Tax Strategy: Buy Parents' Residence; Then Parents Rent Back

Personal Sale and Leaseback

This is the personal version of the corporate or commercial sale and leaseback strategy for real estate that can be a very useful and powerful cash and tax planning tool that can help your parents generate liquidity (cash) on a tax free basis.

No More Tax Benefits From Home Ownership

Let's assume, for example, that your parents are in their 70's and own a single family house in which they live as their primary residence.  Their home has appreciated significantly over the years.  However, they can no longer take advantage of the tax breaks from owning their own home because they are in a much lower income tax bracket.  Perhaps they even need cash to live on. 

Buy Your Parents Home

You can structure a transaction whereby you buy your parents' home from them, and then subsequently lease or rent the home back to them.  It is a classic personal sale and leaseback strategy, and is a win-win situation for everyone. 

Your parents have effectively withdrawn their trapped equity out of their primary residence, and they can then reinvest and diversify the cash into other investments that can generate monthly cash flow as needed.  The transaction would be tax free provided your parents qualify for a 121 Exclusion (refer to Section 121 of the Internal Revenue Code).

And, you now own rental property and can deduct the related depreciation and operating expenses on your income tax return against the rental income paid to you by your parents. 

Structuring The Sale and Rent Back

You have to be careful here.  You do not want to run afoul of the IRS.  The sale of your parents' home to you must be at fair market value.  This can easily be documented by obtaining an appraisal to support your purchase price. 

The rent payment from your parents to you should be made at fair market rental rates.  However, under a Tax Court Decision (TC Memo 1983-411) landlords can charge related party tenants up to 20% under the going fair market rent since the related party is handling all of the property management and maintenance. 

This tax planning strategy can work very nicely as part of an overall estate planning strategy as well, so consult with your legal and tax advisors to see if it might be right for you. 

You can then decide what to do with the property when your parents move out and no longer live there.  It is your rental property, so you can sell it, convert it to your home (primary residence) or 1031 Exchange out of it and into another rental property that might be more suitable for you.