Q: My husband and I jointly bought a rental property this year with our son, who is 18 years old. He has started his own single-owner limited liability company. We are planning to move the property into the LLC so that he can use the rental income from the business for his college expenses.
What is the best way to do this so we avoid future gift taxes? The property cost $124,000. Will there be any tax implications for us if we move the property to our son’s LLC now vs. next year?
A: You’ve asked two separate questions. The first has to do with the tax consequences of transferring ownership of the property to your son. The second is whether your son should own the property in a limited liability company (LLC).
We'll start with the LLC issue. We know that most real estate investors hold their real estate holdings in one or more LLCs. While these professionals handle their operations in this manner, it may not be the best way for your son to hold this investment.
We've written about this frequently in the past. There are quite a number of costs involved in holding property in an LLC, so we always try to ask real estate investors why they want to hold title this way.
If the answer is to protect personal assets from liability, we always ask these investors how they plan to manage and operate the LLC and the property. When a sole member LLC — your son — owns the property and your son handles all of the affairs of the property, there is a high likelihood that if and when something terribly goes wrong at the property, attorneys will sue your son as well as the LLC.
It may also be possible that your son could lose in that litigation if he has failed to operate the LLC as a separate and distinct entity, failed to maintain the books and records separately, commingled personal and LLC funds, and, more importantly, used his own time and effort to make repairs and manage the property.
The purpose of owning the property in an LLC is to protect the LLC owners from personal liability. But you have to think about the possible ramifications if that owner personally oversees repairs or other work on the property and later someone is hurt as a result of that work. In our litigious society, you’d expect the plaintiff’s attorney to sue the LLC, the contractor that did the work and the person who hired the contractor and oversaw the work.
In a nutshell, we prefer small property owners buy better liability insurance, with a higher limit, to protect them (and their assets) in case of an accident at the property. Along the way, your son would save the cost of creating the LLC, the annual fee for the LLC to the state in which it is organized, and accounting fees to file the annual tax returns for the LLC. For more information on this issue, you and your son should talk to an attorney.
On the issue of giving your son the home, you shouldn’t have a federal tax issue in this regard. Yes, the value of the home would be a gift to your son, but given today’s high estate tax limits of around $11,400,000 per individual, it’s unlikely that most people would exceed that amount. (If you have a high value estate, you should speak with your estate attorney or estate planner.)
You’d still have to file a federal gift tax return, as you are entitled to give your son only $15,000 per year (or $30,000 between you and your husband) without filing a gift tax form. Your tax preparer can help here.
When it comes to other possible issues down the line, the situation could be a bit more complicated. When you transfer title to the LLC, you might find that your local real estate tax office will reassess or revalue the property for real estate tax purposes. You may have other transfer taxes and other costs to transfer ownership from you to your son’s LLC. And if you have a loan on the property, the lender could consider the transfer a sale, and may be entitled to call the loan.
So you may be fine with the federal government, but have other issues (tax and otherwise) to deal with when it comes to this investment property. Good luck, and let us know what happens.
Ilyce Glink is the author of “100 Questions Every First-Time Home Buyer Should Ask” (4th Edition). She is also the CEO of Best Money Moves, an app that employers provide to employees to measure and dial down financial stress. Samuel J. Tamkin is a Chicago-based real estate attorney. Contact Ilyce and Sam through her website, ThinkGlink.com.