Capital Gain Tax, Lender's "due on sale" and Property Tax

[addson2title]

What is the name of your state? CA

I bought a house long time ago for $450K and now the value has increased to $900K. The Capital Gain would be $450K if I sell the house now or in the near future. I currently have a mortgage balance of $300K in this house. My son and I have been living in the home for much longer than 2 years.

I'm single and can only exclude $250K gain. Then I will have to pay capital gain tax of 450K-250K = 200K. So, I'm looking into an option to avoid the Capital Gain tax by adding my son's name into the Title this year and will sell the house after 2 years (so that my son will meet the ownership test of 2 years). I have these questions:

1. If I add my son name to the title and 2 years later sold the house for 900K, is my capital gain and my son's capital gain would be each (900K-450K)/2 = 225K.

2. Will this method help me to avoid paying capital gain because each of us own half of the house and each can exclude upto 250K capital gain?

3. Will the Mortgage Lender okay when I add my son name to the title as "Joint Tenants with the right of survivorship". In other words, will they require me to pay off or refinance the mortgage based on "due on sale" clause?

4. Will my property tax be increased or stay the same after I add my son to the title?

5. The proceed will be split between me and my son. (900K-300K)/2 = 600K/2 = 300K. But I want to collect all the proceed or at least most of it. Can I record a promissory Notes or Deed of Trust to the house saying he owes me 300K at the time I add his name to the title? And will this create any problem to my plan? I'm afraid that this Deed of trust will be considered as a sell transaction and will trigger the "due on sale" and will also increase my Property Tax.




Thanks,

-V

 

[HRZ]

The capital gains tax is a mere fraction of the 200k gain .

With a son on title it can get pretty rough if needs change and somebody balks about doing x or y or conveying more than 1/2 to you..

Double check with tax counsel if you retain a life estate but to convey TIC or JWROS are you deemed to,have made a current gift of 1/2 fmv ...I don't think so...but you check ...and do the gain math for his share at his basis? Equally important, be sure you don't trigger any CA reassessment .

I think you may be jumping thru a lot of hoops to save less than you imagine

 

[HRZ]

The Ca tax is nearly ( about 13 % ) is nearly as nasty a bite as the Feds .

THe only sure way under current law to get free step up is to wIll it to your son and then die ...which invites a discussion with tax counsel about some rental options .

 

[FlyingRon]

How old is the son? If he's not going to be 18 when you sell, as HRZ alludes, it can be real difficult because a minor can't convey real estate and the parent can't represent the minor's share. You'd need to go to the court and have a guardian appointed.

Garn St. Germain should cover you on adding children to the title as far as prohibitions on due on sale invocation goes. However, there are a number of reasons why you don't want to do this. You do know that such a transfer is irrevocable. Your son is free to do what he wants with his share, including breaking the joint tenancy.

California shouldn't increase the property tax here just because a transfer of a share to your son, though if they could legally had reassessed for other reasons, this may wake them up. Loans, mortgages, and liens have no bearing on the property tax.

 

[HRZ]

OR moving in his new lover!

 

[addson2title]

The Ca tax is nearly ( about 13 % ) is nearly as nasty a bite as the Feds .

THe only sure way under current law to get free step up is to wIll it to your son and then die ...which invites a discussion with tax counsel about some rental options .

Thanks for your opinion HRZ.
The CG (Fed+State) would be around 28%. With 200K gain, the tax would be around 56K. It's not a lot but this is after tax money.

 

[addson2title]

How old is the son? If he's not going to be 18 when you sell, as HRZ alludes, it can be real difficult because a minor can't convey real estate and the parent can't represent the minor's share. You'd need to go to the court and have a guardian appointed.

Garn St. Germain should cover you on adding children to the title as far as prohibitions on due on sale invocation goes. However, there are a number of reasons why you don't want to do this. You do know that such a transfer is irrevocable. Your son is free to do what he wants with his share, including breaking the joint tenancy.

California shouldn't increase the property tax here just because a transfer of a share to your son, though if they could legally had reassessed for other reasons, this may wake them up. Loans, mortgages, and liens have no bearing on the property tax.

Thanks FlyingRon!
I will make sure he will be more than 18 when I sell the house.
If Lender won't call the mortgage, then this is doable plan for me. If the county won't re-assess the property tax, it is a bonus for me. I'm still concern about adding the Promissory Note (or 2nd Deed of Trust) to the property though.

 

[Taxing Matters]

5. The proceed will be split between me and my son. (900K-300K)/2 = 600K/2 = 300K. But I want to collect all the proceed or at least most of it.

This last point is a real problem for you. If you make a gift or sell an interest in the home to your son it has to be a bona fide transaction — which means he gets his half of the proceeds when you sell it later. If you arrange for the deal to be that he ends up giving back his share to you, then that's not a bona fide transaction. Rather, it indicates that the transfer of interest in the house is a sham in order to reduce your tax. If you end up collecting all or most of the proceeds in the end then you were in fact the real owner of the whole house and the IRS would not respect the transfer to your son. Thus, you'd not get the tax benefits you hope for and doing this could result in civil penalties or even criminal prosecution for tax evasion.

So the choice is yours. You can (1) give away half the house to your son and wait two years and sell it, with you each getting half the proceeds (and none coming back to you in any side agreement or transaction) and get the capital gains savings or (2) if you want all the proceeds, keep the title in your name, sell it, and pay the capital gains tax.

Doing (1) means that you end up making a sizable gift to your kid, for which you will file a gift tax return and reduce your lifetime unified credit against gift and estate tax and you end up with only half the sale proceeds. But you'd end up not having the capital gains tax to pay.Your kid gets the other half of the proceeds, which I'm sure would make him very happy. But if you don't want to give all that money to him (at least not yet) and want to keep the proceeds, you do (2).

Note that selling an interest in half the house to your kid doesn't solve the problem because that sale of half the house to your kid also triggers a capital gain for you, so in the end you'd end up paying that tax anyway.

The maximum tax rate on the capital gain is 20%. Thus on a capital gain of $200,000 your federal tax would be at most $40,000 (and might be less depending on your total income). Not fun to have to pay that, but on total proceeds of $900,000 it's not all that bad. Ordinary income tax on that kind of money would be much more.

 

[LdiJ]

This last point is a real problem for you. If you make a gift or sell an interest in the home to your son it has to be a bona fide transaction — which means he gets his half of the proceeds when you sell it later. If you arrange for the deal to be that he ends up giving back his share to you, then that's not a bona fide transaction. Rather, it indicates that the transfer of interest in the house is a sham in order to reduce your tax. If you end up collecting all or most of the proceeds in the end then you were in fact the real owner of the whole house and the IRS would not respect the transfer to your son. Thus, you'd not get the tax benefits you hope for and doing this could result in civil penalties or even criminal prosecution for tax evasion.

So the choice is yours. You can (1) give away half the house to your son and wait two years and sell it, with you each getting half the proceeds (and none coming back to you in any side agreement or transaction) and get the capital gains savings or (2) if you want all the proceeds, keep the title in your name, sell it, and pay the capital gains tax.

Doing (1) means that you end up making a sizable gift to your kid, for which you will file a gift tax return and reduce your lifetime unified credit against gift and estate tax and you end up with only half the sale proceeds. But you'd end up not having the capital gains tax to pay.Your kid gets the other half of the proceeds, which I'm sure would make him very happy. But if you don't want to give all that money to him (at least not yet) and want to keep the proceeds, you do (2).

Note that selling an interest in half the house to your kid doesn't solve the problem because that sale of half the house to your kid also triggers a capital gain for you, so in the end you'd end up paying that tax anyway.

The maximum tax rate on the capital gain is 20%. Thus on a capital gain of $200,000 your federal tax would be at most $40,000 (and might be less depending on your total income). Not fun to have to pay that, but on total proceeds of $900,000 it's not all that bad. Ordinary income tax on that kind of money would be much more.

He is saying that CA also has a 13% capital gains tax and is figuring that into his calculation. The 28% he is mentioning is federal 15% plus state 28%.

 

[addson2title]

Taxing Matters,

Thanks for the detail explanations.

If I choose option (1), what GIFT tax amount do I have to file to the IRS? 900k/2 = 450K or (900k-300k loan)/2 = 300K?

Do I have to pay capital Gain Tax at the time I add my son name to the title?
I thought I do not sell 1/2 of the house. I just gift 1/2 of the house to my son. He and I will get 1/2 of my original Cost Basis and will pay capital gain on our 1/2 when we both sell the house. Am I correct?

Regards,

-V

 

[Taxing Matters]

Taxing Matters,

Thanks for the detail explanations.

If I choose option (1), what GIFT tax amount do I have to file to the IRS? 900k/2 = 450K or (900k-300k loan)/2 = 300K?

Your gift is half the fair market value of the house, or $450,000 if the house is worth $900,000. That gift of $450,000 then reduces you lifetime credit against gift and estate taxes. Until you use up that credit you don't actually pay gift tax.

Do I have to pay capital Gain Tax at the time I add my son name to the title?

You report the gift, along with any other gifts you made to him during the year plus any other taxable gifts you make during the year, on Form 709 which is due April 15 of the following year, like the income tax return.

I thought I do not sell 1/2 of the house. I just gift 1/2 of the house to my son. He and I will get 1/2 of my original Cost Basis and will pay capital gain on our 1/2 when we both sell the house. Am I correct?

If you gift half the house to your son, then he takes that half interest with a basis that is half of the basis you had in it at the time of the gift. When you sell it, you each get half the proceeds and then compute your gain on the half you sold. But again, there will be a problem with that if the deal is that in the end your son is supposed to give the proceeds he got from the sale back to you.

 

[LdiJ]

Taxing Matters,

Thanks for the detail explanations.

If I choose option (1), what GIFT tax amount do I have to file to the IRS? 900k/2 = 450K or (900k-300k loan)/2 = 300K?

Do I have to pay capital Gain Tax at the time I add my son name to the title?
I thought I do not sell 1/2 of the house. I just gift 1/2 of the house to my son. He and I will get 1/2 of my original Cost Basis and will pay capital gain on our 1/2 when we both sell the house. Am I correct?

Regards,

-V

You are not incorrect but its not quite that simple.

Lets say that you pass away before the house is sold and your son inherits the house. In that instance he would get a step up basis to fair market value as of the date of your death, and would be unlikely to pay ANY capital gains tax if he sells the property within a year or two.

However, if you give 1/2 of the house to him then he doesn't get that full stepped up basis and would end up paying unnecessary capital gains tax.

You have already been given the downsides in other scenarios.

 

[addson2title]

He is saying that CA also has a 13% capital gains tax and is figuring that into his calculation. The 28% he is mentioning is federal 15% plus state 28%.

Yes, that is what I calculated.

 

[addson2title]

Your gift is half the fair market value of the house, or $450,000 if the house is worth $900,000. That gift of $450,000 then reduces you lifetime credit against gift and estate taxes. Until you use up that credit you don't actually pay gift tax.

I got it. So I do not need to worry about Gift Tax.

You report the gift, along with any other gifts you made to him during the year plus any other taxable gifts you make during the year, on Form 709 which is due April 15 of the following year, like the income tax return.



If you gift half the house to your son, then he takes that half interest with a basis that is half of the basis you had in it at the time of the gift. When you sell it, you each get half the proceeds and then compute your gain on the half you sold. But again, there will be a problem with that if the deal is that in the end your son is supposed to give the proceeds he got from the sale back to you.

Okay, so I don't have to pay CG tax. I choose option (1) so I will NOT take back his proceeds. I want him to use it to put down for his future house.

 

[Taxing Matters]

Okay, so I don't have to pay CG tax. I choose option (1) so I will NOT take back his proceeds. I want him to use it to put down for his future house.

That you can do. And it will help him get established in his own home, a great way to get him started.