Put Savings Bonds in Kids’ Names
Currently I buy U.S. savings bonds through a payroll savings plan at work. I’m buying them in my name, but they are eventually intended to cover the cost of sending my two young children to college. Please explain the pros and cons of purchasing these bonds in my name or in my children’s. I am in the 28% tax bracket and do not plan on cashing in the bonds for about another 12 years. --R. V.
ANSWER: According to our advisers, you would be better off--at least through 1989--buying the savings bonds in the names of your two children. How you treat the interest that these bonds accumulate depends on how much unearned income your kids receive each year.
If they receive less than $500 annually, including the bonds’ interest, you should declare that income annually. Children under age 14 are entitled to keep the first $500 of their income, tax-free.
Income between $500 and $1,000 is taxed at 15%, and income above $1,000 is taxed at the highest rate applicable to the parents. If your children, like most kids, have relatively small investment portfolios, they probably will end up not owing any taxes on the bond interest.
However, if your kids have several investments and actually pay taxes, you should carefully evaluate whether the interest should be recognized each year, or if you should wait until you sell the bonds to deal with the taxes owed on the accumulated interest. You might want to consult a personal finance adviser for suggestions tailored to the child’s specific holdings.
You might also be interested in some pending changes affecting savings bonds that are purchased to finance college education. Beginning in 1990, interest earned on Series EE bonds issued after Dec. 31, 1989, can be free from federal taxation if they are redeemed to pay for college or vocational school.
However, as you might expect, there are several restrictions. Bond buyers must be at least 24 years old. The tax break can be applied only to bond proceeds used for tuition and required school fees--not books and room and board.
In addition, it can be applied only to degree programs at colleges, universities and certain vocational schools.
Finally, the tax break can be used only by families and individuals meeting certain income standards. For couples filing jointly, a $90,000 adjusted gross income is the cutoff; for individual filers, the cutoff is an annual adjusted gross income of $55,000.
Plan to Reduce Taxes Probably Won’t Work
Q: My wife and I have just sold an investment condominium in Cali fornia and were thinking of using the money to buy a retirement house out of state that we would move into in about three years. If we go ahead with this purchase, will it reduce any of the taxes we are responsible for from the sale of the condo?--W. D .P.
A: In theory, yes. But this strategy probably won’t work for you. First of all, investment property, such as your rental condo or any other business-related real estate, is not treated like residential property when it comes to deferring taxes. When you sell your principal residence, you can defer all of some of your tax obligation by purchasing another home. But this is not true with investment real estate.
The only way to defer your tax obligation on a gain generated by the sale of investment property is through what is known as a “Section 1031 exchange or trade of business property.” Under these transactions, which are also called “Starker exchanges,” you are allowed to trade the property you are selling for another piece of real estate through what is known as an “accommodator,” or, in plain terms, a middleman.
This accommodator, who acts independently of the buyer and seller, takes possession of the money and title for both the property sold and the property purchased, and then passes them on to their rightful owners. In order to have your transaction qualify as a true tax-deferred exchange, you may never take possession of any part of the money generated by the sale of your property.
So, if you have taken possession of the proceeds from the sale of your condo, as your letter suggests, you are ineligible to take advantage of the tax-deferred exchange rules. For more information about these transactions, contact the Society of CPA Financial Planners at 1-800-445-7526.
Another caveat: Exchanges are allowed for only like kinds of property, so your exchange would have to be for a piece of investment real estate.
A condo could qualify as an investment property if you treat it as a rental for at least one year. After renting it for that period, you could move into it. However, be warned that the government frowns on overt attempts to avoid taxation. If the Internal Revenue Service should suspect that your efforts were so motivated you could be hit with a tax bill and potential penalties. Our tax advisers suggest that you use discretion when discussing your financial affairs.
Think Twice Before Donating Stock
Q: My daughter’s school is holding a major fund-raising campaign and I am thinking of donating 50 shares of stock I hold in a utility company instead of giving cash. This type of donation strikes me on the surface as a smart move, since I would be credited for making a donation of the full fair market value of the stock but would only have an out-of-pocket expense of my initial cost of the shares. Can you evaluate the wisdom of my reasoning and tell me how I might actually execute such a donation? --L. M. C.
A: What you say is true, but it is hardly the whole story. Indeed, your our-of-pocket expense is only what you paid for the shares, and that could be considerably less than their current value.
However, our advisers urge you to think more of what the shares are worth now--and what they could be worth in the future--than what they were worth at some point in time long since passed. By focusing on the past, you could be ignoring the potential of these shares to continue appreciating in value. Our advisers say the best candidates for donation to charity are shares whose value appears stagnant.
Making the donation is an easy matter. Simply sign the stock certificate over to the charity. For tax purposes, your donation is valued at the fair market value of the shares on the date of the gift. You are allowed a deduction for the full value of the charitable contribution on your income taxes.
However, be advised that you must declare as taxable income any amount the shares appreciated in value above your initial purchase price. In case you were thinking you got a free ride, you are not entitled to a deduction for a contribution of untaxed appreciated assets.
Carla Lazzareschi cannot answer mail individually but will respond in this column to financial questions of general interest. Please do not telephone. Write to Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, Calif. 90053.
