Taxes to pay on a sale of property

[jeshas]

So my parents purchased this house in 1996. We lived in it until 2011. In 2011, I purchased the property from my parents. My parents used the money to fix up the house and we put it up for rent. It has been a rental property since 2011. I just sold this house in Dec 1, 2020. My husband and I are planning to use the money gained from the sale to build a new home. Does anyone know if a) can i avoid capital gains tax by qualifying for this to have been a residence for me? b) any other strategies to avoid having to pay taxes on cap gains and the depreciation? c) any strategies/advice to defer the taxes?

[tagteam · Accepted solution]

There is virtually nothing you can do to avoid capital gains tax and depreciation recapture at this point.

Had you met the time frames, you could have done a 1031 (like-kind) exchange (but would not have any utility if you were planning to use the proceeds to build a house to be used as a personal residence).

See https://www.irs.gov/pub/irs-news/fs-08-18.pdf and https://www.law.cornell.edu/uscode/text/26/1031

You could also check into a QOF (qualified opportunity fund), but that involves deferral of capital gains tax only and not depreciation recapture and there are time limits (but would also have no utility if you need the proceeds from the sale to build a personal residence).

See https://www.irs.gov/credits-deductions/opportunity-zones-frequently-asked-questions#180-day

[Carl]

So my parents purchased this house in 1996. We lived in it until 2011.

I assume "we" refers to you and your parents.

In 2011, I purchased the property from my parents.

Thus making your the sole owner of the property.

My parents used the money to fix up the house

Just so I'm clear. The parents used the money you paid them for the house, to fix up a house that you own, and they don't own.

and we put it up for rent.

So now is "we" you and your spouse? I will assume so. Can't be you and your parents, assuming they have no ownership rights to the house.

It has been a rental property since 2011. I just sold this house in Dec 1, 2020.

If you sold the house at a gain, meaning more than what you paid your parents for it, you "will" pay taxes on any realized gain, as well as on the depreciation you are required to recapture. Period.

My husband and I are planning to use the money gained from the sale to build a new home.

What you do with the money realized from the sale does not matter. The gain realized from the sale is taxable income. No way around it, since you did not live in the house as your primary residence for at least 2 of the last 5 years you owned it.

Does anyone know if a) can i avoid capital gains tax by qualifying for this to have been a residence for me?

Basically, if the house was you *PRIMARY* residence for at least 2 of the last 5 years you owned it, then you can exclude up to $250,000 ($500,000 if filing joint) from your taxable income. But as I interpret your post, the house was "NEVER" your primary residence at any time during the last 5 years you owned it. Therefore, you don't qualify for *any* capital gains tax exclusion, unfortunately.

I would suggest you hold back no less than 20% of the gain for taxes. If your state taxes personal income you'll need to hold back to cover state taxes too.

On a positive note, the property improvements paid for by your parents with "their" money (what you paid them for the property) increases the cost basis of the property for "you". That will help reduce your taxable gain.

[Mike9241]

Carl: generally I agree with you. however, it seems that the parents paid for the fix-up from the sales proceeds - after they no longer owned the property.  I consider that a gift. if it was more than the exclusion for that year they should have filed a gift tax return.   the failure to file such a return may make it difficult for the taxpayer to prove the costs of the fix-up

[Carl]

I consider that a gift

So do I. But it does not change the fact that property improvements add value to the property, regardless of who paid for those improvements, and regardless of what we may consider them; gift or otherwise.

Besides, you definitely "WANT" things that add value to the property, since the increase in cost basis decreases your taxable gain on the sale.

[Mike9241]

i not disagreeing with adding to basis.  i'm trying to point out that likely the parents should have filed a gift tax return.  it would be valuable if the taxpayer is audited because they weren't paid by him.  where would the proof come from - maybe the parents could provide documents to the taxpayer.  things happen and documents get lost.  

[tagteam]

---

@Mike9241 wrote:

maybe the parents could provide documents to the taxpayer.  things happen and documents get lost.  

---

Paid invoices from contractors should suffice (hopefully, they retained them).

As a side note, it seems extremely unlikely that the parents would use the entire amount of the sales price they received to "fix up the house" (assuming this was not some sort of bargain/gift sale). Therefore, unless @jeshas posts some additional, clarifying information, no one can do any more than make an educated guess on the particulars of this matter.

[Carl]

Oh I agree on the 709 - Gift Tax Return. But in the interest of not "adding to the mix", since that's not the owner's issue, I didn't address it since this gift occurred years ago. Probably should have though.

As far as documentation on costs of those improvements, that may or may not be available. However, all the filings for the work would still be available at the courthouse. That is of course, assuming such filings for property improvements were required and were actually done. In my experience, a property improvement that does not change the amount of floor space will generally not be filed - though it probably should.  For  example, when someone is going to remodel their bathroom.

[Scott13105]

Would cap gains on the sale of this property have to be paid in the year they are recognized (i.e. property sold in 2022, taxes paid in 2022)? Or do you wait til the next filing year (sold in 2023, cap gains included on 2022 return that's filed in 2023). Wasn't sure if it's like paying estimated taxes or not.

[Vanessa A]

Yes, it is like paying estimated taxes. If you sold the property in 2022, you would make your estimated payments in 2022, then include the sale in 2023 when you file your 2022 tax return. 

[Scott13105]

Thanks Vanessa. I'm not currently making estimated payments, but just sold a property on 3/1/2022 and am estimating I've got a $10k cap gains tax due and roughly $6k in depreciation recap. Can I include that transaction when I file my 2021 return? Or do I need to do it separately before the end of Q1?

[LeonardS]

No, you can not include those transactions on your 2021 tax return.  Those transactions occurred in 2022 and will be reported when you file your 2022 tax return.

@Scott13105