Does 'gift of equity' create capital gain or add to cost basis to home we sold to our son? Home appraised for $187K. Gift of equity was $13K. Our cost basis was $174K.

[Anonymous_]

You can find a local attorney whose practice is concentrated in tax law at the site below.

https://www.avvo.com/tax-lawyer.html

[curiousminds]

As expected. I got a hold of the closing agent at the law firm doing our closing and she told me the amount on the 1099-S will be the purchase price. And really the purchase price is what would always be used because that is what gross proceeds are, anything less then that received by the seller would be called net proceeds. Even then she told me the gift of equity would not reduce net proceeds because the way these transactions are done it is as if the seller receives the money first and then they give the gift of equity, and that there is nothing I could do to have it “corrected” because it is correct. She told me the IRS requires them to report on the purchase price.

so let me ask you all again, do you all “REALLY” know what you are talking about here? Have any of you actually been through this or are you just taking an academic approach to this?

[Hal_Al]

1. So let me ask you all again, do you all “REALLY” know why you are talking about here?
2. Yes.
3. Have any of you actually been through this or are you just taking an academic approach to this?
4. In my case, academic.

The answers above are generally correct.  Whether they apply to your case, depends on the details (how does the contract account for the $25K) and whether, upon audit, you can convince the IRS that you didn’t receive the $200K 1099-S amount. 

A gift of equity is fairly common. “Because a gift of equity reduces the sale price of a home (aka the cost basis), it increases the chances that the BUYER (emphasis added) will end up paying those capital gains taxes”. Reference: https://www.quickenloans.com/learn/gift-of-equity

[curiousminds]

Ya I know, I also believed that the reduction in the buyers cost basis would justify me not having to pay capital gains on that amount but a CPA told me that the buyers cost basis will be the purchase price.

[Anonymous_]

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@curiousminds wrote:

.....a CPA told me that the buyers cost basis will be the purchase price.

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The CPA would be correct in the most common instances but wrong in this one. Was the CPA actually aware of the facts (i.e., the type of transaction)?

What, if anything did the CPA have to say about the following section in the treasury regulations for the purposes of determining a gain? There is no question that this is a part gift/part sale.

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

(a) General rule. Where a transfer 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.....

[TomD8]

"...she told me the amount on the 1099-S will be the purchase price. "

Correct.  And the purchase price should NOT include the gift of equity, if the 1099-S is prepared correctly.

If you think about it, how can a gift that the seller is giving be considered part of the gross proceeds received by the seller (Box 2 of the 1099-S)?   That makes no sense.

Per Quicken Loans, which I think is the nation's largest mortgage lender, "a gift of equity reduces the sale price of a home (aka the cost basis)."

https://www.quickenloans.com/learn/gift-of-equity#:~:text=Negative%20effect%20on%20home's%20cost,pay....

[curiousminds]

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The CPA would be correct in the most common instances but wrong in this one. Was the CPA actually aware of the facts (i.e., the type of transaction)?

Yes I believe so, gift of equity is one of the first things I mention to them, what part do you think they aren’t understanding?

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@Anonymous_ wrote:

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@curiousminds wrote:

.....a CPA told me that the buyers cost basis will be the purchase price.

---

The CPA would be correct in the most common instances but wrong in this one. Was the CPA actually aware of the facts (i.e., the type of transaction)?

What, if anything did the CPA have to say about the following section in the treasury regulations for the purposes of determining a gain? There is no question that this is a part gift/part sale.

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

(a) General rule. Where a transfer 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.....

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Not anything because I can’t get them to actually read any tax code. However let’s talk about that code again and make sure we are on the same page. If I am understanding this right it will be the sum of (1) and (2). Well for (1) the greater amount will be the amount paid which is going to be 200k because that is what the purchase price is right? And for (2) I have no idea what that is talking about because why would anyone ever pay gift tax unless they were insanely rich and generous?

[curiousminds]

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@TomD8 wrote:

"...she told me the amount on the 1099-S will be the purchase price. "

Correct.  And the purchase price should NOT include the gift of equity, if the 1099-S is prepared correctly.

If you think about it, how can a gift that the seller is giving be considered part of the gross proceeds received by the seller (Box 2 of the 1099-S)?   That makes no sense.

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 Because per the attorneys, who issue these forms all the time, it is no different than if someone had just given be cash. Remember the purchase price is 200k, and the gift of equity is just a downpayment towards that purchase price.

Per Quicken Loans, which I think is the nation's largest mortgage lender, "a gift of equity reduces the sale price of a home (aka the cost basis)."

https://www.quickenloans.com/learn/gift-of-equity#:~:text=Negative%20effect%20on%20home's%20cost,pay....

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I’m even using Quicken, and I can’t explain this descrepancy. At the end of the day it seems to be written anonomously and regurgitated across every mortgage lender under the sun, but nobody at Quicken can explain it, and everyone is really quick to tell me that I would have to talk to a CPA about it.

Just called Quicken and spoke to a different guy there, and even he said that we would have to pay capital gains for the sale price of 200k. He reminded me however that really, what it says can still be true, since the purchase price is still significantly lower than the appraised value, so therefor the cost basis IS reduced simply because it is being sold for below market value.

[Anonymous_]

@curiousminds Read the following Tax Court case:

https://www.taxnotes.com/research/federal/court-documents/court-opinions-and-orders/tax-court-determ...

[curiousminds]

Is your point that if I under report then I can be charged a penalty that is equal to 20% of the amount underreported?

[Anonymous_]

My point was that the Tax Court disagreed with the IRS as to the amount realized.

[curiousminds]

Ya I’ve been slowly trying to digest it. I’m going to have to read it a couple time to understand his original argument based on the respondents “logic”. Also that was in 2003/2007, not sure if anything relevant has changed since then. Ultimately it isn’t very encouraging to see that I might have to go to court lol.

[curiousminds]

My thought here though in my specific case is that the appraised value was higher by 55,000 and Quicken decided to stick with their original guess as to what it would appraise for which I believe was 205k to 210k so they set the purchase price for 200k. Part of that case you found by the way (which is a fantastic find probably) is the court agreeing with what the appraised value is/was. Not sure I would get that agreement if I went to court.

[Anonymous_]

Note that if the petitioner had filed a timely 2007 return, he might never have received a notice of deficiency in the first place. Instead, he filed his 2007 return in 2013 (generally bad form to file your returns six years late).

[Anonymous_]

As a final thought, I really do not understand exactly what you do not, apparently, comprehend about the applicable treasury regulation as it is rather clear cut.

Read Section 1.1001-1(e); you are the transferor and Example 1 appears to be precisely on point.

See https://www.law.cornell.edu/cfr/text/26/1.1001-1