The house was in disrepair and we renovated it. I know I can add the FMV, renovation costs, and realtor/broker commission when calculating the cost basis for the home, but can I add the amount I spent buying out my brother and sister to take full ownership of the house?
Can I add the $6,000 to calculate FMV?
Yeah, the $6,000 would be added to your basis.
I would say that you can add the buyout cost to your adjusted basis if you paid a fair price that was similar to (or less than) what you would have paid if the house was co-inherited by an unrelated person. If you paid more than a fair price to your siblings, it could get a bit complicated, but I am not an expert in that area.
@USM Professor , what I see here are two different issues :
(a) Regarding "FMV" ---- Fair Market Value of the asset inherited is important in establishing the basis of the property being transferred and ONLY at the time of death of the decedent. Thus in your case the FMV of the transferred ( by inheritance ) asset/house ( as is & where is ) is FMV -- FMV/3 for each of the inheritors ( assuming that there are a total of 3 inheritors including yourself).
(b) Regarding buying out the other two inheritors ---- Based on the above ( basis of each inheritor being FMV/3), if you paid $XX to each of the other inheritors to acquire their portion of the inheritance, then your basis of the asset obviously goes up by the amount you paid to acquire their share of the inheritance. Thus if you paid $AAAA to each of the other owners, then your basis in the asset now becomes $ ( FMV/3 + AAAA + AAAA ). A point to note here is that the amount paid to acquire each share ( $AAAA) is less than the FMV / 3, then each inheritor has given you a gift of FMV/3 LESS $AAAA and this may need to be reported ( depending on the exact amount and the yearly free gift amount ). In short and besides other considerations, your basis in the asset is FMV/3 plus any monies paid to acquire the shares of other inheritors Plus cost of any improvements prior to sale.
Thus your taxable gain is Sales Proceeds ( Sales price LESS sales expenses like commission, sales prep expenses, transfer taxes , title insurance etc. ) LESS your Basis ( as defined above )
Does this make sense ? Is there more one of us can do for you ?
Thank you, PK.
I appreciate your clear explanations. It is useful to know I may need to consider the "gift aspect."
BTW, it was much more complicated than what I mentioned in my original question, I'll share a little with you for your amusement...
Actually, my brother had a will drawn up so I would inherit the house - probably because I kept in regular contact over the years and provided regular care for him the last 8 months of his life. (My siblings couldn't.) I travelled to Arizona from Maine several times and in his last dying days, but he didn't want to think about dying so I did not push him to sign the will out of respect.
After his death, we had a buyer who signed a contract to buy the house "as is" for $26,500. Up to that point, I personally paid around $15,000 for his needs/bills and for assisted living, and after his death, another ~ $2500 on home insurance, utilities, real estate taxes and other miscellaneous expenses before buying them out. That makes the net total remaining ~$9000 ($26,500 - $15,000 - $2500), thus, $3000 each, which my siblings agreed to accept. (From my reading, the $15,000 and $2500 cannot be added to the basis, but my siblings agreed that they wanted me to be reimbursed.)
THEN, the man who offered us $26,500 tried to scam us and two separate buyers - he forged my name on sales documents for buyer #1, forged "the estate of" my brother's name for buyer #2 - AND set the closing for the two separate buyers on the same day. Fortunately, I caught him and we stopped the sale through the two different title companies. He also threatened to put a lien on the property which would be fraudulent - the county recorder's office explained that anyone could put a lien on a property and it would be recorded, even though there was no legitimate claim. (He was just angry I stopped him.) All of this occurred over several months. (It was an empty threat - he never filed a lien.)
After this fiasco, I spoke with my brother and sister who said they would be happy to sell out to me for $3000 each so I could renovate the house to sell it. (They didn't have the funds or expertise to participate in the rennovation.)
I then spent $31,000 of my money to renovate the home over an 8-month time frame. It sold and I was able to just barely break even - it ends up that my capital gain would be exactly $184.25 - without factoring in the $6000 total I paid my siblings.
So, in total, each of my siblings received $3000 and my gain was $184. I am happy that it is all over and I am past the worst of it.
BTW, I am leaving out some of the challenges, like the home was repeatedly burglarized - before the deed was transferred - by the drug dealer across the street and the meth addict who lived in the house behind my brother's house. (No one was charged, but when the drug dealer - who had served 25 years in prison for murdering his business partner - asked what we did with my brother's guns, it gave it away. Neighbors and people who knew the drug dealer and meth addict also verified they had talked about their caper.) BUT, the meth addict neighbor committed arson and burned his house down (so he moved out) and the drug dealer/convict sold his home so the neighborhood was back to its quiet, lovely condition.
Now we can live happily ever after, my siblings ahead $3000 each and myself ahead $184.25 before capital gains taxes.
my brother had a will drawn up so I would inherit the house
Then there was no need for you to buy out your siblings. You owned the house outright.
Unfortunately, he did not sign it so it was not binding in the state of Arizona.
I never told my siblings he planned to pass it on to me, as I did not want them to think I had acted inappropriately, although I think they would have believed me if I had.
Both my brother and sister agreed to sign the house over to me using a Small Estate Affidavit (SEA) but I told them I would share the proceeds with them. (I provided them a notarized statement I would share the proceeds.) The only way to avoid probate court was to use the SEA - going through probate with an attorney would have eaten up most of the value of the real estate, which was his only asset.
...he didn't want to think about dying so I did not push him to sign the will out of respect.
I will have to think about your figure more specifically, but in general from this response:
1. There was no will. If under operation of Arizona law, each sibling inherited 1/3 of the home, that is what happened.
2. Any support you provided before your father's death is money you freely paid out, and there is no legal way to get recompense from your siblings. (They can offer to make an adjustment, of course, but there is no way to compel them, and that money plays no factor in determining the tax situation of the home.) Costs you paid after your father died should be reimbursed to you before the estate pays any beneficiaries (before the estate divides any other assets, such as a car or bank accounts.)
3. Under the circumstances, the $26K offer could be used as proof of FMV as of the date of death, but if it would be advantageous to claim a higher value, you could probably use the other circumstances of the buyer as proof that the offer was not really a fair market offer (as long as you also had some backup for claiming a higher value).
4. There is a difference between repairs and improvements. Repairs do not adjust the basis. Repairs maintain the property in as-is or as-was condition. Improvements, sometimes called "betterments", increase the value of the home or extend the useful life of the home or one of its systems. Painting is normally a repair, as would be fixing a leaky faucet. Improvements include things like replacing windows, doors, carpet, air conditioning, remodeling a bathroom, and so on. (However, if you remodel the entire kitchen, which includes painting, that painting would be included in the cost of the improvement, even though painting other rooms might be considered repairs. See publication 523.
https://www.irs.gov/pub/irs-pdf/p523.pdf
5. Some selling costs also increase basis. See publication 523.
6. Ignoring all other factors for the moment and assuming the entire $31,000 was "improvements", each sibling inherited 1/3 of the house worth $8,833. Your siblings gave you their shares of the house for a $3,000 payment and a gift of $5,833. Then you paid $31,000 for renovations. So the starting value for your basis is $45,833.
7. You may need to reduce that basis if some of your costs would be considered repairs instead of improvements.
8. Normally, when you give someone a gift, you also give them your basis in the gift. For example, if I give you a baseball card that cost me 10 cents as a child, and you sell it for $100, your basis is 10 cents, and the remaining $99.90 is capital gains. That suggests that even though you paid $3000 for each share of the home, you also received $5,833 in cost basis from the gift portion. That would raise your overall basis when you sold the home. However, this would require a bit more research on my part, due to the fact that the givers were related to you, and no gift tax was paid.
9. You never said what you sold the house for. Remember that you can include in the costs of selling, the real estate commission (if you paid one) and certain taxes and fees if it is customary for the seller to pay fees in your area. For example, the seller might pay a transfer tax to the county, or a fee to record the deed, or it might be customary for the seller to pay for a radon inspection. Essentially, you can add to your basis (or reduce your selling price) any cost that the seller must pay, that the seller would pay regardless of whether it was a cash sale or a mortgage. Costs specifically required to get a mortgage (or allow the buyer to get a mortgage) are not adjustments to the selling price. See publication 523.
If you go through the numbers again, and need to think more about your adjustments or have more questions, let us know.
Thank you, Opus, for your thoughtful reply.
RE: #6 - Can you clarify? If the $26,500 were treated as a FMV, if I add the $31,000 (which was legitimately all improvements according to IRS guidelines), wouldn't the basis be $57,500? Not sure how the $8,833, $3,000, or $5,833 for each sibling factor into the basis - but good to know for the gift aspect of the situation. (Sorry if I am overlooking something obvious.)
Also, my single sister and married brother (with his wife's blessing) willingly signed over their rights to ownership of the house to me, which was a requirement of my ability to use the Small Estate Affidavit, so they legally relinquished their rights. Neither of them was willing to play an active part in the situation.
The buying price of $26,500 was a distressed sale and would have gone through had that buyer not tried to scam me and sell it to two different parities and take off with the proceeds of both sales. (He was one of those "I'll pay cash for your house" buyers.)
Before I agreed to sell it to him, I worked through a realtor who was going to price the house at $57,000. I expect it might have sold for a lower price, if it did sell. My siblings and I live between 1,800 and 2,700 miles from that home many states away, so was all agreed to take the distressed price to make a fast sale. (The buyer promised a fast sale but then he went the scammer route.)
Thank you, again, for your explicit and specific points.
BTW, I am inclined to believe I will need a tax attorney to sort through the details of this transaction. Thank you for bringing up a number of salient points.
RE: #6 - Can you clarify? If the $26,500 were treated as a FMV, if I add the $31,000 (which was legitimately all improvements according to IRS guidelines), wouldn't the basis be $57,500? Not sure how the $8,833, $3,000, or $5,833 for each sibling factor into the basis - but good to know for the gift aspect of the situation. (Sorry if I am overlooking something obvious.)
Because you did not inherit the entire house (because the will was unsigned). Each sibling inherited 1/3 of the house, so each sibling gets 1/3 of the basis. If the FMV (the stepped up basis) was $26,500, then your starting basis for your 1/3 ownership was $8,833. (If I buy a bunch of 3 bananas at the grocery store for $1 and give you and your siblings each 1 banana, the bananas are worth 33 cents each.)
The question then becomes, how much additional basis did you acquire when you acquired the other 2/3 ownership. At a minimum, you obtained $3000 additional basis from each sibling for their share (what you actually paid). You might have acquired the full $8,333 of your sibling's bases, if we take into account both the payment and the gift basis.
So your basis before improvements was at the lowest $14,833 and at the highest, $26,500 (assuming $26,500 is the true FMV.)
If the buyout of the siblings was part a sale.....$3,000 each.....and part a gift then this applies:
(a) General rule. Where a transfer of property is in part a sale and in part a gift, the unadjusted basis of the property in the hands of the transferee is the sum of—
(1) Whichever of the following is the greater:
(i) The amount paid by the transferee for the property, or
(ii) The transferor's adjusted basis for the property at the time of the transfer, and
(2) The amount of increase, if any, in basis authorized by section 1015(d) for gift tax paid (see § 1.1015–5).
In that case, basis is determined by 1(ii), the transferor's adjusted basis. The transferor being the sibling who inherited 1/3 of the home with a stepped up basis of $8,833. So the full basis is transferred.
(By way of additional explanation, rule (2) covers situations where the gift has increased in value more than the transferor's basis, and allows the increased basis to pass to the recipient (transferee) if gift tax is paid. Here, we are not discussing property that increased in value after the sibling inherited it, so we don't need to discuss rule 2, or the rule for property that has decreased in value.)
The taxpayer's basis in the property is the full $26,500.
So if @USM Professor paid $3,000 each and $5,833 was the gift portion then the gift portion would be used as the basis because it's greater than the amount paid.
I think you misread 1(ii). The basis is whichever is greater...the amount paid ($3000) or the giver's basis ($8,833). The giver (sibling) received a stepped up basis, and that basis is what is transferred. Don't be confused by rule (2), that covers increases to basis if the gift has increased in value more than the giver's adjusted basis.
Example: Suppose my friend owns property that he bought for $10,000 that is now worth $20 million. He gives me the property. He is required to pay gift tax on about $7 million (because the $20 million gift is more than the lifetime exemption of $13 million). My new adjusted basis in the property is $7,010,000.
That doesn't apply here because the property did not increase in value between the father's death and the sibling's gift.
I've been following this thread. I have a question. Are we sure all 3 siblings inherited it? Sounded to me like the poster only inherited it. Just a thought and wrinkle.
In that case, basis is determined by 1(ii), the transferor's adjusted basis.
That's right.
Are we sure all 3 siblings inherited it? Sounded to me like the poster only inherited it.
Yeah but first there was a will but then we learned that it wasn't signed so it wasn't valid. Sounds like the deceased died intestate and without lineal descendants......with heirs being the 3 siblings.
@VolvoGirl wrote:
I've been following this thread. I have a question. Are we sure all 3 siblings inherited it? Sounded to me like the poster only inherited it. Just a thought and wrinkle.
There was a will, unsigned. All three sibs inherited, taxpayer bought out his sibs with small payments (the house seems to have been in poor condition and needed a lot of work). Taxpayer was unsure how to calculate their basis to report the sale.
My question was, how is basis affected when the buyout was not at FMV, and was that affected by the fact that the buyer and sellers were related. @M-MTax helpfully found the correct regulation. In the end, the taxpayer is entitled to a full stepped up basis, but by an indirect route.
@USM Professor and my colleagues @Opus 17 , @M-MTax , @VolvoGirl , while this is very good discussion and an illuminating one at that , I see the situation a bit different.
Assumptions ( just to move away from reality of the case :(
( a) inheritors 3;
(b) Estate of the deceased -- 1. House ( FMV of 26000 ); 2. Debt/payables to brother ( $17000 ) for care and incidentals.
A as executor buys the house for $26000 ( FMV). Liquidates the debts ( thus brother made whole ). The remainder of $9000 is then distributed to each of the inheritors.
Thus the buying brother's basis in the [property is $26000. He now spends another $10,000 to rehabilitate the house and sells the house for $40,000. His basis in the transaction is $37,000 ( $26,000 purchase price to provide cash for the estate, pay off the creditors etc. ). His gain before adjustment for sales costs is $3000.
What is wrong with this scenario ?
I stand down
pk
I believe the original poster said they invested $31,000 to rehab the house, not $10,000. Also, I am not aware that if sibling A (the executor) voluntarily helps his brother (the deceased, sibling D), with living expenses before D died, there is any way to recover that from the estate. The expenses of the estate after his brother died, paid by sibling A, were $2500. I don't see how the expenses that sibling A paid to help out sibling D before D's death create a legal obligation, especially as there seems to be nothing in writing. That was the purpose of making out a will leaving the house entirely to A, but the will was never signed.
The three remaining siblings (A, B and C) co-inherited the house because there was no will.
If the three remaining siblings had co-owned the house during the 8 month renovation process, and sold the home together, then each sibling would be entitled to receive 1/3 of the proceeds after reimbursing sibling A the $2500 of estate expenses plus the cost of renovating the house that was paid out of pocket by sibling A.
However, that's not what happened. Sibling A bought out sibling B and C for $3000 each. This seems to have represented a discount price based on the expenses previously paid by sibling A and the need for significant renovations, and the fact that this was the only way sibling A could only perform the renovations without going through probate. Sibling A has still not specified the exact selling price, but based on the way he was calculating basis before the discussion began, and including the FMV of $26,500 and the renovations of $31,000 and proposed capital gains of $184, the selling price seems to have been around $58,000, give or take. Assuming that to be close, sibling A has $58,000 of cash proceeds. Subtract the $31,000 for renovations and the $2500 for estate expenses (A reimbursing themself), that leaves $24,500, or $8,166 per sibling. Since A has already paid sibling B and C $3000 each, A's remaining obligation to B and C is $5,166. However, that is a moral obligation, not a legal one, unless A, B and C have a verbal or written contract about dividing the proceeds of the house sale. (If we take the other $15,000 of pre-decease expenses into account, the remainder to be split 3 ways is $9500, or $3166 per sibling, and since B and C have already received $3000, the remainder due to them is $166. That would depend on whether the voluntary assistance with living and medical expenses creates a legal or moral obligation.)
But that is really beside the point. A's original question was how to determine the basis when reporting the transaction on their tax return; how much of the gain, if any, is taxable. Here, § 1.1015-4 comes into play. If the FMV was $26,500 (determined by the offer to buy by the shady buyer), then even though it was co-inherited by A, B and C, by the time A had full legal ownership, A's basis is stepped up to the FMV of $26,500. A can then add renovation expenses (but not repair expenses), and A can include some other legal expenses from publication 523 that they may not have been aware of.
And I don't think A needs to hire a tax attorney to figure this out, unless they need guidance on the repair vs improvement issue. A may spend more money for tax advice than they would save in taxes. A just needs to carefully document everything and keep the paperwork for 7 years, in case of audit.
By the way, this is what happens when all the volunteers hanging around after the tax deadline don't have enough new questions to answer, so we all pile on to anything that seems interesting.
Cheers.