I currently own a rental home for the last 7 years and recently paid off the mortgage on the home. I have been taking depreciation and claiming expenses on it all of that time. I am thinking of doing one of two things with the home, 1) put it on the market and selling it for what I paid for it, or, 2) give it to my son for free via a quit claim deed.
My concern is the tax ramifications of either option. I know that you can only give me a general answer without all of the specifics, but, would you have an idea of which option would have the least tax consequences?
I currently have an income of around $100k and take the standard deduction on my taxes (in addition to the depreciation on the rental home) and live in Michigan.
What are you actually trying to do? Give your son a home? Give your son money? Because those two things are really different, and not just in terms of taxes.
For both plans, you need to know your current adjusted cost basis on the home. Your adjusted cost basis is the price you paid, plus any permanent improvements you paid for, minus depreciation you claimed or could have claimed as the property was a rental.
Now if you sell,
You may have a capital gain. Your gain is the difference between your selling price and the cost basis. Lets say the property really hasn't appreciated and the current fair market value is the same as the price 7 years ago. Suppose the house cost $100,000 and you have claimed $20,000 of depreciation. You sell it for $100,000 and your selling costs are $6000 (real estate commission). You have a capital gain of (94000 minus 80000 equals) $14,000. Because this gain is less than your depreciation, all the gain as taxed as depreciation recapture, which means it is tax at ordinary income tax rates with a cap of 25%. If you're single, you're in the 22% bracket which is what the recapture will be taxed at.
If you have a larger gain -- say the home sells for $120,000 -- then the first $20,000 of gain is taxed as depreciation recapture at 22% and the remaining $20,000 is taxed as long term capital gains at 15%.
If you give the home to your son, the consequence for you is that you have to file a gift tax return for the fair market value of the gift. Giving a gift is not taxable as long as your lifetime gifts are less than $11 million, but gifts over $15,000 per person per year must be reported to be counted against your lifetime limit.
The consequence for your son is that you give him not only the house, but you also give him the ownership history and the adjusted cost basis. His cost basis will be whatever your current basis is now ($80,000 in my example). If he lives in the home as his main home, then whenever he decides to sell it, his cost basis for calculating his capital gains at the time will be whatever your cost basis is now. He will also have to pay depreciation recapture tax on the part of his gain that is due to your depreciation, even if he otherwise qualifies for the homeowner's capital gains exclusion.
If your son places the home in service as a rental, his basis for depreciation will be the current adjusted cost basis (minus the value of the land), and not the current market price or even the price you paid. He starts the depreciation clock from where the house is now. Then if and when he sells the rental, his taxable depreciation recapture will include both his depreciation and yours.
So make sure that you provide him copies of your depreciation schedules and other tax paperwork so that he can prove his cost basis and tax position when he sells.
However, your son does not owe any tax now for receiving a gift, since gift recipients are never taxed in the US.
Finally, if you happen to be elderly or in poor health and are thinking of giving the house to your son to avoid the government taking it should you require long term care, you should be aware that Medicaid has a 5 year clawback rule and your son could be forced to return any large gifts made to you in the 5 years before you required care, so that you can use those gifts to pay for your own care before the government takes over. (You can't give property away to make yourself poor enough to qualify for assistance.) So see an Elder Law Attorney if that is the sort of event you are planning for.
**If a post answers your question, choose it by clicking on "Mark as Best Answer".**
if you sell the property you'll recapture as 1250 gain all the depreciation taken. since you say the sales price will be equal to your original cost. section 1250 gin is taxed like ordinary income but at a maximum rate of 25%. you do not have recapture if you gift it to your son but he will have to recapture the depreciation you took if he sells the property and has a gain (recapture can not exceed the gain)
for him to know the basis of property received as a gift, he must know your adjusted basis, the depreciation you took, and the FMV at the time it was given to him.