Property Transfer: How To Avoid Tax Penalties

Added June 18, 2007 by Ilyce R. Glink and Samuel J. Tamkin

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Summary: A home owner has just found out that she doesn't really own the property, but her father-in-law's name is on the title. He bought the property under a 1031 exchange and might face stiff tax penalties if he transfers the title to his son and wife. To defer taxes with a 1031 exchange, the owner must replace that property with a replacement investment property within a certain time period, usually 180 days from the sale of the original property.

Q: My father-in-law used to own a condo that my husband and I and our two kids occupied.

My husband is a contractor and agreed to fix up the dated condo in exchange for his father help with a down payment on a home.

His father sold the condo using a 1031 exchange and replaced that property with a single family home. When he completed the 1031 exchange, he helped us with a down payment and kept the rest he made off the property.

He put us on the deed to the property after a year but when I read the documentation, it only shows that we occupy the property. We pay almost $3000 a month, including the mortgage, property taxes and the association fees we pay for lake usage.

Every month he makes us give him the mortgage money, which he then uses to pay the bank. So obviously, the bank doesn't see us as owners of the property. He says he will do what we want to give us ownership but he is worried about a gift tax.

Could he just do a quitclaim? Is there a tax with this? Would we have to refinance? Could he write some type of letter to show we have paid him? We would like the tax break and I don't know if we are entitled to it.

A: Your question is rather complicated. Your father-in-law owned an investment property. Your husband fixed up the investment property and then your father in law sold it.

A 1031 exchange referrers to a statute that permits owners of investment property to sell their existing property and defer the payment of federal income taxes on the sale. To defer taxes, the owner must replace that property with a replacement investment property within a certain time period, usually 180 days from the sale of the original property.

The new property must be owned for investment and must be kept as an investment property for some time after the purchase. Some experts in the 1031 exchange arena state that the property should be kept as an investment property for two years.

If your father in law gifts the property to you, he will have to pay federal income taxes at the time of that transfer on all of his profits. He will obviously want to avoid doing this, because it could be quite costly.

Now let's get to you. In essence, you are correct. You don't own the property. Your father in law does. And he has certain, significant tax issues that he faces if he simply transfers title to you.

The smart move would be to have you, your husband and your father-in-law sit down with an estate planning attorney to work out a way that your father-in-law can transfer title to you. The estate planning attorney may need some assistance from an accountant who has good experience with 1031 tax free exchanges and knows your father in law's tax issues.

It's difficult to tell you what form the transfer should take place without knowing more details, but if your goal is to own this particular home without causing your father-in-law to go through a tax nightmare, you should bring in the professionals who can help you find the right solution..

If you must own your home now, the best bet for you would be to save up enough money to buy your own home, get your own financing, and let your father in law rent the existing home and manage that home as an investment property.

Published: Jun 18, 2007

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