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Selling a Starker exchange property

What you should know about capital gains, rental

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POSTED June 16, 2012 3:06 a.m.

DEAR BENNY: We own a small single-family home (800 square feet) located on the property adjacent to our primary home. We purchased it using a Starker exchange about 15 years ago. We stopped renting it out eight years ago, when the mortgage was paid off. We now use it as an extension of our primary home, with the living room as a game room, garage and basement as storage, one bedroom as an office, and the other as a guest bedroom.

If we were to sell it, would the Starker exchange come back into play? What would happen with the deductions taken during the “rental phase”? --Jim

DEAR JIM: When you did the Starker (Section 1031) exchange, you sold one property (called “relinquished”) and exchanged it for another (called “replacement”). You were able to avoid paying capital gains tax, but the tax basis of the relinquished property became the tax basis of the replacement.

You have now abandoned the investment. The bad news is that you cannot take advantage of the up-to-$250,000 exclusion of gain (or if you are married and file taxes jointly up to $500,000) for any property that you exchanged.

So while you may be able to claim the exclusion on your principal home (assuming you owned and used it for two out of the five years before sale), you will have to pay capital gains on the portion of the property that was exchanged.

But to calculate gain, you must remember that the basis of the replacement property is not what you paid for it, but what the basis was for the relinquished property.

You may also have to recapture any depreciation that you took while it was investment property.

You really should discuss this with a tax accountant to make sure you file the correct documentation. We know that the IRS is always on the lookout regarding these kinds of exchanges.

DEAR BENNY: I have been trying to get rid of my time share for the past two years and have hit a few roadblocks. I would really appreciate your advice on finding an attorney within the Chicago area who may be able to help me. I am a co-owner and am unable to find the other owner since he has changed all of his information about his whereabouts. Any sort of information you may have will be helpful. --Kassie

DEAR KASSIE: If you do not have the name of an attorney in your area, you should contact the local bar association: in your case, the Chicago Bar Association. It is my understanding that most (if not all) bar associations have a lawyer referral program, where lawyers with different specialties can be retained to assist you.

As to finding your co-owner, have you contacted the time-share management company? Perhaps it has this information. Otherwise, you may have to file a lawsuit known as a “quiet title” complaint. You advise the court that you have made a diligent search for your co-owner, but have been unable to find him/her, and ask the court to declare that you are the owner who has the authority to do what you want to do: sell, rent, mortgage, etc.

Such a quiet title lawsuit can be time consuming and expensive, and it may not be worth pursuing for the time share. But talk with an attorney for specific guidance.

DEAR BENNY: My wife inherited her sister’s house when she died last year. We want to allow our two oldest daughters to live there rent-free. The house will remain in my wife’s name. My daughters have agreed to pay all future taxes, mortgage insurance and any costs that come due. The house is valued at $180,000. Please set me straight as to what effect this will have on us as parents? --C.D.

DEAR C.D.: In effect, you and your wife will be renting your house to your daughters. And while you indicate it will be “rent-free,” in reality (since they will be paying all of the expenses) it is not rent-free. The Internal Revenue Service could consider these funds as taxable rental income to you.

Even though these are your daughters, I would recommend having them both sign a lease, spelling out customary terms and conditions. You should check with your state and/or local government to determine if you have to obtain a rental license. And the income you receive will be taxable to you, although you should be able to depreciate the property. Talk to your financial advisers about your proposal, as I cannot provide specific legal or financial advice to my readers.

I do have, however, a couple of suggestions: First, make sure that you have adequate hazard insurance. Next, have you considered adding your name to the title, so that you and your wife could hold the property as tenants by the entirety?

And finally, you can gift each of your daughters, tax free to everyone, up to $13,000; your wife can also make that same gift. Let’s say the yearly expenses that your daughters will be paying add up to $24,000 -- covering the mortgage, real estate tax, insurance and basic upkeep. If you give each of your daughters $12,000 yearly, and then they pay you back with your gift, then the transaction truly is “rent free” for them. You would still have to declare the moneys you receive as income, because even though it seems like it’s your own money, the IRS treats it as a gift. It’s no longer your money.

Bottom line: Before you proceed with this arrangement, make sure you consult a financial and legal adviser about your specific situation.

DEAR BENNY: My mother and aunt have jointly owned a farm since the death of their mother in the late 1950s. At that time, the deed was written up as joint tenants with the right of survivorship between my mother and her sister. Since then, my mother has had a family and would like her portion of the farm to go to her children, not her sister. My aunt, on the other hand, never married and has no children. To complicate the situation, my aunt has been deemed mentally incompetent and my mother is her legal guardian.

Would it be possible for my mother to have at least her half of the farm changed to be willed to her family instead of her sister? Or would the whole deed need to be changed to tenants in common? --MaryAnn

DEAR MARYANN: There is a little-known fact about deeds held as joint tenants: Namely, that at least in some jurisdictions, one joint tenant can unilaterally change the title from joint tenants to tenants in common.

Oversimplified, title can be held in one of the following ways. First, sole owner. That’s an easy one. I own the property all by myself. Next, tenants in common. Here, I own property with someone else, but my share can be sold to any third party who may be willing to buy less than the entire house. On my death, my share will be transferred in accordance with the provisions of my last will and testament (which I should have). My share, in many states, will also have to be probated. Although, traditionally, tenants in common reflects a 50-50 ownership, that is not mandatory. For example, I can own 5 percent, with my son owning the remaining 95 percent. Any percentage split is acceptable.

Next, title can be held as joint tenants with rights of survivorship. Some states do not require the “rights of survivorship” language to be included in the deed, but my preference is to use that language anyway. Although a few states now allow joint tenants to be held other than based on a 50-50 split, it is my understanding that most states still require that joint tenants hold a 50-50 interest in the property. I cannot sell my share, because technically, I do not own a share. Of course, if I unilaterally change this to a tenants-in-common approach, then I can transfer my share to anyone willing to buy. And on the death of one joint tenant, the survivor automatically (by what is known as “operation of law”) becomes the sole owner of the property.

So, the answer is that (depending on your state law) your mother can unilaterally transfer the property so that she owns half of the farm as tenants in common. On her death, her heirs will inherit the farm.

But, one note of caution: Your mother is the legal guardian of her sister. That means that she has a fiduciary duty toward her ward, and cannot unilaterally take away her sister’s property. However, if that is what she wants -- which makes sense to me -- then your mother should go to court and ask the judge to transfer the property into a tenant-in-common approach. Your mother wants to avoid any allegations that she was taking advantage of her sister.



Benny L. Kass is a practicing attorney in Washington, D.C., and Maryland. No legal relationship is created by this column. Questions for this column can be submitted to benny@inman.com.

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