3 Own home. It is #2&3's Main Home, they are MF Jointly, #3 dies aftr 24 yrs, he had Sch C Depr for 15+ yrs. #3 Quit Claim to #1 aftr 12 yrs. Basis? Depr Recapture?

[The Good Son]

Son & Parents Buy a Home in 1999 for Parents to live in. Parents Filed Jointly thru 2023 when Father passed away. Father had home office and associated Depreciation for many years. Tax Prep SW shows "Prior" + Current Depreciation of $3,861 for Father as of 2015 Tax return. Father Quit Claimed Deed to Son in 2011 but was married to mom and lived in the home and was eligible to take home office deduction, so he did. For years starting 2017, Simplified Method was used. Final Tax Return for Father was filed in 2023. Home was sold in 2024. Key Question : Does Mom need to Recapture Dad's Depreciation on her 2024 Single Return? Does anything need to be done about this Depreciation? Regarding Basis, How would Mom and Son think about their basis? Home was also rented out for 1 year in 2007/2008 - how to deal with depreciation on Son's '07/'08 Schedule E, if any? Thank You!!

[Opus 17]

The depreciation applies to the whole property, not the father's "third".  What state did the two parents live in?  (Is it a community property state?)  What about depreciation from 2016? If simplified method was used from 2017, there is no depreciation for those years to account for.

[Edited to correct:]

At the time of the sale, the son owned 1/3 from 1999, and 1/3 from the quit claim deed.  Even though there was an implied life estate, it ended when the father died and the son became the owner in full.  So the son owns 2/3 the home and pays 2/3 the capital gains tax.

It appears that the son is a 2/3 owner and did not live in the home?  What were the circumstances of the quit claim deed in 2011?  If the idea was for the father to give his son his interest in the house to avoid probate, or to otherwise pre-dispose of assets, but the father would have the right to live there until he died, then the son may have an implied life estate, even if the deed was not a written life estate.  If there was an implied life estate, and the son can't sell until his father died, then the son didn't really "own" anything (because ownership implies the right to dispose of the property as he sees fit), and that would allow you to treat the entire selling proceeds as reported on the wife/mother's tax return.  So you can ignore the son's basis.  The wife's basis is determined by whether you live in a community property state.

If no, then her basis is half the cost in 1999, plus half the cost of improvements, plus half the fair market value on the day her husband died (stepped up basis), minus accumulated depreciation, no matter whose tax return it was reported on.  The accumulated depreciation is taxed (recaptured) but any remaining gain is covered by the full $500,000 exclusion for married couples, as long as she sells within 2 years of the date of her spouse's death.  

If yes, this is in a community property state, the wife receives a full stepped up basis equal to the fair market value on the date her spouse died, and the depreciation is wiped away.  Her only capital gain would be any gain in value from 2023 to 2024. 

[The Good Son · Accepted solution]

Thank You Opus 17 for the reply!

The parents lived in Illinois which I believe is NOT a community property state.

2016 Depreciation - cannot find tax filing, cannot download from their IRS account as it is too old.

Son did not live in the home other than during vacations.

The Quit Claim Deed was given to the son specifically with the understanding that Father would be able to live there indefinitely with his wife, which is documented in his Will.  So it appears the Son has an "Implied Life Estate" as you stated (wow, never heard of this before- very informative)

Per your feedback: So Mom's basis is half the cost in 1999, plus half the cost of improvements plus half the FMV from April 2023 (stepped up basis when Dad passed), minus Dad's accumulated depreciation.  Mom did sell within 2 years of Dad's death and did not remarry so the remaining gain is covered by the Full $500k exclusion.   

Regarding entries into Turbo Tax : At the time of sale, Mom and son received 45.3% and 54.7% of proceeds respectively to separate bank accounts to mitigate wire xfer risk.  2024 Substitute Form 1099-S (emailed by Title Company upon request) shows Son and Mom's name under "Transferor's Name and Address", only son's SSN in the "Transferor's ID number" box.  But both names and SSN's are shown on the "Seller's Certification(s) for No 1099-S" with the share of proceeds received and Six Seller Assurance questions each.     

Given the latest facts, would IRS be confused if "entire selling proceeds were reported on wife/mom's tax return"?  Does son need to enter any info/reference at all regarding this transaction on his joint return with his wife?

Thank You So Much!!! 

[Opus 17 · Accepted solution]

OK, so in trying to answer this question, I ran into some information that my previous answer was wrong.  Sorry about that.  I need to ask for extra help, and you may also need to see an accountant.

@Hal_Al  @rjs  @TaxGuyBill 

My mistake was that when the father died, the son got full ownership of the second 1/3 of the home, so the life estate is ended at that point.  

To start with, the son owned 1/3 of the house in fee simple, if it was bought as a 3-way deal in 1999 and there was no life estate at the time.  In 2011, the son obtained another 1/3 share under an implied life estate, making the son the "remainderman."  When the father died, ownership transferred to the son, not the mother, so the mother does not get a stepped up basis.  As of the date of the sale, the mother owns 1/3 of the home, and she should report on her tax return, 1/3 of the selling price and 1/3 of the basis and other adjustments.  The mother does not need a 1099-S, she can report the sale without it (one is not always issued so it is not mandatory on the tax return.)

The son owns 2/3 of the home, 1/3 in fee simple and 1/3 as a remainderman.  The son gets a stepped up basis on the 1/3 from the father (I think) but does not get a stepped up basis on the 1/3 he owned from 1999.  The son can report the 1099-S on his tax return because it was issued with his SSN.  Probably the best way to avoid IRS confusion is for the son to report the full amount of the 1099-S, and then report an inflated basis, so the capital gain comes out right. 

As far as depreciation, I still think it goes with the house, meaning the mother pays 1/3 of the recapture and the son pays 2/3.  But, I don't think it would cause harm if the son paid all the depreciation recapture, especially if it was due to rental activity from the son's tax return and business activity from the father's return.  

[The Good Son]

Thank you for the follow up Opus 17, I understand and Acknowledge. I have a call scheduled with a Turbo Tax, 'Tax Expert' later today to discuss this and other issues. Maybe I need an accountant as well. Based on what I understand so far, I would use the following EXAMPLE numbers just for discussion: Total 3-way deal Purchase Cost in 1999 = $226,689 Average of Zillow, Corelogic and Collateral Analytics FMV in April 2023, Further divided by 3 = $104,577.78 Example of Son's Adjusted Basis (using EXAMPLE Numbers): Original Cost (1/3 of Total cost in 1999) = $75,563 Stepped up Basis after Father Died (2nd 1/3rd via implied life estate) = $104,577.78 Remodeling Costs in 2024 (half of total remodeling costs paid by Son and Mom) = $11,000 Basement Addition in 2013/2014 (1/2 of costs paid by Father and Mother) = $20,023 Basement Restoration after Water Damage in 2022 (1/2 of unreimbursed costs paid by Father and Mother) = $2,906.35 Depreciation Recapture (2/3 of Total Depreciation) = ($2,574) Adj. Basis for Son = $211,496.12 Amount Realized 2024 = Sales Price in 2024 minus Selling Costs Son's PnL = 2/3rds of Amount Realized 2024 - Son's Adj Basis Is it fair to spilt the Basement Addition and Basement Restoration expenses between Mother and Son the way it was done or is it already factored into the Stepped Up Basis when Father passed? Thank You!!