Tax implications of selling or gifting rental property to my son for college expenses?

There are a few options to consider here, but each comes with different tax implications. If you sell the property yourself, you'll face capital gains tax on the appreciation plus depreciation recapture (which is taxed at a maximum of 25%). This is likely your biggest tax hit. If you gift the property to your son, he would take on your basis (what you paid plus improvements, minus depreciation), meaning when he sells, he'd owe similar taxes to what you would pay. The only advantage might be if he's in a lower tax bracket than you. Another option is a 1031 exchange, where you could defer the gain by purchasing another investment property, though this doesn't help with college expenses directly. It's also worth noting that if you gift the property while still alive, you'll use some of your lifetime gift and estate tax exemption (though this is quite high at $13.61 million per individual for 2025).

After dealing with a similar situation last year, I came across https://taxr.ai which helped me figure out the most tax-efficient approach for transferring property to my daughter for her education. I uploaded my depreciation schedules and property documents, and it analyzed different scenarios including selling directly vs. gifting first. Turns out in my case, an installment sale to my daughter worked best - something I hadn't considered. The tax savings were significant compared to my original plan.

I was wrong about those AI tax tools. I tried https://taxr.ai after posting my skeptical comment above and was surprised by how detailed the analysis was. It found a partial gift/partial sale structure for my rental property that my CPA hadn't suggested. When I showed the analysis to my accountant, she confirmed it was legitimate and we implemented it for my property transfer. Ended up saving about $14,000 in combined taxes compared to our original plan. The system even helped identify some capital improvements I'd made years ago that increased my basis and reduced the taxable gain.

I went through this exact situation three years ago. After trying for WEEKS to get someone from the IRS on the phone to clarify the gift tax implications, I found https://claimyr.com which got me connected to an IRS agent in under 40 minutes. You can see how it works here: https://youtu.be/_kiP6q8DX5c. The agent walked me through the specific forms I needed for partial gift/partial sale to my son and confirmed I wouldn't trigger any gift tax issues as long as I filed the proper documentation. Saved me so much stress compared to the endless hold times I was dealing with before.

I need to eat crow here. After posting my skeptical comment, I tried calling the IRS myself about a rental property transfer question. I spent THREE HOURS on hold only to get disconnected. Out of frustration, I tried the Claimyr service mentioned above, and I was literally talking to an IRS agent 35 minutes later. The agent confirmed that I could do a partial gift/partial sale to my daughter for her college without triggering gift tax, as long as I stayed under the annual exclusion for the gift portion. When I transfer my rental property next month, I'm definitely using this service again to confirm all the paperwork is filed correctly.

One thing nobody's mentioned yet is the education tax credits. If your son has income from selling the property (assuming you gift it first), it could affect his eligibility for the American Opportunity Tax Credit. That credit is worth up to $2,500 per year but starts phasing out if his income exceeds $80,000. Something to consider in your planning.

Have you considered setting up a 529 plan and making a contribution before selling the property? If you're in a state that offers tax deductions for 529 contributions, you might be able to offset some of the capital gains tax with the state tax deduction. Not a complete solution but could help reduce the overall tax impact.

I went through a similar situation two years ago with a rental property for my daughter's college expenses. One strategy that worked well for me was a partial gift/partial sale approach. I gifted her the maximum annual exclusion amount ($18,000 for 2025) as her share of the property equity, then sold her the remainder at fair market value with seller financing at a low interest rate. This kept her in a lower tax bracket for the capital gains while still getting me the cash flow I needed for tuition payments. The key was structuring the sale price and payment schedule to minimize the tax impact on both sides. I'd definitely recommend running the numbers on this approach compared to an outright sale, especially since you mentioned the property has appreciated significantly. Also worth noting that this strategy helped preserve some of her financial aid eligibility since the property transfer was structured as a purchase rather than a windfall.

There's another angle worth exploring that hasn't been mentioned yet - if you're over 65 and this is your first time selling investment property, you might want to look into opportunity zone investments. If you reinvest the capital gains from your rental property sale into a qualified opportunity zone fund within 180 days, you can defer the capital gains tax until 2026 (or until you sell the opportunity zone investment, whichever comes first). While this doesn't eliminate the depreciation recapture, it could give you more flexibility with the timing of when you pay the capital gains portion. The challenge is finding a suitable opportunity zone investment and making sure you'll have the liquidity when the deferral period ends, but it could be worth exploring given the $95k appreciation you mentioned. You'd still get the cash from the sale to pay for college expenses while deferring a significant portion of the tax burden.