Limited Partnerships Can Aid Estate Planning
Q: My wife and I own four pieces of residential real estate. We have four children and would like to give each of them one of these properties. Is there some way we can make annual gifts of these at the rate of $20,000 per year? --W.K.F.
A: Yes. The strategy, among the hottest new estate-planning techniques these days, involves forming a family limited partnership with your children and granting to them every year through the partnership an interest in the property. But instead of granting them an interest worth just $20,000 each year, estate planners note that you can justify a slightly larger gift.
Why? Because you are not giving the child the property directly. Instead, you are giving him a minority interest in the family limited partnership equal to a certain value in the real estate. Estate planners, accountants and the like argue that a minority interest in a partnership, because of its secondary status, is inherently less valuable than it would be if it were a majority share. Hence, you can discount its value, and effectively give a greater percentage of the real estate as your $20,000 annual gift. This strategy will accelerate the rate at which you give the properties to your children.
However, our experts warn that your strategy gives your children your tax basis in the homes, meaning that when they sell the properties they face potentially large tax consequences. The trade-off is that these gifts remove these properties from your estate, avoiding potential estate taxes. This strategy makes the most sense if your estate is large. However, if your estate is worth less than the $600,000 exemption granted on estate taxes, you might want to consider holding on to the properties and leaving them to your heirs upon your death. A qualified estate planning expert, familiar with your circumstances, can guide you.
How Exemption Rule Applies to Duplex Sale
Q: I own a duplex. I live in one of the units and rent out the other. When I sell the property, will I be eligible to claim the entire $125,000 exemption on my gains? -- B.G.
A: Assuming that you are at least 55 years old and have lived in the duplex for at least three of the last five years, you are entitled to a full $125,000 exemption. However--and this is an important caveat--the $125,000 profit exclusion can only be applied to the gain on the portion of the duplex that you occupy as your principal residence.
Here’s how it would work. Let’s say that each unit in the duplex is of equal size and that you have a total gain on the property of $200,000. Well, only half that gain--$100,000--belongs to the unit that is your principal residence. You may apply the full $125,000 exclusion to the gain, effectively wiping it out, but you may not save the remaining $25,000 to apply to the gain on a subsequent home sale. If the unit you occupy represents 60% of the total square footage of the property, then you would apply the exclusion to 60% of the gain. So, you see, you are entitled to the full exclusion, but you may apply it only to a portion of the profits, a requirement that could mean, depending on the size of your profit, that you cannot use the full $125,000 exemption.
No Swapping Foreign Investment Property
Q: In a recent column you said a home purchased in a foreign country would qualify as a replacement house for the purposes of deferring the recognition of a gain on the sale of a home. Does this apply to exchanges of investment property as well? --J.C.
A: No. Exchanges of investment properties under Section 1031 of the Internal Revenue Code must be made completely within the United States.
Timing of Home Sale Key for Tax Break
Q: I am in the process of getting an amicable divorce and not yet under any child support order from the court. What if my wife and I agree that I will continue making the house payments for the next two years rather than pay child support directly for my 16-year-old son? The family house would then be sold when the boy graduates from high school. Are there any tax consequences that I would face? --A.O.
A: If you proceed with the plan as you state, the house will not have been your primary residence at the time it is sold. This means that you will not be able to defer payment of taxes on any gain you realize by purchasing a replacement residence with your share of the proceeds.
However, our tax experts say that if you put the house up for sale immediately upon moving out, your gains could be rolled over to a replacement home when your marital house sells--even if that sale takes years to materialize. Why? Because the presumption is that you are trying to sell this primary residence and have only temporarily moved out until the sale is completed. Under this scenario, the family home is still considered your primary residence, not your bachelor pad. So, even if the sale of the family home takes until your son graduates from high school--and given today’s sorry real estate market, this in fact may be what happens--you could roll your share of the gain from the sale over to a replacement home.
