This tax planning idea is not new, some folks have done it with benefits to the parents and the child.
The parents can have cash without having to refinance or do a home equity loan or a reverse mortgage. They can put the sale proceeds (or part of it) into safer investments and have more income.
The idea is for you to buy the parents’ home at fair market value and then lease it back to them for at least 80 percent of fair rental price.
The parents will probably have no gain to be taxed on the sale because of the “gain on sale of a principal personal residence” tax rules — $250,000 of profit is not taxed for a single person; $500,000 of profit on the sale is not taxed to a couple (joint return).
You as owner can claim deductions for all expenses, including depreciation expense. Just be sure to allocate a reasonable part of the purchase price to land (which gives you no depreciation deduction). The rental income you receive is income. Form 1040, Schedule E is where the rental income and expenses would show on your return.
If you don’t pay cash for the property, the promissory note (your promise to pay parents) will have interest income for the parents and rental interest expense for you. The minimum amount of interest to be charged is published monthly (AFRs). You can use an interest rate that is more like what regular mortgage lenders would charge.
The parents’ income tax rates may be low, costing them only say 15 percent of the interest they receive. You might be in a higher tax rate, saving you more tax than they pay.
The parents don’t have to move and you get some new tax deductions. However, if the rental produces a loss for tax purposes and you are in a high tax bracket, the losses may be postponed (Passive Activity Loss rules on form 8582) until you sell the house.
If the parents have to move, or choose to do so, you can rent it to strangers (but consider using a property manager).
One of the problems with this idea is the parents may not fully understand exactly what it means to them. Maybe your attorney or your CPA can help with that communication.
When your parents are no longer the renters, you could consider converting it to your own principal personal residence for more than two years. Then, the favorable tax rules on sale of your home can be used to save you taxes in the future.
This is easier said than done, but if it fits your parents’ situation and your goals, it is worth considering.
Did you hear? “Take risks. Step out of your comfort zone and aspire to new heights.”
John Bullis is a certified public accountant, personal financial specialist and certified senior adviser who has served Carson City for 45 years. He is founder emeritus of Bullis and Company CPAs.
