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.

[nikramp]

The home we sold to our son and his wife was not our main home, it was an investment property we purchased and remodeled.  With our 'gift of equity' our son/wife were able to avoid bringing any cash to the closing - for down payment and closing costs, etc.  We received a 1099-S from the lender for $187,000.  Will the $13K be subject to capital gains tax on our tax return, or does the gift of equity in any way add to our cost basis in the property sold?

[Hal_Al · Accepted solution]

Despite the 1099-S, your sales price was $174,000. Your son's cost basis is also $174,000. The $13,000 is not a capital gain. It is just a gift. 

[TaxGuyBill · Accepted solution]

I agree with Hal_AL.  However, when you report the sale in TurboTax, you should enter the sale price of $187,000, or you will receive a notice from the IRS.  To offset that, you can either enter a higher cost basis ($187,000) or add $13,000 of "selling expenses".

[cknick]

So if my dad sells me his second home for his mortgage payoff of 180k and gifts me the equity of 40k for my closing costs, down-payment, etc.. Will he have to pay capital gains tax on the 40k since that is what the sale price shows? He isn't actually getting the 40k it's the equity gift; he only received the amount to pay off his mortgage

[Texas Roger]

You are posting on a 5 month old thread started by someone else. Please post your question on your own new thread.

[Hal_Al]

cknick- to answer your question we need to know, his cost basis (what he paid for it plus the cost of any improvements). Mortgage payoff is irrelevant.

For example, lets say his cost basis was $150,000. He will report a $30,000 capital gain (180K sale price less 150K cost basis). Your cost basis, for any future sale,  is  the $180K you paid. The gift of $40K is not relevant for income tax.

But, for a 2nd example, let's say his cost basis was $200,000. He has a $20K capital loss. But, he is not allowed to deduct a loss on the sale of personal use (2nd home) property. So, he either doesn't report the sale at all or he reports it at 0 gain/loss. Your cost basis, going forward, is his $200,000 basis. not the $180,000 you paid, and not the $220,000 it is worth.

[negrillive]

These answers are wrong. The selling price is the whole $187k on the 1099-S. And your basis doesnt go up as a result of the gift.

[fanfare]

as far as I can see, "Gift of equity" is just a gimmick used by the banks The seller is out $13K and  the buyer takes out a bigger mortgage based on a purchase at $187K instead of $174K.

[TaxGuyBill]

@negrillive   As fanfare pointed out, the selling price is $174,000, which is the amount the seller actually received.

However, to avoid an IRS notice (based on the $187,000 on the 1099-S), most people add the difference to Basis or to Selling Expenses when they report it on the tax return.  That is an acceptable method of reporting the sale, because it still shows the proper amount of gain on the tax return.

[negrillive]

Lets assume you sell your house to your kid for 120. You had a basis of 100 in the house and the FMV was 135. You gift 15 of equity to your kid. If you had not previously recognized the 35k gain (FMV-Basis) then your basis after the gift is 85 (100-15). and the gain is 35 (120-85). On the other hand, lets say the same facts but you gift 15 cash to your kid. sale price of 135 less basis of 100 same 35 gain. I don't see how you avoid gain on the diff between selling price and basis. In the second example (cash gift) if you ALSO reduced the selling price below FMV you would have made an additional gift since it is related parties. I have this real actual circumstance right now for this 2017 filing year. I have not finished the return because I am looking for support for the position. I really need the help getting there. I am a CPA with 35 years tax experience. Appreciate any help you can give me to get me over the substantial authority hill.

[TaxGuyBill]

Ah, now that I know I can speak legal gibberish, that changes how I can respond.   🙂

§1.1001-1(e) shows the gain is based on the actual amount received (assuming the seller's Basis is less than the amount received).  See Example #1.
<a rel="nofollow" target="_blank" href="https://www.law.cornell.edu/cfr/text/26/1.1001-1#e">https://www.law.cornell.edu/cfr/text/26/1.1001-1...>

For the buyer, his Basis is USUALLY the actual amount paid, but that can get a bit wonky, depending on the circumstances.  See §1.1015-4.
<a rel="nofollow" target="_blank" href="https://www.law.cornell.edu/cfr/text/26/1.1015-4">https://www.law.cornell.edu/cfr/text/26/1.1015-4</...>

Does that help?  If not, please respond with any followup questions.

[negrillive]

Thanks TGB !  If dad's basis before the gift is 100 and he makes a gift of equity of 15 to his son, isnt his basis 85 for purposes of computing the gain? I get the carryover basis rules to the son, but... don't I take amount realized (120 in my example above) and use his "adjusted basis" of 85 to come back to the 35 gain ? Sorry I feel dense on this one. Believe me , I want to get there!

[TaxGuyBill]

I understand what you are saying, and have wondered that myself.  However, as far as I can tell, the Basis of the Gift does not come into play.  So you can essentially ignore the Gift completely for the gain/loss calculation.

It takes a few times of reading those two Regs above, but the examples in those two Regs indicate the Gift Basis really doesn't come into play (again, read Example #1 in the first link).

Because of the examples, I interpret that the Gift is NOT giving a piece of the property itself (which would take a piece of the property's Basis), but the reduced sale price is like Gifting cash simultaneously or after-the-sale.

[negrillive]

I like that. Dad is giving away unrecognized gain. And then he doesn't realize the gain either.

[negrillive]

Thanks TaxGuyBill !