Sale of Inherited Home and Gift Taxes

[mgawro01]

When my mother passed away my Dad had me remove her from the deed (2008) and add me to the deed.  The thought being I could sell the house when he passed away not thinking of the tax consequences.   Well He passed away (2023) and I sold the house to my nephew and the proceeds to be split between the siblings.    I figured its inheritance and no tax consequences.  Well a 1099-s was generated for the sale in my name.   We had the house appraised when he passed away.  Do I have to pay capital gains on the sale?  Would the starting value of the home be when I was added to the deed in 2008 or value at time of death 2023? Since we sold to a family member for less than appraisal value would that be a lost if stepped up value to 2023?  

Now the splitting of the profits.  I figured I would just write a check to my brother and sister for their share but would that amount now be consider a gift and subject to the gift tax since the amount is over $17,000.   Is there any way around the gift tax.  I'm sure I can write a check to their spouses but still over $34,000.    Can I just give them some cash over the year, or zelle.  I just don't want to get stuck paying the capital gain tax and gift tax since my name was on the deed.  Thanks for any help

[rjs]

Don't try to handle this yourself. Consult a local tax professional. There are too many complications to cover it all here.

[tagteam]

I agree with @rjs in the sense that you should definitely not try to handle this situation yourself.

Considering there are other potential heirs involved (i.e., your siblings), you should probably consult with local legal counsel prior to distributing any proceeds from the sale.

See https://www.avvo.com/estate-planning-lawyer.html

[Hal_Al]

As others have said, professional tax help is advised.  That said, here are some things to be aware of.

Q. Since we sold to a family member for less than appraisal value would that be a lost if stepped up value to 2023?  

A. Maybe. You are not allowed to deduct a loss, in a sale to a close family member. But, a nephew is not considered close enough (reference:https://www.law.cornell.edu/uscode/text/26/267). In addition, the difference between the value and the sale price is  a "gift of equity" and requires a gift tax return if the difference amount is more than $17,000.  

You ability to deduct a loss is further limited by how the property was used, after you inherited it, but before you sold it. You may not deduct the loss on personal use property. If the house was vacant during that period, it is considered investment property and the loss is deductible. 

Q.  I figured its inheritance and no tax consequences?

A.  It probably is, depending on the details.  The usual rule, for a gift, is that the recipient's basis is the giver's basis (what you parents paid for it, adjusted for the stepped up value at your mother's death). But there is an exception for the gift of a home, where he retained the right to live there ("life estate"). "If you give away an asset and keep a life estate in that asset..... the cost basis of the house is "stepped-up" to the value of the house on date of death [IRC 2036]")

More info: http://www.law.cornell.edu/cfr/text/26/20.2036-1

Q. Well a 1099-s was generated for the sale in my name?

A. The 1099-S should be reported on your tax return, but there is a way to show it was the sale of an inherited asset. Besides, there was no capital gain to report. You report $0 capital gain, on your tax return. 

Q.  Would the starting value of the home be when I was added to the deed in 2008 or value at time of death 2023? Since we sold to a family member for less than appraisal value would that be a lost if stepped up value to 2023?  

A.  Half the original cost basis steps up in 2008, on your mothers death (100% step up if they lived in a community property state). In 2023, his half steps up (your half does too, if the life estate rule applies and it probably does.

Q.  Is there any way around the gift tax?

A. "Gift Tax" is somewhat of a misnomer.  Even though a gift tax return may be required, very few people ever actually pay federal gift tax. The purpose of the gift tax return is usually only to document a reduction in the allowable estate tax exemption.
See https://turbotax.intuit.com/tax-tools/tax-tips/Tax-Planning-and-Checklists/The-Gift-Tax-Made-Simple/...   

If his will stated that the proceeds (from the sale of your half) was to be shared, then your distribution, to them,  may not be considered a gift. 

[tagteam]

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@Hal_Al wrote:

As others have said, professional tax help is advised.  That said, here are some things to be aware of.

Q. Since we sold to a family member for less than appraisal value would that be a lost if stepped up value to 2023?  

A. No. You are not allowed to deduct a loss, in that situation.  In addition, the difference between the value and the sale price is  a "gift of equity" and requires a gift tax return if the difference amount is more than $17,000. 

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This is one of the reasons I suggested (as did rjs) that @mgawro01 seek professional assistance and, most likely, local legal counsel. 

We have no way to examine the deed and determine how title was held between @mgawro01's mother and father and we also have no way to examine the deed after @mgawro01's mother was removed from title. 

As a result, we have no way of knowing how title was being held between @mgawro01 and @mgawro01's father. The foregoing makes a great deal of difference as does whether or not there was some sort of valid testamentary document.

Finally, and with reference to the above-quoted Q&A, @mgawro01 stated that the sale was to a nephew and that relationship is not included in the related party rules in the Tax Code (Section 267). As a result, a loss on a sale to a nephew could be recognized.

[Hal_Al]

@tagteam  thanks for that clarification. I did not realize "related party" was that limited.

references: https://www.law.cornell.edu/uscode/text/26/267

https://www.castroandco.com/blog/2019/february/section-267-b-1-related-family-members/

I have revised my reply above and also added a comment about "personal use" and the ability to deduct a loss. 

[Opus 17]

I think there's one other thing missing from the discussion.

If your father retained a life estate (the right to live in the home as long as he was alive), then you inherited the entire house with a stepped up basis.  That would mean you had no taxable capital gains, as long as you sold the home at or below the FMV on the date of your father's death. 

If he did not retain a life estate, then you inherited half the house with a stepped up basis, but the other half of the house (the half gifted to you in 2008) has a cost basis equal to half your father's cost basis in 2008, which is calculated from the purchase price, cost of other improvements, fair market value when your mother died, and whether or not your parents lived in a community property state.  

Now the key is, a life estate can be in writing in the deed, or it can be implied by the facts and circumstances even if is not in writing.   If you can show by facts and circumstances that your father retained an implied life estate, your tax position suddenly becomes much simpler.  This is another reason to consult a professional tax and legal advisor. 

[mgawro01]

Thanks for all of the great information.  It was extremely helpful.    The state is Massachusetts which is not a community property state.   In 2008 my Dad had me fill out a quit claim deed that removed my Mom from the deed and added my name.  We filed with the registry of deeds.  Thought being when he passes it would be easier to sell and avoid prorate (which it did).  He continued to live in the house up until his death.   I never lived in the house since I was added to the deed and it was never occupied after his passing.  I did have it appraised after his to help determine sale price for nephew.   Since he retained the right to live there the step up value would be to the time of his death (2023) and not (2008 date I was added to the deed)?

Since I sold to my nephew for $50,000 less than it was appraised I shouldn't have to worry about any capital gains?  maybe even a loss?  The $50,000 would be counted as a 'gift of equity'.    Not taxable just applies to $12.06 million lifetime exemption?

The proceeds are to be split among my siblings and just don't want to be stuck paying taxes come tax time.  So is it safe to say if I write a check for over $17,000 to each of them that I won't in fact pay a gift tax on that amount over $17,000 but it would just be counted towards my lifetime exemption?

Thanks in advance

[mgawro01]

In 2008 we just filed a quit claim deed with the registry of deeds in Massachusetts that removed my mothers name from the deed and added my name to the deed.  We just did it ourselves

[mgawro01]

Yes after I was added to the deed he continued to live there up until his death.  Adding myself to the deed was just to make the sale of the home easier up his death.   Nothing was in writing as far as a 'Life Estate' estate but I sure I can show with facts that he lived.

I am planning on consulting a tax professional but was hoping to wait until 2024 tax season.   In the meantime I'm just trying to get a feel if I go ahead and split the proceeds among my siblings I won't get hit with a large tax bill next year or should I retain some in escrow until after tax season.

thanks

[rjs]

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@mgawro01 wrote:

I am planning on consulting a tax professional but was hoping to wait until 2024 tax season.

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It would be better to consult a tax professional now, when they're not busy.

[tagteam]

I agree with @rjs; consult a local tax professional now (or legal counsel).

The result you want is a stepped-up basis but also where you do not have to use part of your lifetime exclusion in order to distribute the proceeds to your siblings (which, admittedly, may not be possible).

[Opus 17]

@mgawro01 

Given all the facts, your father probably had an implied life estate.  You will want to get that documented as best as possible in case of audit.  (You don't need to submit proof with your tax return, but do your best to document the circumstances and keep the information with your other important tax papers for at least 3 years.)

Assuming a life estate, you inherited the property at full market value.  Selling for $50,000 under market value has several implications you need to review with a specialist. For one thing, there is no absolute requirement that you sell property at market value, and if you sold at less than market value, you may have a capital loss that you can report on schedule D and use to offset any other capital gains you might have.  (You can treat the home as an investment and deduct a loss as long as you never used it as your personal residence.)

However, selling to a "related person" may disallow the claiming of a capital loss.  (And that depends on whether a nephew is considered a "related person" for this type of transaction, which I am not sure about.)   Also, if the nephew is considered a related person, it is possible that not only are you disallowed from claiming a capital loss, but you might have to report $50,000 as a gift of equity to your nephew on form 709.  

(It would be a deductible capital loss and not a gift of equity if you sold it to a stranger.  The question is whether a nephew is a close enough relative to be a "related party" under tax regulations.  I don't know off the top of my head.)

And lastly of course is the issue of whether or not the money paid to the other relatives is considered a gift for purposes of form 709.  I suspect that if the house did not go through probate, then it is legally yours alone, and even though you might be following your father's wishes in sharing the proceeds, that will legally be considered a gift reportable for tax purposes.  I'm not sure you can avoid that.  However, there is a $13 million gift and estate exclusion, so gift tax will probably not be owed even if the gifts are reportable.  (And if you expect your gifts or estate to be more than that, you should definitely be hiring your own expert who will back up their opinions by standing with you in case of audit.)

Finally, off the topic of taxes, I wonder if you have considered the implications of the below market sale to the nephew.  Supposing you had 4 siblings so the proceeds are to be divided 5 ways.  By selling for $50,000 less than market value, your siblings are each getting $10,000 less than they would have gotten if you had sold it to a stranger at market price.  Do they know this and are they ok with that?  Lesser amounts have torn families apart.

[tagteam]

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@Opus 17 wrote:
The question is whether a nephew is a close enough relative to be a "related party" under tax regulations.  I don't know off the top of my head.)

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I mentioned this issue in a previous post; a nephew is not considered a related taxpayer for the purpose of recognizing a loss in this instance (per Section 267(b)).

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@Opus 17 wrote:

Given all the facts, your father probably had an implied life estate. 

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Given the facts, particularly that the father, apparently, wanted the proceeds of a future sale to be distributed among @mgawro01 and the two siblings, it would be optimum to assert that there was a constructive trust (of which @mgawro01 was the trustee) rather than an implied life estate. 

The foregoing is precisely why @mgawro01 needs to consult with a local tax/legal professional.

[mgawro01]

Thanks again for all of the great advice.  Yes, we all agreed upon the sale price for the family member so that won't be an issue.

It sounds like I shouldn't have to worry about any capital gains for the sale of the property.   Possibly a loss and a gift of equity for my nephew.   I will have to report the gift tax for my siblings but I won't have to pay any actual gift tax until I hit the maximum which I don't see me reaching unfortunately.