Does this transaction fall under Capital Gains/Loss or Gift Tax? And is filing necessary?

[taxman33]

Hello fellow taxpayers!

Just wanted a clarification on how this should be filed or if it even needs to be filed at all.

Money received from a sibling as a buyout for inherited property that was left by a parent.

In this case the money received from the buyout was substantially less than the FMV of the property at the time the deceased passed away and even far less now. So here's the breakdown example: FMV was 400K, buyout was 150K. How should the person who received the buyout report the 150K on their taxes and does it even need to be filed? Should it be reported as a Capital Loss which in this case given the example it would be or given that it's a transfer of a property between two siblings would it be subject to the gift tax?

Also, if there is no other taxable income for that year or it falls under the federal threshold for filing, does the IRS still require a tax return to be filed just for the purposes of having this transaction on file?

Thank you for the help in advance!

[Mike9241]

the seller is supposed to report the sale, especially if they got a 1099-s. however, because this is a sale between related parties (siblings) the loss is not allowed. They would enter cost in the proper column of form 8949, then use code L and report the loss as a positive number in column g.

if they got a 1099-S, they need to file. Otherwise, see this link to see if they need to file based on gross income. Gross income is not reduced for capital losses.https://www.irs.gov/newsroom/heres-who-needs-to-file-a-tax-return-in-2024 

[Bsch4477]

Seems like it was a sale of inherited property so your cost basis was the value at the time of the death of the decedent. You don’t get to deduct a loss on the sale of personal property. 

[taxman33]

Thank you for the reply. I believe you meant to say report it as a negative number and not positive correct?

So it sounds like from your response that unless a 1099-S is received you would not need to file considering it would be a loss and losses can't be reported because it's between two siblings. Here's my followup question tho, how do I prove all this to the IRS and make sure that I'm ok if a return is not filed? Just keep copies of all documents associated with this like for example, the Quit claim Deed, some type of FMV valuation that proves the value of the property was significantly greater than what I received in the buyout?

Will Turbotax even allow me to file if it's not necessary just so the IRS has proof of all this?

[Opus 17]

If you don't get a 1099-S, and it is a loss on personally owned property, you don't have to report it.  You could report it anyway, show the loss, and indicate that it is personal (Turbotax will include the sale on form 8949 and schedule D to show the work, but won't take a deductible loss).  Regardless of whether you report it or not, you should keep proof for 6 years in case of audit, including proof of the inheritance and the FMV, and proof of the sale to a relative (any documents, contracts, deeds, the check, etc.).

[taxman33]

Just to clarify, you're not saying that a buyout on inherited property from a sibling is considered gross income for income tax purposes correct?

And to your point if it's considered personal property then why wouldn't it qualify as a capital loss?

Taken straight from the IRS : If the buyout price is lower than the stepped-up basis, you may have a capital loss (deductible for investment or rental property but not for personal-use property).

I'm not even sure what type of property this would qualify as, I did not live on the property but I also collected no rent so is it considered personal or investment in the eyes of the IRS?

[TomD8]

If you sold your interest in the property for less than its FMV as of the date of sale, then you've given your sibling a gift of equity, which requires filing a gift tax return (IRS Form 709) if the amount of the gift exceeds the current annual gift tax exclusion amount ($18,000 in 2024).  The gift is the amount between the FMV of your interest in the property and the price you received.

If you sold your interest in the property for less than your adjusted cost basis, then you have a capital loss.

If the property was not used as rental, investment or business property during your time of ownership, then the property is considered personal-use property and your capital loss would not be deductible, nor would it be eligible for the $3,000 annual capital loss carryover. In that case it is not necessary to report the loss on your income tax return.

https://www.freetaxusa.com/answers?faq=10581

[Opus 17]

"Just to clarify, you're not saying that a buyout on inherited property from a sibling is considered gross income for income tax purposes correct?"

Everything is income, the question is whether it is taxable, and whether you have to report it.

"And to your point if it's considered personal property then why wouldn't it qualify as a capital loss?"

It may be a capital loss, but you can't take a tax deduction on a capital loss if this was personal property.

"I'm not even sure what type of property this would qualify as, I did not live on the property but I also collected no rent so is it considered personal or investment in the eyes of the IRS?"

This is an important question.  There is some argument that, if you inherit a home from a relative, and do nothing more than fix it up, clean it out and sell it, then you can treat it as investment property.  Since the selling price so soon after death is probably the fair market value (FMV is defined as the price a buyer is willing to pay a seller in an open sale, an appraisal is just an estimate), there is a small capital loss when you account for the real estate commission, and I have seen it argued that if you sell an inherited house, and never lived there, and only cleaned it out to sell it, you can take that small capital loss created by the real estate commission and use it to your benefit.  I don't know if it is a universally agreed upon concept, but it is a common argument.

However, while you are under no obligation to sell for the highest possible amount, there are problems if you sell something to a relative at a below market cost, and then try to take the loss as a tax deduction.  It's a back door way to deduct a gift, which is not allowed.  (In other words, if you could sell to a stranger for $50,000, but you sell to a relative for $40,000, you are giving the relative a $10,000 gift.  You can't take a tax deduction for a  cash gift, so you should not be allowed to take a capital loss for the amount you gifted to the relative.)

So even if you want to go by the argument I first mentioned, that this is investment property to you (given the circumstances, even if your sibling is living there as their personal home, it might be an investment for you), then you have the issue of the gift of equity, and how that affects your ability to deduct a loss (which exceeds my knowledge on this topic). 

[taxman33]

It definitely wasn't intended to be a gift that's for sure lol. So I'm good on that one.

But yeah I guess my conclusion from this is I won't be able to deduct the loss but it seems since it's not considered a gain at least I wont have to be taxed on it either. So seems like a draw. From everything I've read it's not considered part of taxable gross income, it's considered capital gains which again is not the case here that's for sure.

Thanks to everyone who responded, appreciate the help!

[Opus 17]

"Regardless, a loss cannot be taken on this transaction since the property was sold to a related person (a non arm's length transaction),"

I knew there was a limitation like that but I didn't remember the specific reason.  Thanks.