I have a question regarding Capital Gains taxes. My parents changed the deed to their house in 2005. Adding myself and 2 other siblings on the deed

[deriggin]

I have a question regarding Capital Gains taxes. My parents changed the deed to their house in 2005. Adding myself and 2 other siblings on the deed  I believe this is considered a gift. . My parents passed in Late December of 2017.  We are in the process of selling the house. My understanding is that Capital Gains will need to be paid for the Fair Market Value in 2005 against the sale price.  Based on Tax reciords the  property Value in 2005 was $450,000, we sold the house for $900,00, so we owe Capital Gains on the $450,000. And since the proceeds will be divided by 3 than we each owe Capital Gains taxes on $150,000 each.Am I under the right assumption?     As a follow up question, If I use my proceeds from the sale $300,000 to pay off my primary resident Mortgage off, do I still owe the capital gains tax?  I can pay off my present mortgage which is $2000,000.  Thank you for your response

[jtax]

Sorry for your loss. 

First off taking the proceeds and paying off your mortgage has no affect on whether you owe capital gains on the sale of your parent's house. Sorry.

You are correct that your parents gifted you a share of the house in 2005. However you are not right about the gain. It is much more complicated.

What was the form of the title? Were you joint owners or tenants in common?

This is fairly complicated and I would recommend seeking the professional advice of a estate/probate/tax attorney.

Assuming joint ownership with three children and two parents you would have owned 1/5 = 20% of the property in 2005. The tax records are not really good enough to find the FMV. You really need to have had done a professional appraisal. (Tax assessments in many towns do not reflected reality). You could try to use that but it might not hold up. Again that is a good question for your attorney to answer.

When you think and report what you own or sold think of it is 20% or 25% or whatever of the house at 123 main st. Just like if you own stock you own a certain number of shares. You report what you get and what you owned. X% of the total.

Your capital gain is the amount you get for selling (gross proceeds - costs of sale like commissions, transfer taxes, etc.) - your adjusted basis.

The general rule (see below for some twists) is that Adjusted basis is purchase cost (including expenses) + improvements (e.g. adding a room).

Going with the $450k valuation, in 2005 each kid received a gift of 20% x $450k = $90k. Your parents were required to file a Gift Tax return (Form 709) in 2005. No actual gift tax would be paid unless your parents made total lifetime gifts through 2005 of more than $1M. [The state might have a gift tax with different rules.] The receiver of a gift does not pay income tax on it, so that is not a problem.

However your basis in the property is not $90k. Instead it is 20% of your parent's basis. Yes you have to go back to their records of purchase and improvements over the years to find that number. Let's call that your gift basis.

When your first parent died (assuming joint ownership again), each of the owners (including your surviving parent) splits his or her 20%. So then you own 20% + 1/4 of 20% = 25% of the house. 

The basis is "stepped up" to the FMV on the date of death for the % owned by the decedent.Your basis at that point is your gift basis + 5% of the FMV at the date of death. [Your siblings and surviving parent get the same thing, so the overall basis is stepped up by 20% of FMV].

Upon the death of your second parent you do that calculation again except that parent's share is 25% of the house just like yours. Your basis becomes your gift basis + first step up + 1/3 of 25% of the FMV at the time your second parent passed away. You then own 1/3 of the house.

Just for others reading this, if there had not been the gifting, then basis in the hands of the inheriting kids would have been 100% stepped up and there would be no gain, maybe a loss, unless the market moved between date of death and sale. There are other considerations of course. (medicare, asset protection, etc.)

[deriggin]

the Deed shows a Property Transfer, so the owners on the deed was the 3 of us.

[jtax]

I am sorry, you said they "added" which I thought meant your parents stayed on as owners.

If your parents were not owners after 2005 and it was joint ownership (or equal share tenants in common) then each sibling would own 1/3 of the home. Your basis would be your parent's adjusted basis plus some share of any improvements made (perhaps 1/3, perhaps more or less if not evenly paid for).

So your gain is not [$900k - $450k] x 1/3, but rather [$900k - of your parent's basis] x 1/3. [Each # adjusted for commissions, transfer taxes, etc.]

The FMV in 2005 is not relevant except for filing of the 2005 Gift Tax return.

[deriggin]

thank you, sorry for confusion.  I suggested we devide the proceeds, and everyone files for their own Capital Gains, since we three are in different tax brackets, does that make sense?

[jtax]

You still haven't said how the property is titled. If the property were titled in a trust things might be different. If you are joint owners (and not tenants in common with different percentages), you each own the property equally. You don't have a choice on splitting it up. Tax law does not allow you to shift income to lower bracketed taxpayers after the fact.

In fact the closing agent is required to ask you about the split. So that each of you will get your own 1099-S. See <a rel="nofollow" target="_blank" href="https://www.irs.gov/pub/irs-pdf/i1099s.pdf">https://www.irs.gov/pub/irs-pdf/i1099s.pdf</a> page 3, "multiple transferors"

It says, among other things:

For multiple transferors of the same real estate, you must file a
separate Form 1099-S for each transferor. At or before closing,
you must request from the transferors an allocation of the gross
proceeds among the transferors. The request and the response
are not required to be in writing. You must make a reasonable
effort to contact all transferors of whom you have knowledge.
However, you may rely on the unchallenged response of any
transferor, and you need not make additional contacts with other
transferors after at least one complete allocation is received
(100% of gross proceeds, whether or not received in a single
response). If you receive the allocation, report gross proceeds
on each Form 1099-S accordingly.

You are not required to, but you may, report gross proceeds
in accordance with an allocation received after the closing date
but before the due date of Form 1099-S (without extensions).
However, you cannot report gross proceeds in accordance with
an allocation received on or after the due date of Form 1099-S
(without extensions).

If no gross proceeds are allocated to a transferor because no
allocation or an incomplete allocation is received, you must
report the total unallocated gross proceeds on the Form 1099-S
made for that transferor. If you do not receive any allocation or
you receive conflicting allocations, report on each transferor's
Form 1099-S the total unallocated gross proceeds.