House sale as co-signer on loan with family

[owlcreekla]

We helped our child purchase a large primary residence in 2020 and all three of us are on the deed. Our child took over all expenses and extra bedrooms were rented to friends. We saw the property as a rental and took depreciation. The renters moved out in 2023 and residence is now being sold with proceeds going towards a smaller primary home for child where there will be no renters. Mortgage will still need us as parents as co-signers. The sale is for $280k with a gross profit of $100k. How should the gain be divided between child and parents on the 1099-S? 

[Mike9241]

The info you provided leaves out much data that we would need to give you a proper answer. Additional questions could be asked but your answers may lead to more questions.  Examples: Was fair rental being charged? if not, that might lead to the conclusion, that the rental should not have been reported at all by anyone and thus no depreciation taken. if it was rented at fair rental value did your child report the rental on his/her tax return? since the child paid all the expenses, did you deduct things like mortgage interest, taxes and other rental expenses on your return? That might be improper since you didn't pay them. How did you compute depreciation since you were co-owners with your child and only part of the house was being rented.   

My suggestion would be for you and your child to confer with a tax pro to go over what each reported on their returns. They can ask whatever questions they feel are required so reporting of the rental and sale is proper. Maybe everything is fine maybe not. if not it's likely that amended returns and or form 3115 would be needed to correct the reporting for each year of the rental. Maybe gift tax returns should have been filed. 

[TomD8]

"We saw the property as a rental and took depreciation."

Did you apportion all of your deductions (including depreciation) based on the square footage of the rented (not shared) space?  Did you rent the rooms at FMV?  Did you deduct only the portion of expenses that you actually paid?

As @Mike9241 pointed out, these are some of the issues that might come up in an audit.  

Capital gain in cases of joint ownership is normally apportioned according to each person's ownership share.

I agree with @Mike9241 that you might do well to seek the services of a tax professional.

[Opus 17]

Starting with a very basic setup.  Child buys a home, parents co-sign the loan, bank requires the parents be listed on the deed as well.  Child lives in the home and pays all the bills, and takes the tax deduction for mortgage and property taxes.  The facts would show that the child was the 100% owner in fact, even if not in name, and the child could report the gain only on their tax return and use the $250,000 personal capital gains exclusion.  

Once you start complicating things with the rental, Mike's questions become very important.  Did you file tax returns as if the child was the sole owner, the child reported all the rental income, deducted expenses and claimed depreciation?  Or you did you file taxes as if the ownership was divided 2 ways (child and parents) or 3 ways (child and two individual parents)?  Who deducted the property taxes for the rental portion on schedule E?  Who deducted the property taxes and mortgage interest on schedule A?

If you established a new fact pattern, where you are co-owners and co-landlords, you may be stuck with that fact pattern.  Parents and child may need to split the sales proceeds and each report a share of the capital gains.  Child can claim the capital gains exclusion on their portion of the gain, but parents will owe capital gains tax on their portion.

The bottom line is that you can't treat the property as co-owned when it is convenient to do so (such as a rental) but claim it was really owned by the child when it later becomes convenient to claim that.