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Q: I am a 76-year-old widower with a 43-year-old son. I own six rental properties in Bernalillo County, all free and clear, have about $200,000 in liquid investments, and receive an annual pension of $82,000 per year. Between my pension and Social Security, I don’t spend what I bring in. The rentals are probably worth $750,000 and net about $40,000 a year. My son was laid off two years ago, had a few years of college but never finished, and has bounced from job to job most of his adult life. He was living with me, and I got him to do some fix-up work on the rentals and for the past four months he has been managing the properties and living in one of them while he does some repair work. I would like to give my son all of the rentals so he will have something to be responsible for and also be able to get the income. But I really need him to show me that he will take this seriously. Should I hire him to manage and repair the properties for a salary, and is it possible to give him the properties over five or 10 years as he proves that he will be industrious?
A: It is definitely possible to do and the key would be for you to decide the terms of his work and of your willingness to gradually transfer the properties. I think the easiest way to accomplish this would be to set up a limited liability company (LLC) to hold all of the properties.
The LLC structure will allow you several benefits. First, you can continue to control the properties by holding a managing interest. You could, at least initially, transfer a non-managing interest to your son.
Second, it is difficult, and generally not advisable, to transfer fractional (partial) interests in real estate. But you can transfer interests in the LLC very easily, and those transfers will effectively shift partial ownership in the properties held by the LLC.
Third, if you have any concerns with judgments that may be entered against your son, the LLC will provide some protection for your ownership interest. It is unusual that a judgment creditor of a member would be able to dissolve the LLC and get to the assets. More typically, the creditor is entitled only to cash distributions made to the owner.
An LLC with you and your son as members will be taxed as a partnership. A partnership tax return will be required and the income will be allocated among the owners, generally by agreement.
A partner cannot be an employee of a partnership, but you can pay your son a fixed amount to manage the properties. This is called a “guaranteed payment,” and the partnership is allowed to deduct it for tax purposes just like a salary.
Your son will pay tax on the guaranteed payment, including self-employment tax, and he will also receive some of the net income of the partnership. Because this is a family partnership, his share of the net income cannot exceed his share of the capital that he owns.
When you transfer membership interests to your son, you will have made a gift. If the gift exceeds $14,000 in any year, you will need to file a gift tax return on IRS Form 709. You will not have to pay any gift tax because your overall estate is not large enough.
You may need to hire as many as three professionals to help with this plan. Your situation is not that complicated, so the fees should not be an impediment.
You should hire an attorney to set up the LLC and to draft an operating agreement that specifies the rights and responsibilities of you and your son. The attorney can also explain the non-tax aspects of the LLC form, including how it is managed, creditor protection, and how membership interests are transferred.
You may need a tax preparer to handle the partnership tax filings and to answer any tax-specific questions that you may have. Finally, it may be necessary to have a qualified appraiser help to value the gifts to your son.
James R. Hamill is the director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at jimhamill@rhcocpa.com.
— This article appeared on page 11 of the Albuquerque Journal
