Q:

Subject: help

Kerry:

 

I have a client who owns a home with his wife which otherwise would qualify for the Section 121 exclusion.  They want to “sell” their home for a promissory note to a controlled entity (LLC or S corp) and then have it developed into condos to be sold.  The entity/purchaser will be 99% owned by the seller and 1% by another.  Assume the sale is “respected” by the IRS.

 

Results:  no ability to use installment sale treatment (453(g)); ordinary income on the sale (707/1239).

 

Even given the potentially “bad” tax results above, this is no problem because 121 still excludes the gain even if it is ordinary income under 707/1239.  Do you agree??

A:

I’m not aware of any restriction on the Sec. 121 exclusion for full unrestricted sales to a related party.

The only mention of any such restriction in Pub. 523 is the following for when only a remainder interest is sold to a related party.

“Exception for sales to related persons.   You cannot exclude gain from the sale of a remainder interest in your home to a related person. Related persons include your brothers and sisters, half-brothers and half-sisters, spouse, ancestors (parents, grandparents, etc.), and lineal descendants (children, grandchildren, etc.). Related persons also include certain corporations, partnerships, trusts, and exempt organizations.”

Kerry Kerstetter

Follow-Up:

agreed.  Thanks!!

 

 

Q:

Subject: Tax Question

Dear Kerry,

I have friends that want to sale their residence valued at $1.5 million.  They also want to make a contribution to a charity of approximately $500,000.  They are wondering if they can donate 1/3 of the residence to charity before it is sold.  Then after the home is sold and they get $1 million for their 2/3 share of the residence, still deduct the $500,000 exclusion for sale of a partial interest of a residence.  Your thoughts are appreciated.

A:

Such a plan could be possible, with proper documentation, including an IRS approved appraisal of the value of the partial interest.

However, such a plan might not work out to give your friends the lowest tax.  It could very well work out that having them sell the home as 100% owners and then donate $500,000 cash would have a smaller bottom line than the scenario you are proposing.  Long term capital gains are taxed at a much lower rate than is ordinary income. 

Their personal tax professional should run the numbers under both scenarios.  It could end up showing that a $500,000 cash donation saves them more ordinary income tax than the extra capital gains tax on $500,000 additional taxable profit from their residence sale. 

Of course, with numbers that large, all kinds of other factors will kick in, including the insane AMT and phase-outs of deductions and exemptions.  The only way to get a decent handle on the figures is with a good tax software program, which their personal tax professional should have.

Kerry Kerstetter