@lojsimms
Father and son screwed up. If son had sold the home, he could have excluded up to $250,000 of capital gains, on the basis of having lived there as his personal home for at least two of the past five years, and owning the home at least two years.
Because father has neither lived in the home nor owned it for at least two years, father must pay capital gains. The capital gains is the difference between the selling price and the son‘s purchase price in 2017, it has nothing to do with how much is realized before or after the mortgage is paid off. It will be a long-term capital gain, because when the son gave the father the house, that included the son’s ownership period (which was more than one year), and it included the son’s cost basis (which is whatever the son paid in 2017).
Because the son gave the house to his father, the son must also file a gift tax return form 709 reporting the value of the gift. Gift tax is not usually owed unless the giver’s lifetime gift total is more than $11 million, but the IRS requires the form to track large gifts against that lifetime total. TurboTax does not include form 709, it is filed separately but is also due at the same deadline, which would be April 15, 2022, if the transaction occurred in 2021.
Father and son may have violated the terms of the mortgage. This is not likely to result in criminal issues, and if there is a sale in process, it is likely that the mortgage company will be happy to get their money, but if there are any delays or unexpected complications, father and son could get in quite a deal of trouble with the mortgage company. Legally, father is not required to pay off the mortgage. However, since there is a lien on the home, another buyer can’t buy it unless the lien is released, and son can’t release the lien without paying off the mortgage, which son can’t do because son doesn’t have any money. It’s not clear how the sales money will go from buyer to father to son to mortgage lender.
You definitely need to see a real estate attorney. The simplest thing to do may be to quit claim deed back to son. If the buyers attorney gets wind of this complication, they may have legal cause to back out, and it may be in their best interest to back out since they would have great difficulty in obtaining clear title from the son’s mortgage lender.
