Estate planning

Feb. 1, 2003
My wife and I are both 65 and own our home, which was originally purchased for $220,000 (debt free) and has a current value of $720,000.

Charles Blair, DDS & John McGill, MBA, CPA, JD

My wife and I are both 65 and own our home, which was originally purchased for $220,000 (debt free) and has a current value of $720,000. I would like to sell it to one of our children for this amount, in exchange for a promissory note with payments over 30 years at no interest.

Can I claim the $500,000 gain exemption from the sale of the property, or must the $500,000 be received upfront? Furthermore, if both spouses die before the end of the 30-year payment period and leave the note to the child who purchased the property, could the child then take the real estate debt-free with the related note cancelled without incurring any federal or estate tax?

Your question involves a number of different federal income, gift, and estate tax issues. Under current law, Section 121 of the tax law allows parents to exclude up to $500,000 of the gain on the sale of their personal residence from federal income taxes, provided they lived in their home for at least two years. Accordingly, if the transaction was entered into at a fair market sale price, the gain should be tax-free, not withstanding the fact that it was sold to a related party using an installment sale.

However, tax law does not permit an interest-free installment sale. In the event a fair-market interest rate was not included in the promissory note, the IRS would restructure the sale to reduce the principal and impute interest at the applicable federal rate at the time of sale. Accordingly, this would result in a portion of the payments received by the parents being characterized as taxable interest income, and the child benefiting from the tax-deductible home mortgage interest, provided the installment sale promissory note was secured by the personal residence being sold.

In the event the promissory note was transferred to the child following the death of both spouses, it would be extinguished, since the child would own both the home and the related mortgage. However, the value of the promissory note received would be included in the estate of the parents, unless a self-canceling installment note was used.

Because of the complexity of this transaction, we would recommend seeking the advice of a competent tax attorney before entering into this transaction.

Last year, I exchanged an office building that I owned for a small apartment building in a tax-free swap under Section 1031. Since my property was not worth as much as the property I acquired, I paid an additional $100,000 in cash. How fast can I write this extra cost off?

The additional $100,000 that you paid for the apartment building received in the exchange is depreciated over 27.5 years, the recovery period for residential real estate. However, be sure not to overlook the fact that you are entitled to write off the remaining undepreciated cost basis of your former building over the recovery period remaining for that property.

Due to medical insurance costs for my staff, I am now forced to look at other options. I have been reading about medical savings accounts (MSAs) and understand the concept of buying a high deductible policy and making contributions to the medical savings accounts where earnings grow tax-deferred. What are the tax limits on these plans?

The minimum deductible for MSA accounts has recently been increased. Policy deductible must now range from $1,650-$2,500, with a $3,300 ceiling on out-of-pocket costs.

For married doctors and family coverages, the deductible must be $3,300 to no more than $4,950, with a $6,050 maximum on medical bills paid outside of the policy.

The information provided in this column is based upon the current Internal Revenue Code, regulations, IRS rulings, and court cases as of the date of publication.

This column is not to be construed as legal or tax advice with respect to any particular situation. Contact your tax attorney or other adviser before undertaking any tax-related transaction.

Dr. Blair is a nationally known consultant and lecturer, and is a member of the American Academy of Dental Practice Administration. McGill is a tax attorney, CPA, and MBA, and is the editor of the Blair/McGill Advisory, a monthly newsletter helping dentists to maximize profitability, slash taxes, and protect assets. The newsletter ($184 a year) and consulting information are available from Blair/McGill and Company, 2810 Coliseum Centre Drive, Suite 360, Charlotte, NC 28217, or call (704) 424-9780.

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