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I recently was reading some deeds and in one case I noticed that a vacant lot had been transferred for a lot more than its value. On the open market the lot would sell for maybe $300,000 at best. However, according to the conveyance it was "sold" for $1,000,000 to someone else in the same family.

The tax advantages of doing this are obvious: if the "buyer" later develops the lot, they can deduct the million against their building costs as a capital expense. Or, if they sell the land for real later, say for $250,000 then they can declare a capital loss of $750,000.

Is the IRS wise to schemes like this, or is this kind of thing a standard practice?

  • It can also help "juice" the price of neighbouring lots, which benefits the seller if he owns more property in the area. – Rupert Morrish Jul 3 '18 at 22:58
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    Isn't there an equally obvious tax disadvantage of paying tax on the phantom $700,000 of over fair market value proceeds? – quid Jul 3 '18 at 22:59
  • @quid Even after the Trump cuts, capital gains tax is less than corporate tax. Highest long-term capital gains is 20% (15% 2003-2007). Compare this to a corporate tax of 21% now, but from 1994-2017, the highest bracket was 35%. So if this happened in 2003, there would be a 20% difference. – user71659 Jul 4 '18 at 1:59
  • @quid Also consider how to return money from a company to its owner and how it is taxed. Salary: ordinary income for the owner, expense for the company. Dividend: capital gains for the owner, taxable for the company (double taxation, the worst case). Overpaying for real estate: capital gains for the owner, expense for the company. The latter is the best case for both. – user71659 Jul 4 '18 at 4:07
  • Most local governments will not include the sale of property to a family member when using sales data to determine the market value of other properties. Many times these transactions between family members have other issues that drive the prices. – mhoran_psprep Jul 4 '18 at 11:35
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I would think the IRS would be rather happy if you want to pay real taxes on made-up gains now, to save those taxes at a future point of time. Basically, you are voluntarily prepaying taxes many years in advance.

You seemed to miss in your example that by a transfer for a made-up high price, a corresponding gain is implied, which is taxable. So if a sale for a 300k base price is made for 1000k, the difference of 700k is taxable, which mean that the IRS gets several hundred thousand in taxes right now. They will not get those taxes at the next sale, correct, but they already have it, so why would they care?

Typically, cheating taxes works by faking a sale at a lower price, so you save taxes now.

  • The point you miss is tax rates are different for companies vs individuals, ordinary income vs capital gains, and expenses vs dividends. Selling real estate yields the lowest tax rate for the individual seller (capital gains), and a tax deduction (expense) for the company. This can be used as a method to transfer money from the company to the seller. – user71659 Jul 4 '18 at 4:11
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    @user71659 Maybe you should write an answer. I certainly am and I'm sure Aganju is aware that taxation differs between individual income, corporate income and long term capital gains. The whole point here, in the question, is "sold" in quotes, indicating an illegitimate sale. An illegitimate sale would indicate that both buyer and seller are involved so you can't simply look at the potential benefit to the buyer without considering the rather immediate downside to the seller. And nevermind the potential property tax that may or may not take in to account the buy price depending on locality. – quid Jul 4 '18 at 4:22
  • That wasn't the question though. The question is what is IRS's awareness of padded sale prices. This answer, and my comment simply say why you want to do this. Neither answer the question. I am not sure, and not a lawyer, but I suspect the point where it it becomes illegal is if the new owner/company tries to deduct a business/capital expense that is knowingly excess of fair market value, and when the buyer claims the excess as capital gains on the property. There is nothing illegal in the sale itself, or if taxes are properly paid. – user71659 Jul 4 '18 at 4:39
  • If you think this is a matter of a couple of family members who own a company playing hot potato with some money and a piece of real estate to conjure a marginally improved tax rate, then, respectfully, I think you've missed the point of the question. It seems to me that would oppose the "sale" indicated in the question where there is an artificially high price attached to a piece of land and money doesn't actually transfer between buyer and seller. The question is asking about fraud, pointing out a potential benefit to buyer, but conveniently omitting the immediate tax burden to seller. – quid Jul 4 '18 at 4:44
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    @user71659: The point you've apparently missed is that the OP's question is about one individual selling to another individual. No mention of companies that I can see. – jamesqf Jul 5 '18 at 4:33
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The scam is not when a property is transferred between known family members. It is when the property is "sold" between people with no apparent connection. Person A sells to B, and then B sells to C: But A, B, and C are working together. If they do this a couple of times in the neighborhood the market looks hot. Then others walk in and buy at an even higher prices, but when they go to sell there is no market.

The original transactions are faked, the info about the purchasers is made up. They commit mortgage fraud. If they also hide the money made the IRS will also get involved.

In the question when a business decides to overpay, then the IRS does not care as long as the business and the person properly report the transactions. The relationship between the business and the person will make it likely that the local government will not include it in the calculation of property values, and other appraisers will follow the lead of the local government.

Now if the company has stockholders, the may be upset if the company overpays for property that was owned by an employee. That would be transferring corporate funds to an individual, and would reduce the profits of the company.

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