Another Capital Gains Reduction Question!
Hi!
We're buying a "vacation property" from a nice family who have had it for about 2 years. They have never rented, so they do not qualify for the 1031 or depreciation or any of the other methods of savings on CG that come along with having an investment property.
We want to help them out so I wanted to propose two options:
1. We reduce the sale price and then "gift" them the balance.
or
2. They are leaving the property with all the appliances and furniture, so, we reduce the selling price and then do a separate Bill of Sale for all the stuff they are leaving with the property ie. furniture, glassware, etc
Which option will have the least tax consequences for them and does not have an air of "fraudulency" about it. 
Thanks!
posherov
I have no expertise about number 1 so I am not commenting about that.
Number two seems perfectly leget to me as long as you are actually giving them a fair market value for these furnishings and are not inflating the price of these items. As you have stated, you could keep the house purchase as a seperate transaction from the transaction of purchasing the furnishings.
Interesting.
Option 1 is a sham and the IRS would disregard the transaction if they found it on audit (minimal possibility but you could be subject to penalties on this transaction). Also your gift amount is subject to certain annual limitations or the gift is taxable to you.
Option 2 is legit but where are the tax advantages? Possibly they have a high basis in this property allowing for a lower gain?
Capital gain tax is 15% on real property ( 28% on personal property) however certain low income taxpayers are taxed at 5%. State taxes generally have no separate capital gain provision and are therefore taxed at the normal state rate based on your income level.
You are correct to point out that when they sell the vacation home, the capital gains exemption of up to $500,000 in gains does not apply. To qualify for the exemption, they would have had to make the vacation home their principal residence for at least two of the five years before the sale.
You are also correct that the IRS allows a 1031 exchange if certain rules are followed. The first key rule is that the properties exchanged must qualify: They must be held for productive use in a trade or business or for investment (such as raw land, rental apartments, office buildings, warehouses, industrial, retail). Properties held for personal use, such as a vacation home, do not qualify.
You may want to consider creating a strategy for using gifts to shift the vacation property to family members with a lower tax bracket. If the couple transferred or gifted the vacation home to their children, who are in a lower tax bracket, they may be able to reduce the capital gain tax from 15% to 5%. You would need to research this planning technique as the laws can be complex and I would suggest you contact a reputable tax adviser to help you through the tax minefield.
[ Edited by ScipioZama on Date 08/05/2004 ]
Bear in mind that the capital gains tax rate on personal property is 28%. If you write your contract to allocate a significant portion of your purchse price to the personal property, you have made the situtation worse for the seller.
Thank you for the input!
For others reading this, here's a clarification of the taxation rates:
There are two holding periods for capital assets sold:
1. Those held for one year or less are considered short-term and receive no preferred tax treatment. You'll simply pay taxes at your "normal" tax rate on those gains.
2. Those held for more than one year are considered long-term and you will receive a tax break on the sale of those assets.
Here's the bottom line:
If you're in the 15% tax bracket:
1. Capital gains on assets held for a year or less are taxed at your ordinary income tax rate (in this case 15%).
2. Capital gains on assets held for more than a year are taxed at a reduced tax rate of 10%.
If your ordinary income tax bracket is greater than 15%:
1. Capital gains on assets held for a year or less are taxed at your ordinary income tax rate (anywhere from 28% to 39.6%, depending on your specific ordinary tax rate).
2. Capital gains on assets held for more than a year are taxed at a reduced tax rate of 20%.
posherov