Rental properties, stock investment and other income generating properties are commonly assets that parents transfer to the second generation. Before giving the instructions to your bankers or lawyers, you’d better ask the common question: what is the tax implication?

Here is a real case:

Mr. Wonderful transferred Apple shares to his spouse in return for $50,000, when the fair market value of the share was $80,000. The tax costs of these shares to Mr. Wonderful was $20,000. Mr. Wonderful subsequently sold the shares for $90,000.

Looks very familiar, doesn’t it? The transaction is simple but there are a few tax implications. Since the fair market value of the property transferred by Mr. Wonderful is greater than the consideration received by himself, tax rules called attribution rules apply. Later on, the capital gain on the final sale by him also attributes to Mr. Wonderful.

As you can see , If income-producing property is transferred or loaned to a spouse, the income and capital gains from the property will normally be attributed back to the person who gives the gift.

What about transferring to the kids then?

If a income-producing property is transferred to a related minor, the income from the property will normally be attributed back to the person who gives the gift. However, the capital gains from the property will be taxed on the hands of the minor. Then, who are the minors? For the purpose of the attribution rules, it refers to a child who is under 18 years old and does not deal with the individual at arm’s length, or is a niece or nephew of the individual.

Same rules apply when money is loaned to the minor to acquire the income-productions property.

Tax rules always have some exceptions:

• if the income is earned on the original income will not be considered income of the individual who gives the gift. However, it will belong to the minor or the spouse who receives the property.
• The attribution rules apply only to property income, not to business income earned from money or business assets transferred. So, parents gift the money kids to start the new venture. It is worry-free from attribution rules perspective.
• And the most important thing that you may need to remember is the attribution rules do not apply to loans where interest is charged at a rate at least equivalent to the prescribed interest rate. What’s the analysis if loaning to the spouse on investment? I am going to talk about it in another blog.

Transferring assets to second generation needs proper planning. Like some parents plan to transfer the mortgage-free property to a kid who is only 15 years-old, oh no, there must be some better planning than such a quick thought.