Q:

Subject: Older client sells home and retains right to live in it until death or abandoned

I have an older client who sold her home to her neighbor below fair market value because she retained the right to live in it rent free until she died or abandoned the property (nursing home for example).  We are now trying to see if she can take the $250K exclusion on the sale.  It was arms length in that the buyer paid less and can’t take possession until a future unknown event.  The neighbor went through a regular escrow. 

My feeling is that the “discount” was an arms length transaction with a lot of give and take before a price and terms were agreed on.  The tax person is saying that since she did not sell her entire interest (retained a right to live there) that the entire gain is capital gain.

Thoughts?  I have been doing research and have not found anything on point.  Most retained life interest data refers to 706 preparation.

Mahalo,

A:

As long as her neighbor wasn’t related to her, it seems that she can utilize the Section 121 exclusion, as described in IRS’s own Pub 523.   

Sale of remainder interest.   Subject to the other rules in this publication, you can choose to exclude gain from the sale of a remainder interest in your home. If you make this choice, you cannot choose to exclude gain from your sale of any other interest in the home that you sell separately.

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.”

The sale that you described sounds exactly like the normal definition of a remainder interest, so it should be eligible for the exclusion, as long as the neighbor wasn’t a relative.

Good luck.  I hope this helps.

Kerry Kerstetter

Follow-Up:

Thank you for your quick reply. 

Thanks Again

Q-1:

Subject: Fiduciary – Estates & Trusts

 

If a trust return 1041 has a total   of only $10,000.00 in taxable interest for the year, can the trust pass on a proportion of the tax obligation via k-1 to the beneficiaries, and show the remaining income for that same year on the 1041?  For example, show $8000.00 income on the trust return and show $2000.00 on the k-1’s to the beneficiaries.

 

thanks

A-1:

The governing documents for the trust should either specify how the income is to be allocated and distributed or at least empower a designated person (usually the trustee) to make those decisions during the lifetime of the trust. 

Kerry Kerstetter

Q-2:

guess I was more concerned if the IRS would allow part of the income each year to be listed on the trust return and the rest of the income for that same year, and its tax obligation, be put on k-1’s to the beneficiaries

thanks for your comments

A-2:

You can technically enter the income any way you want in regard to how much is passed through via K-1s and how much is taxed at the trust level.  However, if IRS were to ever question the methodology of the allocations, via a direct audit of the 1041 or more likely, a 1040 audit that reaches back to the 1041, you would have to provide the auditor with documentation (the trust’s governing documents) that the allocation was properly authorized and not just done arbitrarily.  If there is no such documentation, the auditor will be able to reclassify the income allocation to whichever method results in the highest taxes for the government, plus penalties and interest.

I hope this clarifies how this matter should be addressed.

Good luck.

Kerry Kerstetter

Follow-Up:

thanks you are very good at your work.  best to you

Republicans Warn of Tax Hikes Ahead – With so many of Bush’s tax cuts expiring in the next few years, we are looking at some huge tax increases just from our rulers continuing to sit on their hands and failing to act on extending them; or better still, making them permanent. Hillary is literally chomping at the bit to be in command and responsible for even bigger tax hikes than the humongous ones the Clinton-Gore team retroactively forced on us back in 1993. 

Q:

Subject:  Permission to print your web page on corporations

 

I would like to recommend your web site C vs S Corporations in a brochure about starting a business. Your site is very well written and easily understandable.

 

My intent is to print the pages out and included in a handbook but of course I will not recommend such without your permission.

 

Allow me to thank you advance for your consideration.

 

Sincerely

A:

As long as you mention where you found it, such as the URL to my blog or website, feel free to print and distribute anything you find.

Good luck.

Kerry Kerstetter

Follow-Up:

Thanks,  I’d wouldn’t do it without mentioning you! That is the only way I know how to play.

Q:

Subject: Question

My Mom wants to gift me and my brother $100,000 each.  Her entire estate is worth approximately $300,000. 

Question:  Can she do this with paying a gift tax ? 

Question:  Will we have to pay any taxes.

Question:  I assume the 5 year time period will have to pass before this money is considered no longer her asset??

Thank you,

A:

It sounds as if your mom is trying to do some impoverishment planning to qualify for Medicaid and/or other programs that penalize people with too much net worth.  This is an actual specialty with some attorneys and financial planners, so she really needs to work out such a strategy with a professional experienced in this area, including the specific look-back rules for her state.

She also needs to consult with a qualified professional tax advisor who can explain the mechanics of making such large gifts in regard to gift tax returns and how this will affect her future exclusion from estate taxes. 

In regard to you and your brother, there will be no taxes required on the receipt of the gifts.  What you do with the gifts could create tax issues, that you and your brother need to discuss with your own professional tax advisors. 

If those gifts are made via money, documenting the transactions will be simple.  If you are being transferred assets, such as real estate, you will need to determine your mom’s cost basis in those assets, because that will now become your costs basis in the event of a future sale of those items.  A good tax advisor can help with this.

While you are not required to report the receipt of gifts on your income tax returns, you may want to attach a note to your return describing the gift, especially if you use some of the money in ways that show up as large deductions on your tax returns, such as donations or business expenses.  Without an explanation of the tax free source of the funds, IRS could suspect you of under-reporting taxable income and launch an excruciating examination of all of your finances.  I have seen its happen, so t’s not mere alarmist fantasy.

I have some basic info on Gift Taxes on my website, which you should look over before meeting with a professional tax advisor.

Good luck.  I hope this helps. 

Kerry Kerstetter

Follow-Up:

Kerry,

Thank you so much for your response.  I just wanted to make sure we were not doing anything illegal.  We will take your advise and contact a

professional.

Kind regards,