Attorney Thomas B. Burton answers the following question:
"How to Buy Real Estate from Uncle for Vacation Rental?"
Attorney Burton discusses how to buy real estate from the questioner's uncle to use as a short term vacation rental such as listing the property on Airbnb or VRBO and discusses how setting up an LLC for the real estate could be a useful business entity for managing the real estate as a vacation rental business.
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Welcome back!
I'm Attorney Thomas Burton and today we return to my popular Question and Answer Series where a reader asks a question about two of my favorite things - Real estate and Vacations, specifically Vacation Rentals and here's the question -
"How would my dad and I go about buying my uncle's property and turning it into a vacation rental? My uncle is currently 80 and would like to get out of some of his real estate holdings. He has expressed that he wants to keep his hard-earned properties in the family. My dad and I are interested in buying one of the homes from him as an investment property and turning it into a vacation rental. We are looking for advice for all three of us to come out with a good deal and not get hit heavy on capital gains or gift tax as well as non-arms like transaction issues on either side. So we are not sure if we should have my uncle's seller finance, put the property in a trust and we control it and be able to rent it out, buy it outright but he doesn't want to deal with the capital gains issue like I noted. We are open to any ideas.
Thank you for your help and time."
So this is a complex question as you can see and I think my first advice is seek out the advice of a qualified lawyer in your area. I can tell you've done your research to know about some of the issues here, we've got capital gains tax, gift tax and then you've got liability issues to think about with renting out to vacation rental owners.
Now a vacation rental, many people, it's popular in Northern Wisconsin and all over the U.S., many people do it through Airbnb or Vrbo or other rental platforms or they simply host it on their own website but my first advice would be, if you're thinking about renting out the home as a vacation rental, I would put the property inside of a limited liability company from the get go and operate the property as a business, separate from your personal assets from the very beginning. In my opinion, in Wisconsin, the limited liability company has quickly become the most popular business enterprise formed every year. I was just looking at statistics and it wins hands down, it's no contest over other forms of business entities formed annually in Wisconsin because of the flexibility and how it was designed by the authors of the LLC statute, they purposefully wanted to set up a business entity that could be used by small businesses, set up easily but provide and maintain that separate liability asset protection from your personal assets.
So my first answer is, regardless of how you take title, how you get the property whether you buy it, whether your uncle gives it to you or whether you get it at his death, if you start operating it as a business, I would look at getting it inside an LLC, from the beginning because if you're going into this to operate as a business, an LLC makes sense to me.
Now, how to get it from your uncle to you, that is going to depend on a variety of factors and like you said, you've got the tax issues to consider. So if your uncle has a very low basis in this cabin and he doesn't live there as his primary residence, I'm guessing, he's concerned about paying capital gains tax on the sale to you. That's going to be a decision he has to make if he wants to sell and pay that capital gains tax and I don't know his basis in the property, so again that's something you should examine with your attorney and or CPA or both.
Basis, as a reminder to folks is generally, what you pay for the property when you bought it, then real estate, if it appreciates, it generally goes up over a long period of time and you get an increase in basis for improvements you make to the property like adding a new roof, things like that but if you've held a property a long time and it's appreciated a lot, your basis may be a lot less than what it's worth. Let's say you bought it for $50,000, the cabin's now worth $300,000, that could be potentially a capital gains of $250,000 at the sale. Now currently under current tax law, anyone can get new basis at death on appreciated assets by leaving it at death to their heirs. So if your uncle's inclined to give you the property at he's advanced age, you might want to consider having him leave it to you upon his death if his primary concern is avoiding that capital gains tax. If he left it to you at death, it would be a tax free gift and you could get new basis or step up in the property, provided your uncle is under the 11.7 million dollar federal estate tax limit. I'm talking about capital gains here. If he's above that limit, he could owe the estate, its own estate tax to the federal government. If he's in that situation, you definitely want to work with a lawyer about structuring this transaction, in the most tax efficient way possible.
So if he left it to you at death, you could potentially get new basis at death. If you're going to buy it then you need to buy it at the fair market value or whatever value your uncle is willing to take for it, it would be a straight sale. He would owe capital gains on any increase in basis, on the sale as from his basis, from when he bought it as explained earlier.
If he gives the property to you during life like just gave it, he would need to fill out a gift tax return, assuming it's worth more than $15,000. $15,000 is the limit you could give to one person, per year, without a gift tax return but if he is below 11.7 million, he could fill out a gift tax return and let's say the cabins were $300,000, that amount would get deducted from the amount he can leave tax free at death to his heirs.
If he's willing to do owner financing, that's an option for you, you could buy it on a land contract or something like that but you wouldn't actually receive title until you make the final payments.
So to me, the cleanest transaction would be for you to buy the property, just buy it, acquire title, place it inside your own LLC before you begin operating it as a business and if you can't or don't want to do that, maybe your uncle should put it inside the LLC and begin operating it as the business and you could be a member, possibly of the LLC in exchange for doing work in the business. Something like that.
So again, a lot of issues here. I would look at using an LLC as the main business entity for the vacation rental. I think it's great you're thinking of entrepreneurial ways to make money. Hope this is helpful to you and best of luck in your new business venture.
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