cknick- to answer your question we need to know, his cost basis (what he paid for it plus the cost of any improvements). Mortgage payoff is irrelevant.
For example, lets say his cost basis was $150,000. He will report a $30,000 capital gain (180K sale price less 150K cost basis). Your cost basis, for any future sale, is the $180K you paid. The gift of $40K is not relevant for income tax.
But, for a 2nd example, let's say his cost basis was $200,000. He has a $20K capital loss. But, he is not allowed to deduct a loss on the sale of personal use (2nd home) property. So, he either doesn't report the sale at all or he reports it at 0 gain/loss. Your cost basis, going forward, is his $200,000 basis. not the $180,000 you paid, and not the $220,000 it is worth.
