| Question: Dear Mr. Pancheri, I read your great | | | | membership units. It's important that you create |
| article "Gifting Real Estate Under the Annual Gift | | | | enough membership units in the LLC so that the |
| Tax Exclusion." In this article you explain that an | | | | value of each unit is somewhat less than the |
| LLC can be used to accomplish this. I am | | | | amount of the annual gift tax exclusion. Then you |
| considering an LLC as a method to gift my house | | | | can give your son one membership unit each year |
| to my son. I have two questions:- Is there any | | | | without having to pay a gift tax or use any of |
| change in the basis when membership units are | | | | your unified credit against gift or estate taxes. |
| transferred (that is, can I take advantage of the | | | | Over a period of time, your house will be |
| Capital Gains exclusion)? | | | | transferred entirely to your son without any gift |
| Question: Dear Mr. Pancheri, I read your great | | | | or estate taxes. Of course, the article also |
| article "Gifting Real Estate Under the Annual Gift | | | | discussed ways to accelerate this whole process |
| Tax E | | | | by having your spouse elect to join in on the gift, |
| -Can property taxes continue to be used as an | | | | and by making gifts to your son's spouse and/or |
| income tax deduction when property is in an | | | | children.Now that we've put all this into |
| LLC?I appreciate your help. Thanks. E.R.Answer: | | | | perspective, let's tackle your specific questions. |
| Dear E.R. - You ask some very good questions | | | | You asked, first, whether there is any change in |
| that need to be addressed before you start | | | | the basis when membership units in the LLC are |
| giving away your home, whether through an LLC | | | | transferred to your son and/or others? Under |
| or otherwise.First, let's step back a bit and | | | | current income tax laws, if you transfer your |
| consider the consequences of selling your home | | | | home to an LLC in exchange for 100% of the |
| outright to a third party rather than gifting it to | | | | membership units, no gain or loss is recognized. |
| your son. Under §121 of the Internal | | | | The value of your membership units is assumed |
| Revenue Code, you can exclude up to $250,000 | | | | to be equal to the value of the property |
| of gain realized from the sale or exchange of | | | | transferred (i.e., your home, in this case), and |
| your personal residence if you owned and used | | | | your tax basis in the membership units is deemed |
| the property as your personal residence for at | | | | to be equal to your tax basis in your home |
| least two years during the five-year period ending | | | | immediately prior to the transfer. In our |
| on the date of the sale or exchange. This can be | | | | hypothetical, the value of your home was |
| an important tax benefit if you meet the | | | | assumed to be $550,000 and your tax basis was |
| requirements and your personal residence has | | | | assumed to be $300,000. Following the transfer, |
| appreciated considerably in value. For example, if | | | | the value of your membership interests in the |
| you purchased your home for $300,000 and then | | | | LLC is assumed to be $550,000 and your tax |
| sold it for $550,000, your gain of $250,000 would | | | | basis in the membership units is assumed to be |
| normally be subject to a tax of around $37,500. | | | | $300,000. If you received more than one |
| However, under I.R.C. §121, this tax is | | | | membership unit in the LLC at the time of the |
| avoided on the sale of a personal residence.If you | | | | transfer (which you should in order to bring the |
| give your house to your son instead of selling it | | | | value of each unit to less than $12,000), then |
| to a third party, the tax consequences are | | | | your tax basis in each membership unit would be |
| different. By gifting it to your son, you will avoid | | | | equal to your basis in the property transferred |
| the capital gains tax. That's because a gift is not a | | | | divided by the number of membership units you |
| sale or exchange of the property. In that case, | | | | received. Assuming you received 47 membership |
| your son would step into your shoes and assume | | | | units following the transfer, your tax basis in each |
| your tax basis (i.e., $300,000 from our | | | | unit would be $6,383.If you then starting gifting |
| hypothetical above). If he later sells your home, | | | | membership units to your son, each membership |
| he would pay a capital gains tax on the difference | | | | unit that your son received would carry a tax |
| between the sales price and his $300,000 basis. | | | | basis equal to your tax basis in that unit (i.e., |
| Of course, if he meets the requirements of I.R.C. | | | | $6,383 in our hypothetical). If your son later sold |
| §121, he would be able to avoid the capital | | | | one or more of his membership units, then he |
| gains tax on the first $250,000 ($500,000 if he's | | | | would incur a capital gains tax on the difference |
| married) of appreciated value as well.Now let's | | | | between the sale price and his tax basis of |
| consider the estate-tax benefits of gifting your | | | | $6,383.You also asked whether you could take |
| home to your son rather than selling it. Let's | | | | advantage of the Capital Gains exclusion under |
| assume that your overall estate is currently | | | | I.R.C. §121 if you transferred your home to |
| valued at more than $2 million ($4 million if you're | | | | an LLC. The IRS has generally treated single |
| married). In that case, if you simply deeded your | | | | member LLCs as disregarded entities, which |
| home over to your son, you would pay no | | | | means that if you transfer your home to an LLC |
| income taxes or gift taxes on the transfer. | | | | and take back all the membership units, you'll still |
| However, to eliminate the gift tax, you would | | | | be eligible for the capital gains exclusion if the LLC |
| have to use a portion of your unified credit | | | | then sells the home.However, if you transfer one |
| against the gift and estate tax.So, what's the | | | | or more membership units to another person (i.e., |
| benefit of gifting your home to your son now | | | | your son) while the LLC still owns the home, then |
| instead of giving it to him upon your death? By | | | | the LLC will be converted from a disregarded |
| giving it to him now, you avoid the estate tax on | | | | entity to a partnership for tax purposes. In that |
| the value of the appreciation of your home from | | | | case, it appears that you will lose the capital gains |
| the time of the gift to the date of your death. | | | | exclusion if the LLC then sells the home while you |
| That could be significant in view of rapidly | | | | still own some of the membership units. In that |
| increasing property values. For example, if your | | | | case, the LLC would have to file a partnership tax |
| home increases in value from $550,000 to $1 | | | | return, and the net profits would then be taxed |
| million from now until you die, then you will have | | | | to you and your son in proportion to your |
| avoided the estate tax on $450,000 - a tax of | | | | membership interests.Incidentally, any real estate |
| approximately $207,000 under current estate tax | | | | taxes paid by the LLC would be fully deductible |
| laws.But, wouldn't it be better if you could | | | | for tax purposes. If you're the sole member, then |
| eliminate the estate tax on the entire value of | | | | the tax deduction would be claimed on Schedule |
| your home - not just the future appreciation? In | | | | A of your Form 1040. If you're not the sole |
| my article, entitled "Gifting Real Estate Under the | | | | member, then the taxes paid would reduce the |
| Annual Gift Tax Exclusion," I discussed the use of | | | | net profits on the LLC's partnership return, and |
| an LLC to do just that, by bringing the entire gift | | | | the resulting taxable gain reportable by you would |
| under the annual gift tax exclusion (currently | | | | be reduced accordingly.While the loss of the |
| $12,000 per year per recipient). That would not | | | | Capital Gains exclusion may seem to be a deal |
| only avoid the estate tax on the appreciation in | | | | breaker, it really shouldn't be. If your estate is |
| value, it would also exempt the current value | | | | large enough to be subject to a federal estate |
| from the estate tax simply because you wouldn't | | | | tax, then the estate tax savings will far out weigh |
| have to use any of your unified credit in the | | | | any loss of the capital gains tax exclusion. |
| process. In our hypothetical, the net estate tax | | | | Moreover, if your son owns the house and lives in |
| savings wouldn't be just $207,000 (the tax on the | | | | it for two years, he will be able to use the |
| appreciated value), it would be roughly $460,000 | | | | exclusion himself. In that case, you won't have |
| (the tax on the $1 million date-of-death value.The | | | | lost the exclusion, you'll just have shifted it to |
| technique is quite simple. In order to give your | | | | your son.Attorney Michael Pancheri is a practicing |
| home away in increments that are valued at less | | | | attorney and the founder and CEO of the Living |
| than the annual gift tax exclusion (currently | | | | Trust Network. You may contact him by email at |
| $12,000 per year), you would transfer your home | | | | You may also contact him at the Living Trust |
| to an LLC in exchange for 100% of the | | | | Network's web site. Its URL is 2006. |