My siblings and I inherited a small house and I ended up buying them out for a total of $6,000. I renovated the house and sold it. Can I add the $6,000 to calculate FMV?

[USM Professor]

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?

[M-MTax]

Can I add the $6,000 to calculate FMV?

Yeah, the $6,000 would be added to your basis.

[Opus 17]

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. 

[pk]

@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 ?

[USM Professor]

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. 

[M-MTax]

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.

[USM Professor]

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. 

[USM Professor]

...he didn't want to think about dying so I did not push him to sign the will out of respect. 

[Opus 17]

@USM Professor 

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.  

[USM Professor]

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. 

[USM Professor]

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. 

[Opus 17]

@USM Professor 

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.)

[USM Professor]

Thank you for the clarification, Opus. Very helpful. 

[M-MTax]

If the buyout of the siblings was part a sale.....$3,000 each.....and part a gift then this applies:

§ 1.1015-4 Transfers in part a gift and in part a sale.

(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).

For determining loss, the unadjusted basis of the property in the hands of the transferee shall not be greater than the fair market value of the property at the time of such transfer. 

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.

[Opus 17]

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.