Sale of rental property to tenant - our son

[JAF3]

We have been renting a single family row house to our son since 2009 at or near FMV as to rent amount.  We am considering gifting the house to him during 2024.

We are aware of the gift tax return required and required recognition of gain on the sale – however, we are not sure of the amounts to use for the gift return and for the capital gain. For conversation sake, the cost basis of the property will be about $120K and we plan to “sell” the property to him for an amount just over the cost basis perhaps $125K to avoid IRS scrutiny (and gift that amount). The fair market value of the property based on an actual appraisal in 2021 is approximately $180K today. Is our gift amount $180K? or $125K for the gift tax return purposes. As to the gain we believe the gain would be $125 less $120.

Also, we believe our son’s cost basis going forward would be the $120K (our cost basis at the time of sale) when he goes to sell the property sometime in the future. Can you comment on the accuracy of the above?

[MonikaK1]

The scenario you shared has limited details so may not be completely accurate. For example, you don't need to report the gift of a rental property on your income tax return because there wasn't a taxable event (i.e. gain or loss on sale or disposition). You just need to report it on Form 709 United States Gift (and Generation-Skipping Transfer) Tax Return).

See this IRS article for more information about renting to relatives.

There may be information missing about the basis of the property, if you have been renting the property at fair rental value since 2009, then you should have been reporting the rental activity on your tax return and taking depreciation. Depreciation, allowed or allowable, reduces your cost basis in the property that you report when you sell or otherwise dispose of the property. 

The gift tax applies to the transfer by gift of any type of property. You make a gift if you give property (including money), or the use of or income from property, without expecting to receive something of at least equal value in return. If you sell something at less than its full value or if you make an interest-free or reduced-interest loan, you may be making a gift. For additional information, review Form 709 and its instructions.

See this IRS article regarding the gift recipient's basis in the property. 

You may want to obtain professional advice before proceeding. This will impact your estate planning as well as your/your son's income tax returns.

[JAF3]

Depreciation has been taken every year.  After doing our taxes for 2023 the TurboTax calc of cost basis is approx 112,000. If we transfer the rental property to our tenant son, does our son carry our cost basis? And do we avoid capital gain?  How do we show the sale price in TurboTax? The FMV of the property is about 180,000. Should We get an independent appraisal? We do realize a gift tax return would be required. Is the gift amount 180.000 or (180,000 less 112,000) 68,000?

Thx

[roger-vw]

If I gift my rental property to a long time renter, do I report the selling price as $0?

[KrisD15]

You don't mention your basis and depreciation taken (or could have been taken)

Your adjusted basis is the original cost plus improvements less depreciation. 

If you have been renting since at least 2009, that means 15 years of depreciation or at least half the original value. 

If the Fair Market Value today is 180,000 I would assume your adjusted basis is a lot less than 120,000.  If you purchased the rental for 120,000 your adjusted basis would be more like 50,000 (120,000 basis less 70,000 depreciation) meaning anything you sell for over 50,000 to 120,000 would be depreciation recapture (ordinary income up to 25% tax rate) and anything over 120,000 would be capital gain. 

If you sell it to your son for 125,000, you would have 70,000 ordinary income and 5,000 capital gain and 55,000 gift tax. 

If you sell it for 110,000 you would claim 60,000 depreciation recapture and your son would need to claim the remaining 10,000 when he sells. 

Gift is FMV less selling price (180,000 - 125,000 = 55,000)

Property that is inherited gets the step-up for basis and no depreciation recapture. 

@JAF3