A Sham of a Tax-Avoidance Idea

· Sell to a subchapter S corporation. Up until a decade ago, one of the tax benefits available to homeowners was known as a rollover. If no more than two years elapsed between the time you sold one principal residence and bought another, you did not have to pay any capital gain tax. The profit that you made on the old house was rolled over into the new house.

Back when the rollover was in effect, the IRS issued a private letter ruling. That's a written statement that interprets the law as it applies to one specific taxpayer's situation. That letter said that if the homeowners sold their old house to a subchapter S corporation -- even if the corporation was wholly owned by the owners of the old house -- and if the sale took place within the two-year period, the IRS would consider this a sale within the rollover rules.

Private letter rulings cannot be used as precedent because they are a specific ruling for the person requesting the opinion. However, they do reflect the thinking process at the IRS.

So instead of trying a less-than-valid "sale" with a straw party, why not consider creating a subchapter S corporation and selling the house to that company? The price would have to be close to the market value, and you would have to pay the appropriate recordation and transfer tax. The corporation would give you a promissory note and sign a deed of trust in your favor, and the corporation would be legally obligated to make regular payments to you.

If there is a mortgage on your property, you would have to get your lender's permission for this type of transaction. Most loan documents contain what is known as a "due on sale" clause, which means that if the property is sold or transferred to a third party, the bank has the right to call the entire loan balance due. There are a number of exceptions, such as transferring property to a family member, but the exceptions would not apply to the sale to your new corporation. (Under your proposed scenario, your lender also could call your loan due, because your friend does not fall within any of the exceptions.)

Limited liability companies didn't exist when that IRS private letter ruling was issued. Perhaps transferring your property to an LLC would also work, but the course of action that is safer -- although still not guaranteed -- would be to sell to a subchapter S.

Consult your legal and financial advisers to make sure you are following all of the corporate rules and regulations.

Benny L. Kass is a Washington lawyer. For a free copy of the booklet "A Guide to Settlement on Your New Home," send a self-addressed stamped envelope to Benny L. Kass, 1050 17th St. NW, Suite 1100, Washington, D.C. 20036. Readers may also send questions to him at that address or contact him through his Web site, http://www.kmklawyers.com.