What Are the Tax Risks of Co-Owning Residential Property?
A joint ownership of residential premises can be with family members, friends, or business partners, which may be thought of as financially savvy. Nevertheless, it harbors various tax risks that most people do not consider until it is too late. Suitable follow-up questions and some of the most frequent confusions will be answered and clarified in this article so that you are well-informed and free of troubled legal options.
Does Co-Ownership Automatically Mean Equal Tax Responsibility?
No, not at all times.
Liability to taxes does not always match with percentages of ownership. Income and expenses are normally studied by the IRS for allocation. Using the example of one co-owner getting all the rental income but the expenses shared 50/50, the IRS might look at this as a possible fraud, and this agreement may be looked at first, automatically sending the co-owner to an audit.
How Is Rental Income Reported When a Property Is Co-Owned?
The co-owner must also account for their share of the rental income and expenses in proportion to their ownership stake.
This would normally be done through Schedule E (Form 1040). Reckless allocation, e.g., where one owner gets all the mortgage interest deduction, will be treated as a red flag by the IRS, resulting in adjustments or penalties for taxes.
Can Unequal Contributions to the Property Lead to Tax Issues?
They are able to do it, yes.
Co-owners may end up with tax disagreements whenever they pay different amounts of mortgage instalments, repairs, or property taxes, yet both of them use the same deduction. It is critical to maintain clear records and even come up with a co-ownership agreement to prevent legal tangles and division.
Are There Capital Gains Tax Complications in Co-Ownership?
Absolutely.
It is a liability in the event of each co-owner upon the sale of the property to capital gains on his or her share of the appreciation. Notice, though, that in the case of one owner qualifying in regard to the Section 121 Exclusion (up to $250,000 or $500,000 in the case of marital status) and the other not, only a percentage of the gain is allowed to be avoided in terms of the total tax amount.
What Happens If a Co-Owner Passes Away?
The impact of this on tax varies with the form of ownership.
When conveyed as joint tenants with right of survivorship, the surviving owner takes the entire property but does not enjoy the full step-up in basis, so that the surviving joint tenant may owe more capital gains tax on sale. In tenancy in common, the owner dies, leaving behind shares to the heirs, and this can complicate ownership and reporting of taxes.
Can Gifting a Share of the Property Create Tax Problems?
Yes.
Gifting of property shares would be a possible issue to incur gift tax requirements. In case the amount is more than the limit of annual exclusion ($18,000 in 2024 per recipient), the donor must potentially report using Form 709, and it will be a part of their lifetime gift tax exemption.
