Rental Sale or Gift?

Posted by Lee Reams Sr. on

An interesting situation was recently posted on the ClientWhys tax forum.  One of the forum members had a new client, and while looking at the prior year’s return discovered the taxpayer had sold a rental to his son for $100 which resulted in a loss of $628,000. However, the return did not include a Form 4797. The previous preparer, being improperly creative or uneducated, reported the transaction on Schedule D and created a huge capital loss carryover.

Of course, sales of business property are reported on Form 4797.  In addition, losses on the sale or exchange of property are not allowed if made directly or indirectly between certain related persons (Code Sec, 267(a)).

The disallowance of losses on sales to related taxpayers covers “property” of any kind. Thus, taxpayers have been denied losses on sales of mortgage and real estate, partnership interest, land, buildings, etc., and of goods sold in the ordinary course of business.

If an owner combines a gift with a sale (e.g., to a family member), gain is realized to the extent the price received exceeds the owner's adjusted basis. However, no loss is recognized if the amount received is less than the owner’s basis (Reg Sec 1.1001-1(e)).  

If a donor gives appreciated property to a donee on condition the donee pay the donor's gift tax, there's a sale by the donor for the amount of the gift tax. To the extent the gift tax paid by the donee exceeds the donor's basis, the donor has income.

Of course the proper thing in the case being reviewed by our forum member would have been to treat the sale as a gift in the first place. But the case does point out how to handle transactions that are part sale and part gift to related parties.