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ryuy
Level 2

Do I qualify for tax exclusion for home capital gain for a gifted property that was used for rental in the past 10 years?

I would like to know if I qualify for fully or at a prorated rate for the exclusion for the home capital gain of a property that was given to me as a gift? 

 

The history of the house looks like this, and the tax (related to the real estate tax or rental income) was never filed under my name : 

 

2010 - I purchased the property with my sister; I paid full in cash and the property started being used as a rental; the property value was ~$200k

2012 - My name was removed from title upon mutual agreement (the property was still used for rental) \

2013 - The property was put under title of my sister's LLC 

2021 - The property was given back to me as a gift (no monetary exchange at all); the property value is now expected to be ~$500k. 

 

I am thinking of living in that property as a primary residence for the next few years. If I live more than two years, will I qualify for the full amount of tax exclusion for home capital gain ($250k per person), or will it be prorated (i.e., for example, if I live there for 2 years, the tax exclusion applies at (2/11) 2 years out of 11 years of $250k)? 

9 Replies
tagteam
Level 15

Do I qualify for tax exclusion for home capital gain for a gifted property that was used for rental in the past 10 years?

You most likely should have filed a gift tax return (Form 709) when you gave your share of the property to your sister in 2012.

 

Your sister should file a gift tax return for the 2021 calendar year.

 

Everything, starting from the period of your sister's sole ownership until the time she gifted the property to you will carry over to your ownership. That would include depreciation deductions taken (or which should have been taken) during the period(s) of rental use - note that the recapture of those depreciation deductions will not be shielded by the ($250k) home sale exclusion.

 

You should consult, in person, with a local tax professional and/or legal counsel.

Critter-3
Level 15

Do I qualify for tax exclusion for home capital gain for a gifted property that was used for rental in the past 10 years?

This mixed use and ownership  situation really needs you to sit down with a local tax pro so you can get all the ducks in a row for future tax planning.  Gift tax returns are a must as well.  

Carl
Level 15

Do I qualify for tax exclusion for home capital gain for a gifted property that was used for rental in the past 10 years?

2013 - The property was put under title of my sister's LLC

Which means "you" did not own the home or have any legal ownership in it at all.

2021 - The property was given back to me as a gift (no monetary exchange at all); the property value is now expected to be ~$500k.

If you sell the home in 2021, you will not qualify for any type of capital gains exclusion at all. In order to qualify, the property must have been your *primary* residence for at least 2 of the last 5 years you owned it, counting back from the closing date of the sale. Since you did not own the home prior to 2021, and it was never your primary residence for any period of time after 2016, no part of the capital gains exclusion rules apply here. Additionally, if you sell the property within one year after you obtained title/ownership of the property, then you will pay the higher short term capital gains tax rate. If you own the property more than one year prior to the closing date on the sale, then you'll pay the lower long term capital gains tax rate.

Please consult with a professional in your local area to confirm all the above. But for the most part based on the limited information provided in your post and making no assumptions on my part, you just flat out do not qualify for any exclusions.

 

 

Opus 17
Level 15

Do I qualify for tax exclusion for home capital gain for a gifted property that was used for rental in the past 10 years?

For purposes of the exclusion rule, everything that happened before the gift deed in 2021 doesn't matter (it resets the clock).  However, that will definitely affect your cost basis.  So I will discuss the exclusion rule and the cost basis separately.

 

First, you don't qualify for any exclusion until you have owned the home for 2 years and lived in it as your main home for 2 years starting from the gift deed in 2021.   Then, if the home is currently a rental, and you then move in to use it as your main home, the fact of there being a non-qualified period of ownership before the qualified period of ownership triggers a special set of rules.  Let's say the tenant's lease ends in 6 months and you move in, live there for 3 years, and sell.  You would have 6 months that is considered non-qualified and 36 months that is considered qualified, so only 36/42 or 85% of the gain is qualified.  You would pay gains tax on 15% of the gain, then 85% of the gain is applied to the exclusion rule.  Let's say your gain is $300,000.  The first $45K is taxable, the next $250,000 is excluded, and the last $5K is taxable (if you are single or head of household and not filing as married filing jointly).  If you lived in the home as your main home for 5 years, the 60/66th of the gain, or 91%, is excludable, and so on.

 

Now, to actually figure your gain, you have to know the cost basis, and this is where the ownership history is critical.  

As of 2010, your cost basis in your half of the home was $100,000 and your sister's basis was $100,000.

As of 2012, when you gave your half-interest to your sister, you gave her your basis.  So your sister's basis is now $200,000.

As of 2021, when the property is gifted back to you, your basis is your sister's basis which is $200,000, unless your sister made improvements that can be added to the basis.

 

However, you or your sister were eligible to deduct depreciation on the rental, and that must be accounted for even if you didn't actually take it.  That should be about $36,000 at this point.  You should get copies of all your sister's tax returns, or at least the depreciation schedules, so you have records of the depreciation taken.

 

If you sell the house now, your adjusted basis for the sale will be your basis ($200K) minus depreciation.  If your selling price is $500K, your gain is $336K.  The first part of the gain, which is due to depreciation, is taxed as depreciation recapture, which is taxed as ordinary income with a cap of 25%.  Then the remaining $300,000 gain is taxed as capital gains.  If you own less than 1 year, it's short term capital gains and if you own more than 1 year, it's long term capital gains.  

 

Now finally let's integrate these two concepts.  Suppose you move into the home after the tenant leaves and live there 3 years, and you sell for $600K.  Your capital gain is $436K.  The first $36K is taxed as depreciation recapture (you must always recapture the depreciation first).  Your remaining gain is $400K.  You are eligible to use the exclusion on 85% of the gain, which is $340K.  Since that is more than $250K, you use the full $250K exclusion, and the last $150K is taxed as long term capital gains.  If you are married, you can exclude the full $340K that is eligible for the exclusion. and you would have $60K of long term capital gains.

 

Hope this helps.  I agree you will want to engage a tax advisor, sooner is better. 

*Answers are correct to the best of my ability at the time of posting but do not constitute legal or tax advice.*
Hal_Al
Level 15

Do I qualify for tax exclusion for home capital gain for a gifted property that was used for rental in the past 10 years?

If you live in the home for more than 2 years, after getting title,  you will be able to exclude (up to $250,000) the portion of the gain attributable to residence time.  

 

You will have to allocate the gain between the time it was YOUR rental and your residence time.  Apparently  it was your rental  2010 to 2012, but not 2013 to 2021.  

 

You will have to recapture all depreciation "allowed or allowable" from 2010 to 2021.  As others have said, your sister's basis, including depreciation transfers to you with the gift. 

 

 Your cost basis is what you and your sister paid back in 2010  (~$200K).  The $500K present value is not relevant for income tax purposes (but is relevant for your sister's gift tax* return)

 

That's my opinion, based on the facts as I understand them.   As others have said, professional help is advised.

 

*"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/....

ryuy
Level 2

Do I qualify for tax exclusion for home capital gain for a gifted property that was used for rental in the past 10 years?

@tagteam 

Thank you for your advice! Yes my sister will be filing the gift tax. 

A few local CPAs that I have talked to said the same - the depreciation deduction needs to be recaptured (though I still need to talk to them further in order to understand what recapture means). 

 

I will talk with the CPA for further details and numbers. 

 

 

 

ryuy
Level 2

Do I qualify for tax exclusion for home capital gain for a gifted property that was used for rental in the past 10 years?

@Critter-3 

Thank you for your advice! Yes, I have started talking to a few CPAs and I will continue discussing with them for further details and numbers.

Mike9241
Level 15

Do I qualify for tax exclusion for home capital gain for a gifted property that was used for rental in the past 10 years?

a simple example of depreciation recapture ignoring the home sale exclusion

 

original tax basis $200 

depreciation taken or should have been taken $30

net tax basis $170 ($200- $30)

sell for $470 after holding for more than 1 year

gain = $300 ($470 - $170)

$270 of the gain would be taxed at your long-term capital gain rate(s)

$30 of gain is section 1250 (depreciation) recapture taxed at a special rate (up to $25%) depending on your other income

now let's consider the home sale exclusion

note that with a home sale depreciation must be recaptured before the home sale exclusion can be applied. 

if you qualified for the maximum home sale exclusion you would still pay recapture taxes on the $30

then the exclusion comes in so you would pay long-term capital gain taxes on only $20.

 

 

as noted you will not get the maximum exclusion if your current ownership starts while it is still rental property. 

 

 

 

 

tagteam
Level 15

Do I qualify for tax exclusion for home capital gain for a gifted property that was used for rental in the past 10 years?


@ryuy wrote:

@tagteam 

I will talk with the CPA for further details and numbers. 


You will be fine, @ryuy, as long as you consult with a qualified CPA (or other tax professional).

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