 49%. Under IRC §121 he must own the interest in the home that he is selling for at least two of the five years immediately preceding the date of the sale. Since the home is sold promptly after he receives the additional 49% that additional 49% interest does not qualify for the gain exclusion under § 121.

 

[Taxing Matters]

This sounds convoluted. How much could the gains on 1% of the house in 8 years be?

The plan the parents have in mind is trying to shelter gain on the sale of the home by transferring a large part of their interest in it to him with the hope that he'd qualify to exclude the gain on that large interest. They want to do that because either (1) they don't meet the requirements for exclusion of the gain or (2) all of their gain exclusion is used up with the sale of just 50% of the property. Unfortunately for them, their plan will not work to exclude the gain on the 49% that they transfer to the OP unless they are willing to wait two more years after the transfer so that the OP will meet the ownership and use tests for that 49%.

 

[xylene]

The plan the parents have in mind is trying to shelter gain on the sale of the home by transferring a large part of their interest in it to him with the hope that he'd qualify to exclude the gain on that large interest. They want to do that because either (1) they don't meet the requirements for exclusion of the gain or (2) all of their gain exclusion is used up with the sale of just 50% of the property. Unfortunately for them, their plan will not work to exclude the gain on the 49% that they transfer to the OP unless they are willing to wait two more years after the transfer so that the OP will meet the ownership and use tests for that 49%.

While I agree with your analysis, I need to ask if you are privvy to additional info? Maybe the parents aren't concerned about the tax bite on their son? Maybe they are simply ignorant? What is their goal? To minimze their own taxes or the total taxes. To avoid gift tax issues? If they are going to wait, what about property taxes?

This is a 'scenario', by a third party, about a friend allegedly getting a extremely large sum. It's fantasy land.

 

[Taxing Matters]

While I agree with your analysis, I need to ask if you are privvy to additional info?

My statements were based on nothing more than what the OP stated — I did not have any additional info nor was any additional information needed for what I stated. The plan as I stated it was simply a restatement of the plan the OP stated. If the parents qualified to take the exclusion and the exclusion would cover the entire gain from the sale then they'd have no reason to want to do the transaction, so my statement on why they want to do it simply reflects that they'd get hit with a tax bite that they'd rather not have to pay. If they don't qualify for it but the OP's friend would qualify for it with the transfer, then it benefits everyone to do it given the facts stated.

Maybe the parents aren't concerned about the tax bite on their son?

The transaction proposed has nothing to do with helping the son save tax. The only ones would save tax with that transaction (if it had worked) would have been the parents. Since they plan to make the gift anyway, making it early with this transaction to avoid tax certainly would make sense, if it worked. If they are content to wait a few years after the gift before selling, it may indeed save them tax.

Maybe they are simply ignorant?

Well, they certainly are not tax experts or they'd have known the transaction would not work if immediate sale of the property is at hand. If they want to wait a few years after making the gift of the 49% interest in the house, the plan may indeed work.

What is their goal? To minimze their own taxes or the total taxes.

Focusing on the transation they proposed, the goal is saving their own tax. Again, nothing about this is tax saving for the son.

To avoid gift tax issues?

The proposed transaction does nothing to help the parents avoid the gift tax issues.

This is a 'scenario', by a third party, about a friend allegedly getting a extremely large sum. It's fantasy land.

It may not be fantasy land. I suggest that perhaps you do not have experience with how often these kinds of situations arise — where parents with some substantial assets want to make gifts to their kids and are looking for ways to do that which will reduce their taxes. That's what this is about, and as a tax lawyer in practice for many years I've seen that situation many times before, and have had clients ask about doing exactly the kind of thing the OP is asking about.

 

[xylene]

That's what this is about, and as a tax lawyer in practice for many years I've seen that situation many times before, and have had clients ask about doing exactly the kind of thing the OP is asking about.

So, as a tax lawyer, you gave seen third party "friends" involve themselves in financial dealings of people expecting extremely large large gifts?

Who are you even giving advice to here?

 

[xylene]

The transaction proposed has nothing to do with helping the son save tax. The only ones would save tax with that transaction (if it had worked) would have been the parents

Which is stupid as they intend to give him cash as well from the sale proceeds.

 

[Taxing Matters]

So, as a tax lawyer, you gave seen third party "friends" involve themselves in financial dealings of people expecting extremely large large gifts?

No, but I have had clients who were in similar positions of wanting to pass homes on to their kids and who I know did tell their friends about it.