While giving a gift to your family member might seem like a nice thing to do, it can come with surprising tax implications. What tax mistakes are often committed by well-meaning family members?
Renting a Home to a Family Member
Whenever a taxpaying adult rents a home to a relative for a principal residence, the treatment of the rental depends on whether or not the person renting it is paying fair market value or renting at a discount. If the home or property is being rented at fair market value, it is treated just like any other rental property. If it is being rented at a discount, tax law treats it as being used for personal use. That means that any expenses for the property are not deductible and depreciation is not allowed. Rental income, however, will be fully taxable and reported on the 1040 form.
Depending on the discount the family member is offering, there might also be a gift tax issue in play. The current gift tax exemption is $15,000. If the difference between fair rental value and charged rent is higher than $15,000, a gift tax return might be necessary.
Below-Market Family Loans
Loans between two family members are relatively common, but charging no interest or charging interest rates well below market rates can complicate things. In general, the tax code considers a “gift loan” to be any loan that is below-market where the interest-free nature of the loan is considered a gift. The Treasury Department’s AFR is currently 2.55% for loans <3 years, 2.83% for loans 2-9 years and 2.99% for loans over 9 years. The lender is seen as gifting the amount of interest between interest actually paid and the ARF rate and must treat that as investment income. Borrowers are seen as paying interest at the AFR rate when the loan was made, so the interest can be deductible if the loan qualifies. None of the above terms apply to gift loans that are directly between two family members if the total loan amount is under $10,000.
Transferring a Home’s Title
If someone passes away, the fair market value of assets is tallied up. The fair market value of the house, whether or not an estate tax return is required, becomes the value of the house that is inherited by the beneficiaries. However, when a house is transferred to a child as a gift while the parent is still alive, the parent’s basis in the house is transferred to the child which, in most instances, is much less than the fair market value of the house. For tax purposes then, it is better for a child to inherit a house rather than receiving it as a gift.
However, if a parent retains a life interest in a house that is gifted to a child and resides in the property until death, the child can take over the house at a fair market value. A number of complications can occur if the parent moves out of the house before death.
Prevent Family Tax Issues with Miles Tax Advisory
If you are dealing with family tax troubles, you should contact Miles Tax Advisory today. We can work you through all of your options and help you determine what to do. We are always here to assist you!