Why Selling Your Minneapolis Duplex To Your Family May Not Help

The other day a long-time duplex came into my office to explore the possibilities of selling a property.

Having done a 1031 exchange into his current property, he faced over 40 years of capital gains tax and depreciation recapture should he sell and cash out.

Of course, he understood selling the duplex on a contract for deed could help him spread his tax liability over time, while also providing the opportunity to plan and perhaps offset additional tax consequences.

Better yet, the seller had an adult child interested in taking on the property.

The problem was, the property is in a sought-after neighborhood, and worth a substantial amount of money. In other words, it worked for the seller when he bought it because he had a large amount of equity. His family member was not in the same position.

Logic would say to structure the contract for deed in a way that helped the seller get what he wanted, while also helping the property make financial sense for the family member buying it.

Enter the IRS. Of course. It turns out that selling a property to a family member under discounted terms can trigger tax consequences.

For example, if the duplex was sold at a below-market interest rate, the IRS may decide it was a better deal than Fair Market Value based on the difference between it and Applicable Federal Rate (AFR) at the time of sale. The AFR is the minimum interest rate the IRS allows for private loans.

If the duplex sold for less than it was worth on the open market, part of the sale may be considered a gift to the buyer. Also, sales between family members can have specific tax rules that limit deductions or change how gains are calculated.

In other words, it may seem on the surface that selling a Minneapolis duplex to a family member is a good idea. As always, however, it’s a good idea to speak with your tax advisor about the potential consequences first.