Clarifying my post above:
The amount of a mortgage does not necessarily equal the Basis in the property. Basis is purchase price plus some closing costs plus improvements.
In order for something to be a gift under state law, you generally must have Delivery and Donative Intent. Not clear that participating in a refinance and going on the deed is a gift or simply an agreement to share in future liability and future sale proceeds.
Whatever the intent and agreement of the partners, the sale Proceeds, closing costs, and Basis in the property will have to be allocated to the two tax returns.
It is good practice to document the allocations and the reasons for such allocations so you can show at any future date that you made a good faith effort to treat the sale transaction properly.
