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 Sara Gould advises ...
Buy your parents' house? Sure, and write it off.
Does this situation sound familiar? Your aging parents live in a home that has appreciated, but they have stopped getting home-ownership tax breaks. After all, they've paid off their mortgage and their property is continuing to appreciate.
On the other hand, with one transaction, your whole family can win. Your parents get immediate access to their home equity (without moving) and you pick up some generous new tax deductions.
Here is the strategy. Buy the home from your parents and then rent it back to them at the going rate.
First, the sale provides cash to your parents without having to refinance or dip into a home-equity loan. Second, this gives them a chance to put their money into safer investments. Third, if their capital gain has grown to more than the $500,000 home-sale gain exclusion for married couples, they're just creating more taxable income for themselves the longer they own the home. (IRC Section 121[b])
Unexpected benefits: Once you own the house, you can write off travel expenses when you visit the house. Plus, if your parents want new furniture, they can gift the money (up to $12,000 per parent) to you so you can buy it for them and depreciate it.
Completing the sale. You must pay a fair price for the home to avoid gift-tax complications. Suppose you need some help with the down payment. Your parents can gift $12,000 per parent to help you. Then, if necessary, the gift could be added back to the purchase price and financed.
Drawing up the lease. It is important for the two sides to enter into a lease at a fair rental value. A long-term lease may be appropriate for your peace of mind or for some particularly skeptical parents. Remember that courts have said landlords can reduce the fair market rent as much as 20% when renting to relatives. The lower rent reflects a savings in maintenance and management costs. (L.A. Bindseil, TC Memo 1983-411)
Tax-time deductions. Once you own your parents' house, you are now able to claim the tax benefits of owning rental property. (IRS regulation 1.280A-3) This includes taking write-offs for operating expenses, repairs and supplies.
Finally, you can claim depreciation deductions for the home. You can't depreciate the cost of the property apportioned to land. So, it is advisable to obtain an appraisal allocating the price paid between the depreciable structure and the non-depreciable land.
You can use all of these deductions to offset the rental income received from your parents. Remember that ANY allowable tax loss will phase out between $100,000 and $150,000 of AGI. (IRC Section 469[i]) Any suspended losses may be taken when you actually sell the house.
Completing the circle. Eventually, your parents won't be able to live in the house. Then, you can sell it, rent it to another tenant or move in. If you move in and make it your principal residence for at least two years, you can sell it and shelter another $250,000 or $500,000 worth of capital gains. This is a win-win all the way around!
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