Q. I own property in the District which is my principal residence, and I also own a condominium in Virginia. My son, his wife and their baby live and rent my unit in Virginia. I would like to give them the Virginia condominium unit. I understand that I cannot give this property to them as a gift, since it would exceed the $11,000 per year gift limit. The value of the apartment is approximately $110,000, which unfortunately they cannot afford to purchase. Am I permitted to sell this condominium to them for a very low, nominal price?

A: I first have to know if there is a mortgage on the Virginia condominium, since this will make a difference as to how you handle the situation. From your question, I have to assume that the property is free and clear of any mortgage.

You can sell the property to your son and his family for a very low price, but there will be adverse taxable consequences to you. You have indicated that the fair market value is $110,000. Let’s assume that you purchased the unit several years ago for $60,000 and have made no improvements to it, so that your basis for tax purposes is still $60,000 (Note: I am ignoring for this discussion any depreciation which you may have taken on the property.)

If you sell the property to your son for $60,000, the IRS will consider the difference between that sales price and the fair market value to be a gift which you have given, and this will be taxable to you. While the IRS will allow you to deduct the savings you will have made by not having to pay a real estate commission, and perhaps some closing costs, you still will have gift tax consequences. You must talk with your personal tax consultant to determine the significance of this.

There is, however, a better way to solve your problem, namely gift the entire property to your son and his family. You are not exactly correct that you are limited to $11,000 per year; this limitation is per person. Thus, if you are married, both you and your husband can give $11,000 each – or $22,000 per year to each recipient.

More importantly, you alone can gift $11,000 per year to your son, $11,000 per year to your daughter-in-law, and another $11,000 per year to their child – although if your child is a minor, this is not recommended under the scenario which I will describe.

My recommendation: convey the house to your son and daughter-in-law for the sum of $110,000, which is the full fair market value of the property. They will sign a deed of trust (a mortgage) in your favor for the full amount of the purchase price. They will also sign 5 promissory notes, each in the amount of $22,000. (The numbers just happen to work out perfectly in this example, but other readers will have to divide the amount of sales price by the amount of the allowable gift to determine the number of promissory notes to be signed).

Every year, no later than December 15, you will forgive one of these notes, by gifting them the amount of $22,000. In five years, you will have forgiven all of promissory notes, by virtue of your annual gifts.

What are your tax consequences? Absolutely none, since you are gifting only up to the yearly limit.

What are the tax consequences to your son and his family? That depends on whether they keep the property for a period of time. The law makes it clear that the basis of the donor becomes the tax basis of the donee – in this case your son and his wife. Thus, when you have gifted them the entire house – i.e. forgiven all of the five promissory notes – their basis will be your original basis, which we have decided was $60,000.

If, for example, they live in the house two out of five years before it is sold, and if they file a joint tax return they can exclude up to $500,000 of capital gain. Accordingly, unless they can sell the condominium unit for more than $560,000 (in which case I have no sympathy if they have to pay some capital gains tax), they will not have to pay any tax when it is ultimately sold.

I mentioned earlier that you could give the minor child a similar gift, but in that case the child would have to be on title. I cannot recommend that a minor be on title; it is difficult and expensive to get the property sold or refinanced under those circumstances.

If you have an existing mortgage, you will either have to come up with sufficient funds to pay it off, or your son will have to obtain a mortgage for the maximum amount that a lender will allow and you will have to take back a second trust – again secured by several promissory notes. Once again, however, there has to be sufficient moneys available so as to pay off your existing mortgage.

Example: you sell the house for $110,000, and your son gets a mortgage of $50,000. You owe $45,000 on the house, which will be paid off when you go to closing with your son. You will take back a second deed of trust in the amount of $60,000, secured by three promissory notes in the amount of $20,000 each. Every year, you will forgive (i.e. gift) your son and daughter-in-law one of these notes, so that at the end of three years, they will only be obligated on the first mortgage.

You and your son must seek independent tax advice, since everyone’s personal and financial situation is different.

Published: September 16, 2002

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Author of the weekly Housing Counsel column with The Washington Post for nearly 30 years, Benny Kass is the senior partner with the Washington, DC law firm of Kass, Mitek & Kass, PLLC and a specialist in such real estate legal areas as commercial and residential financing, closings, foreclosures and workouts. Mr. Kass is a Charter Member of the College of Community Association Attorneys, and has written extensively about community association issues. In addition, he is a life member of the National Conference of Commissioners on Uniform State Laws. In this capacity, he has been involved in the development of almost all of the Commission’s real estate laws, including the Uniform Common Interest Ownership Act which has been adopted in many states.