@teg2k wrote:
Market value = $110,000
Bought for $24000 (in 1977)
Formal rental agreement, declare income
Lived there 41 years
Cousin has rented for 2 years this August - will not be 3 years
Thanks so much for any insight!
Since the home is being sold at (or slightly above) market value, the concept of a gift of equity doesn't enter into it.
Your parents will owe recapture of depreciation but no other capital gains tax.
When your parents put the home in service, they should have claimed depreciation. The basis of depreciation is their cost basis, or FMV at the time, whichever is lower.
Their cost basis is the price they paid in 1977, plus the cost of any permanent improvements or upgrades (which I forgot to ask about), such as a new furnace, new roof, or other remodeling. Let's assume that there were $10,000 of improvements so their cost basis in 2017 was $34000.
They were entitled to claim depreciation over 27.5 years during the rental, so about $1236 per year. (They will need to provide exact numbers.) When selling, they must pay tax on depreciation they previously deducted or could have deducted as a rental expense.
Then, if they owned the home at least 2 years (yes) and lived in it for at least 2 years (yes) ending not more than 3 years before the sale (yes), then the first $500,000 of capital gains is excluded from income.
The math works like this.
Original cost basis minus depreciation = 34,000 - (1236 x 2 years) = 31,528.
Selling price $115,000.
Capital gains = $83,472.
The first $2472 of capital gains is depreciation recapture, it is taxed as ordinary income with a maximum tax rate of 25%.
The remaining $81,000 of capital gains is covered by the homeowner exclusion and is non-taxable.
