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The Honolulu Advertiser
Posted on: Thursday, March 2, 2006

Property profits make great gifts

By Greg Wiles
Advertiser Columnist

Q. I sold my house worth $700,000 to one of my children for $200,000 and would like to give the money to my oldest child. Will he be taxed? Will I be taxed for the profit I earned?

A. The simple answers are no and no. But be aware that other factors could complicate the answer such as whether the property has been used as a rental.

What you're doing is giving gifts to your children. The homeowner is buying two-sevenths of the home and receiving a gift of the remaining five-sevenths.

The other child is getting a gift of $200,000. Both of them aren't required to file anything, said Judith Sterling of the Honolulu-based estate planning firm Sterling & Tucker.

There is something called a gift tax return (Form 709) and you'll have to file that. You usually don't have to file this if your annual gifts to someone are under $12,000. As is the case so often with taxes, there are exceptions to this tuition payments for someone, gifts to charities and political organizations are excluded.

To be certain about this, check with a tax expert or look at IRS Publication 950 on estate and gift taxes.

Even though you have to file the gift return you probably don't have to pay taxes because there's a credit that excludes the first $1 million from the tax, Sterling said. You are giving away $700,000. If you gave away more than $300,000 before this, you may owe something.

As for paying tax on profit on the sale of your home, here again it appears you are free and clear. Generally you can exclude the first $250,000 from the gain on the sale of your home, Sterling said.

As much as the gifts mean to your family, you should know it could have implications in the future. Sterling said it can come back to haunt you if you have to go into a nursing home later and have no way to pay for it. You probably won't qualify for state Medicaid assistance because you gave the $700,000 away, she said.

Q. I'm selling an investment property in Virginia and am thinking about doing a 1031 exchange. What happens if I choose to do this and can't find another property to do the exchange?

A. You'd have to pay the capital gains taxes. Furthermore, you probably are out the $625 or more it can cost for an exchange accommodator, title company or attorney to set up an account and handle the paperwork.

"It's just as if the transaction had never happened," said Jon Anderton of Exchange Accommodators of Princeville, Kaua'i. "She'd have to pay the capital gains."

He said you may be able to negotiate your exchange accommodation account and paperwork costs depending on your situation. Some firms, such as his, might take a portion of the payment initially and charge the balance when a replacement property is found.

Generally, a 1031 exchange allows people to escape capital gains taxes if they buy another property similar in price and use to the property they're selling.

The seller also can defer taxes while trying to find a replacement property. They've got 45 days to identify a property they may buy. If they are having a difficult time making up their mind between properties, they can file a list of those under consideration.

But they must buy one of these and complete the purchase within 180 days after their property sale closed, Anderton said.

Q. I am retired and receive rental income. I report this on the federal income tax form Schedule C. Can income from this be considered as earned income for purposes of opening a Roth IRA?

A. First things first. You may be using the wrong form to report rental income, which can't be used to fund an IRA. As with most questions dealing with taxes, you should check with a tax adviser to make certain this applies to your situation.

Usually rental income goes on Schedule E, the bottom line of which can't be used for IRAs, said Michelle Tucker of the estate planning firm Sterling & Tucker.

Unless there is some reason why your tax adviser says you should be using a Schedule C (for profit and losses from businesses), you need to look elsewhere for IRA funding money.

The Roth IRA differs from traditional IRAs in that it is uses income after taxes have been deducted. The advantage is that the investments grow tax free and withdrawals after age 59 1/2 can be made without incurring taxes.

How much you can contribute varies depending on your age and how much you make. Within this is something that probably applies to you: The government restricts contributions to IRAs from income earned passively, i.e. dividends, pensions and any earnings or profit from rental and other properties.

You are allowed to make contributions from wages, salaries, self-employment income or other compensation you make from working. You can get more information by looking up IRS Publication 590 on IRAs. The definitions are on Page 8 of the 104-page booklet.

Do you have a question about personal finance, taxes or other money matters? Reach Akamai Money columnist Greg Wiles at 525-8088 or gwiles@honoluluadvertiser.com