Does 'gift of equity' create capital gain or add to cost basis to home we sold to our son? Home appraised for $187K. Gift of equity was $13K. Our cost basis was $174K.

[Anonymous_]

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@curiousminds wrote:

I agree it sounds like the regs are in understanding of our position but the regs don’t tell you how to properly file your taxes so that the seller doesn’t end up paying capital gains on the gains in addition to their gift of equity.

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This thread is both ridiculously long and idiotically old (probably 3-5 years old since the thread migrated from an old TurboTax board). Moreover, there are at least four different fact patterns posed by different users (is it any wonder why there is confusion here?).

Regardless, a seller does not include the value of the gift in the seller's gain/loss calculation. For example, if the sales price is $100,000 to a related party, the seller's adjusted basis is $50,000, and the FMV of the property is $125,000, then the seller has made a gift of $25,000 and the seller's gain is $50,000 ($100,000 amount realized less adjusted basis of $50,000). The $25,000 gift does not factor into the seller's gain/loss computation. 

[curiousminds]

Look, I think we are beyond the academics of what should and shouldn’t be considered a capital gain in this situation. What you’re not getting into despite my repeated efforts to steer the conversation back into this direction is HOW? How do folks properly file their taxes to reflect this reality? Remember, the IRS is going to see your purchase price of 50k, and a sale for 125k.

[TomD8]

@curiousminds --

Q:  "How do folks properly file their taxes to reflect this reality?"

A:  Assuming the seller does not qualify for the capital gain exclusion and therefore must report the sale, in TurboTax the user would go to Personal Income > Less Common Income > Sale of Home (gain or loss), and follow the program prompts.  This will result in the sale being properly reported on the user's tax return..

[curiousminds]

Okay, and do one of those prompts have something todo with a possible gift of equity? I don’t yet have TurboTax.

[TomD8]

The program requires the user to enter the home's adjusted cost basis.  If the home was acquired with a gift of equity, the user would have to factor that into the adjusted cost basis.  (The gift of equity reduced his cost basis.)

[Anonymous_]

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@TomD8 wrote:

If the home was acquired with a gift of equity, the user would have to factor that into the adjusted cost basis.  (The gift of equity reduced his cost basis.)

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Could you possibly post an example of this scenario? 

I believe the confusion (stated elsewhere in this thread) might simply be the result of posters herein using different terminology (or methodology) for determining basis when property is acquired part through sale and part through gift.

[TomD8]

@Anonymous_ --

Jack's parents' home is worth $200,000.

Parents sell the home to Jack for $175,000 - thus giving Jack a $25,000 gift of equity.

Years later, when Jack sells the house, his cost basis is $175,000.

The gift of equity reduced Jack's out-of-pocket cost at purchase, but also added $25,000 to his potential capital gain when he sells the house. 

[curiousminds]

When you say “the gift of equity reduced his cost basis” are your referring to the buyer? So it should say “the gift of equity reduced the buyer’s cost basis”? Otherwise that would just increase the amount of capital gains for the seller.

[TomD8]

@curiousminds 

Q:  "are your referring to the buyer?"

A:  Yes.

[Anonymous_]

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@TomD8 wrote:

@Anonymous_ --

Jack's parent's home is worth $200,000.

Parents sell the home to Jack for $175,000 - thus giving Jack a $25,000 gift of equity.

Years later, when Jack sells the house, his cost basis is $175,000.

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Yes, thank you, that is correct (finally) and we were apparently simply using different terminology. Regardless, the end result is the same.

Also, perhaps we have a different thought process in analyzing this particular scenario. Mine simply follows the applicable regulation (part sale/part gift basis is the greater of price paid or transferor's adjusted basis).

[Anonymous_]

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@curiousminds wrote:

When you say “the gift of equity reduced his cost basis” are your referring to the buyer? So it should say “the gift of equity reduced the buyer’s cost basis”? Otherwise that would just increase the amount of capital gains for the seller.

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If you read the following sentence in an earlier (much earlier) post, I suspect that is what might be causing a great deal of confusion.

If dad's basis before the gift is 100 and he makes a gift of equity of 15 to his son, isnt his basis 85 for purposes of computing the gain?

Clearly, the seller's (in the above instance, the dad's) basis is not reduced by the amount of the gift of equity when the seller makes a gift of equity.

[curiousminds]

I do want to reiterate that in these transactions what is happening is, the home's purchase price is still $200,000, however the gift of equity becomes a down payment on that amount, however it isn't the same as the buyer giving cash to the seller to use as a down payment, there is still no hands exchanging money involved. This is why when someone get's a 1099-S form they are worried about paying capital gains because it reflects the purchase price, not the price the seller sold for. Does that still make sense?

[curiousminds]

True, this was definitely causing me some confusion. The easiest way for me to reconcile this as true, is the fact that everything I read which talks about these kinds of transactions talks about how one of the cons is the fact that it lowers the buyers cost basis (which makes sense) therefor the sellers cost basis must go up as a result, or at least something is adjusted so that the same capital gain taxes aren't being payed twice by the seller and the buyer when they go to sell say in the same year.

[Anonymous_]

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@curiousminds wrote:

I do want to reiterate that in these transactions what is happening is, the home's purchase price is still $200,000.....

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No, it is not. The purchase price is $175,000 and, in the hypothetical set forth in the post above, the 1099-S should reflect that price, not the $200,000 fair market value; $175,000 is what the parents are receiving (gross proceeds).

See https://www.irs.gov/instructions/i1099s#idm140083296860480 (gross proceeds)

[curiousminds]

Did you read the OP of this whole thing? I understand that 175,000 is what the parents are receiving, but that is not the same as the purchase price.  Mortgage companies keep the purchase price close to but under the appraised value, and the difference between the two becomes the gift of equity which becomes the down payment for the buyer.