This is likely not an easy question to answer, especially with possibly some missing details, but here goes.
My spouse bought a house a dozen years ago with a first-time homebuyer program from the city that the house is in. The city considered this a "loan" that you do not have to pay back until 30 years, or the house sells, whichever comes first. However, the contract says they own the percentage of equity that they initially contributed. Example figures are:
- Purchase Price: $600,000
- City "loan": $200,000
- City says they have 33.3% equity of this property
For selling the house, let's say we cannot claim any exemptions to the capital gains tax (e.g. no 1031, no primary residence exemption, etc). Let's then say it sells for, as an example, $1,000,000 after all closing costs. How do we calculate capital gains tax with equity sharing? Upon closing, if I understand correctly, the city would get their 33% of funds automatically through escrow (if that matters).
My hope is that we would say that our purchase price was ($600,000 minus $200,000) = $400,000, and sale price is ($1,000,000 minus their 33% equity of $333,333) = $666,667. So the capital gains would be $266,667.
However, my pessimistic mind also says that the IRS doesn't care about equity sharing, and would want the owner (not the equity sharer) on the hook for the original purchase price and sale price. If that's the case, then the capital gains would be $1,000,000 - $600,000 = $400,000 in taxable capital gains.
I'm not sure which is correct. Since this situation is uncommon, it seems to have to be manually entered in Turbo Tax. Thus, we have to know which figures to input. Thanks a lot for any advice.
