Capitol Gains - deeded home

[cfh92]

Good morning--

I am trying to figure out how much I need set aside at tax time for an capitol gains I may incur. Here is the scenario:

In 2017 my grandparents bought my now-husband and I a home. They took out the loan and were the names on the mortgage. We moved in and it was our only primary residence until 2021.

In June of 2020 we deeded ourselves onto title and deeded them off, then refinanced the mortgage loan into solely our names.

In May of 2021 we sold the home.

The house was our primary residence from July of 2017 to May of 2021, but we officially owned the home from June of 2020 to May of 2021. Prior to owning, we had the property taxes homesteaded in our names as a relative-homestead and we made various improvements to the property. We had the home appraised when we refinanced into our name (June 2020) and it was valued only 10k less than what we sold it for less than a year later in May of 2021.

What are we looking at for capitol gains? Are we safe because of how long we lived in the house? Do the improvements we made prior to owning the home count toward anything?

[Carl]

In order to qualify for the capital gains exclusion you must have lived in the house for at least 2 of the last 5 years "you owned it". You have not owned the property for 2 years. Therefore you do not qualify for any capital gains exclusion unfortunately.

In June of 2020 we deeded ourselves onto title and deeded them off,

Unless there's something I'm not aware of (and there could be) "you" can't just arbitrarily remove someone from a deed.  The person being removed from the deed is the one who signs and submits the quit-claim deed on the property. So it's perfectly possible that those who quit-claimed the property to you may be required to file IRS Form 709-Gift Tax return with the IRS, if the value of the property was more than $15K. (I'm sure it was too.) Now they won't pay any taxes on the gift if it was less than $11.2M. But the reporting requirement is still there.

[Opus 17]

You likely owe substantial capital gains tax.  

Here's how the transaction looks to the IRS.

1. In June 2020, your grandparents gifted you a home.  At this time, your grandparents would have been required to report the gift on a form 709 gift tax return, although they would typically not have to pay actual tax. The form 709 is mostly a tracking requirement.

2. In May 2021, you sold the home.  Since you did not own the home more than 2 years, you do not qualify for the capital gains tax exclusion.  Since you owned the home less than 1 year, you will pay capital gains tax at the higher short term capital gains rate.

Your capital gains is the difference between your cost basis and selling price.  It has nothing to do with the amount of cash proceeds, any appraised value, or the amount of the mortgage that was paid off.  

Since the home was a gift, your cost basis is the same as your grandparents' cost basis, which is what they actually paid for the home in 2017.  You can add some (but not all) of the 2017 closing costs to the basis.  You can add some (but not all) of your closing costs from the 2021 sale to the basis as well.   You can also increase the basis by the cost of permanent improvements made to the home or the land.  Improvements make the home more valuable or increase its useful lifespan.  For example, new windows are an improvement, while painting or fixing a leaky sink are repairs and don't increase the cost basis.   Allowable adjustments to basis are discussed on page 8 of publication 523.

https://www.irs.gov/pub/irs-pdf/p523.pdf

• For example, your grandparents paid $100,000 in 2017.  You can document $3000 of closing costs that are allowable adjustments to basis.  
• You made $20,000 of improvements.
• You sold the home for $200,000.  You paid a 6% commission ($12,000) and had other closing costs that were allowable adjustments to basis of $1,000.  
• Your adjusted cost basis is $136,000.  You have a $64,000 capital gain.  Because it is a short-term gain, it is taxed as ordinary income, which will probably be 22% or 24%for federal taxes, plus 3%-10% state income tax depending on what state you live in and your other income. 

If you moved because of an unforeseen emergency (like changing jobs, losing your job, etc.) you might qualify for a partial exclusion of the capital gains.  This is discussed on page 6 of publication 523. 

Unfortunately, some of these tax issues could have been avoided with better advance planning.