We purchased a home for our daughter and her family. Now that their credit is fixed, they want to purchase the home from us. We will be facing a capital gains tax of approximately $28,000. We want to eliminate this gain by a gift of equity $14,000 from me and $14,000 from my wife. Is this possible and how is this reported on our Tax Returns?
Yes. You simply report the actual sales price (after the $28,000 "discount") on form 8949 and sch D. You are not allowed to show a loss on the sale.
Since the gift is less than the gift tax rule, you do not need to file a gift tax return. "Gift Tax" is somewhat of a misnomer. Even though a gift tax return may be required, very few people ever actually pay federal gift tax. So, you could make an even bigger gift of equity to avoid capital gains. But keep in mind that long term capital gains are taxed a lower rate than ordinary income and at 0% for many people.
The purpose of the gift tax return is usually only to document a reduction in the allowable estate tax exemption.
See https://turbotax.intuit.com/tax-tools/tax-tips/Tax-Planning-and-Checklists/The-Gift-Tax-Made-Simple/INF12127.htmlYes. You simply report the actual sales price (after the $28,000 "discount") on form 8949 and sch D. You are not allowed to show a loss on the sale.
Since the gift is less than the gift tax rule, you do not need to file a gift tax return. "Gift Tax" is somewhat of a misnomer. Even though a gift tax return may be required, very few people ever actually pay federal gift tax. So, you could make an even bigger gift of equity to avoid capital gains. But keep in mind that long term capital gains are taxed a lower rate than ordinary income and at 0% for many people.
The purpose of the gift tax return is usually only to document a reduction in the allowable estate tax exemption.
See https://turbotax.intuit.com/tax-tools/tax-tips/Tax-Planning-and-Checklists/The-Gift-Tax-Made-Simple/INF12127.htmlIsn't this an investment and so when sold to the daughter, the parents will have a short term gain on that investment, since they never lived in it?
The never lived in it part does not govern whether the gain is long term or short term. That's determined by when they bought it.
The fact that they never lived in it,, only means they don't qualify for the rule that allows an exclusion (up to $500,000 for a couple) of the capital gain of a primary residence.
Also. when making a gift of a capital asset, you shift the capital gain to the recipient, at a later date. But because the daughter will use it as her primary house, she will be eligible for the $500,000 exclusion.
Hi Hal_Al - Can you clarify your post above. I’m in a similar situation. I want to sell my rental property to my sister at the at the remaining loan balance and do a Gift of Equity up to the FMV. I’m getting confused on the Capital Gains (if any for the giver). Scenario to put some figures:
Basis $410k
Loan Balance $180k
FMV $650k
Gift $650k minus $180k net $470k
Capital Gains ? = $650k minus $410k = $240k or is it ZERO since my Cost Basis will be transferred to my sister. And she will pay any capital gains when she sells ?
What would the 1099-S show. The title company I had talked to said the 1099-S would show the FMV.
I was reading this "<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#e"</a> and from this <a rel="nofollow" target="_blank" href="https://ttlc.intuit.com/questions/3357256-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">https://ttlc.intuit.com/questions/3357256-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</a> Which you had contributed to the conversations as well. Obviously, I’ll be consulting with a Tax Lawyer or CPA, when we do this, but Really want figure out or at least understand the Capital Gains (if any). If I have to claim CG, then what’s the point of gifting it when I have to pay tax on something I’m not receiving.
Thank you.
leapy88 - You will have no capital gains to report. You are shifting the future tax burden to your sister. The link to the other AnswerXchange question (post) explains how to handle the 1099-S. Your sale price is $180K. Your cost basis for reporting is $180K. You may not claim a loss, since you are selling to a related party. Your sister's cost basis in the property is $410K. Your accumulated depreciation also transfers to your sister and she will continue depreciating on the same schedule you were using. She will have to "recapture" (pay tax on) the depreciation when she sells. If your sister uses the home as her primary residence, for the required 2 years, she can avoid tax on the ordinary capital gain (up to the limits) but not the depreciation recapture. You will be required to file a gift tax return (explained above).
Hal_Al - Thank you. That was how I interpreted in the 26.1 code. But I'm still confused as to how to report the 1099-S. Are you saying that the 1099-S is going to reflect the FMV but I should only report that the Basis as $180 and Sale as $180? I would assume the Gift of Equity Letter should state all the Details of Depreciated value used, cost basis, and gifted amount at the least?
I don't know how much the 1099-S will be for. You'll have to ask the closing agent that question. It could be $180K or it could be the FMV. Based on other postings I've seen here, in this forum, If the mortgage Co. handles the closing it probably will be the FMV. The gift of equity goes no where on your tax return. That's a side issue.
What ever amount is on the 1099-S is both your sale amount and your basis for form 8949, as you want the gain/loss to show as 0.
Ok in that case we just bought home from my mom that we have been living in. 150k was purchase price but total cost was 153k Appraised at 170k (not sure if relevant). Gifted 34k and our loan was 120k. Her orig cost was 134,700. So how would that math work?
See my math below.
Without the gift, you would not have gotten the mortgage, financing and house is what it sounds like to me. This gives you a basis of $153,000.
I am in a situation where A. I don’t know how todo my own taxes. And B, 3 different CPA’s have all told me the same thing which is that I have to pay capital gains taxes on an investment property I sold to family with a gift of equity.
Details:
- I originally payed 150k for the house.
- House appraised at 200k when sold.
- My sell price was 175k.
- Gift of equity was 25k.
- Purchase price was 200k.
I’ve repeatedly been told now that I will have to pay capital gains taxes on 50k, and not the 25k I expected and still believe is correct. Why should I have to pay capital gains taxes on money I didn’t actually get? Not only that but everything I have read says that the gift of equity should lower the cost basis of the buyer, which makes me paying capital gains tax on the full 50k difference make even less sense.
How can I make these lazy and uninformed CPA’s see the light?
@curiousminds, I am investigating the exact same issue right now. Can you tell me what you ended up doing? Much appreciated.
Unfortunately nothing too specific as I was asking the question for someone else I know. But I can tell you that their accountant got it done, meaning, they were able to make an adjustment to lower the sale price of the home based on the gift of equity. I will tell you though, it was a struggle. Even people who do this professionally are incredibly either ignorant about this, or just stuck in their ways. There is legal precedent set for tax code being interpreted this way, yet the majority of accountants, and tax lawyers won’t want to agree with you, or won’t engage you on this. It’s probably easier and cheaper to just file it yourself. There are probably more correct and less correct ways of lowering the sale price of your home based on a gift of equity, but it’s more important I think to know that it can be done and it is 100% legal todo so. I went through hell to find an accountant who specializes in real estate who actually knows wtf he’s doing to confirm my interpretation was correct. Unfortunately my friend couldn’t use him because he wasn’t taking in anymore clients, but he found someone on his own. So just know know that if you are needing someone to file your taxes for you, there exist people who know how todo it properly and save you a ton of money.
As I'm sure you felt at the time, I feel like I've stumbled upon the biggest tax "blind spot" in existence. I fully agree that the regulations are clear, you do not pay capital gains tax on "unrealized" gains, i.e., a gift of equity.
The closing company just fills out the 1099-S with the sale price, without any consideration for the gift of equity. The CPAs just want to plug in whatever number is on the 1099-S and not risk making perfectly valid adjustments. I guess I just need to find a better CPA as I doubt I will be able to convince the closing company to adjust the 1099-S.
I have a feeling the IRS is well aware of this and simply doesn't bother to clarify how it should be handled in a more direct way. I can't imagine how many people are paying the extra tax because they just don't bother to look further into it.
Thanks for the follow-up. Hope it helps someone else out there in the same situation.
Very eloquently said, that is exactly it. And ya I tried the route with having the 1099-S changed, I even expected the current closing company to give me a hard time so I called some others just before things were really finalized, and I was basically laughed at by everyone I spoke to. All of these people are machines, and evidently gift of equities don’t happen enough for anyone to actually care enough to make them do something differently. Meanwhile lenders are perfectly aware of it and will push for this direction when anyone wants to sell their house to someone below market value.
It really is the most frustrating thing, that can have you thinking that you are, in fact, a crazy person. But ya, no telling how much extra tax revenue the IRS is making because of everyone else’s closed mindedness. Sometimes I think it’s a classic case of it being the idea of the uninformed, and therefor the automatic reaction of no, you can’t do that, not how this works. I get that a lot with police for example, they don’t like it when something is my idea. So maybe try a little bit of reverse psychology haha.
but seriously, just be patient, either fill out the taxes yourself, or keep looking. If you remind me, I can dig up the response I got from the CPA who actually knew what they were doing. Might help you.
Here is my email to this particular CPA…
“So when we spoke you wanted me to send you an email with some of the details of this transaction so you could verify what the most correct way of filing a tax return for this transaction would be.
The home that my cousin is selling to me has not been his primary residence for some time but we do believe he was living here for at least 1 year of the last 5. He would be selling me the house for $176k, and my purchase price would be 213-215k. This amount was initially based on the lender's best guess of the FMV of the home, the appraisal did come in higher at $255 but my lender thinks this amount is just fine as it is still within 25% of the appraised value. So the gift of equity will be my down payment which is roughly the difference between his selling price of $176k and my purchase price of $213-215k.
Now the closing agent I spoke to said that when they fill out the 1099-S that they will use my purchase price for gross proceeds. This transaction is not finalized yet so maybe there is time to find someone who will correctly fill out a 1099-S and make this easier for everyone. If you know of a simple and concise way I can express our position on the fact that gross proceeds should not include a gift of equity that may help me with our current closing attorney's or it may help me find ones who are willing to do this right. Or maybe you think that angle is a lost cause, let me know.
If a correct 1099-S is not possible the options we discussed were and in no particular order...
1. Adjust cost basis.
2. Add to selling expenses.
3. Make the adjustment in column (g) of form 8949.
Some relevant tax code and links if it makes your task any easier...
For the transferor...
26 CFR § 1.1001-1 - Computation of gain or loss
(e) Transfers in part a sale and in part a gift. See Example (1)
Also see Amount Realized (b)
https://www.law.cornell.edu/cfr/text/26/1.1001-1#e%22%3Ehttps://www.law.cornell.edu/cfr/text/26/1.1001-1#e%3C/a
For the transferee...
26 CFR § 1.1015-4 - Transfers in part a gift and in part a sale. (understanding basis)
1099-S instructions (Gross proceeds)
https://www.irs.gov/instructions/i1099s#idm[phone number removed]480
Relevant court case (see judgement on "amount realized"):
https://www.taxnotes.com/research/federal/court-documents/court-opinions-and-orders/tax-court-determines-capital-gain-on-partial-sale%2C-gift-of/1w9lf
So would like to know what the most prudent way of filing and correcting for an incorrect 1099-S is, but also if you think there is a better way we could do this transaction I am all ears on that too.”
And here was his response…
”I did do some research to confirm what I thought was the best treatment and while I can’t find any support from the IRS as to why the lawyer wants to report the gross “sales price” and not the cash transaction I don’t think there’s going to be any way to convince them otherwise. I did see a few articles that seemed to support this treatment but nothing directly from the IRS so I think the lawyers are doing this to just cover any possible liability. One of those things where they know the sales price from the agent so they have to report that and not the sales price regardless of what the IRS instructions say.
That being said I don’t think it will be an issue with the reporting on David’s 2021 return, what you’ll need to do is report the gross sales price on the Schedule D Part II column D, then include the gift of equity in the cost basis column E, increasing David’s basis and reducing the gain on the sale. Based on my research column E is more appropriate than an adjustment on column G. David will also be required to file a 706 gift tax return showing the gift of equity as a gift to Andrew. David is going to need Andrews SSN and address to report on the 706 so just an FYI of the requirement.
For you Andrew, your initial thought was incorrect your basis in the building is going to be what you paid for it plus the gift of equity. So, if you ever end up renting the place or if you sell and maintain primary residence you can include the total amount on the 1099S for the purchase price as your basis in the home.
For David, one additional item needs to be considered when you calculate the gain on the sale of the property. Since you lived in the home for 1 of the last five years you can still exclude a portion of the gain as the primary residence exclusion. But be aware that if you use a portion of the exclusion you can’t use it again for at least another two years. So for example say you end up calculating $10k in the allowed exclusion, if you sell your current primary residence as single sometime in the next two years, then the max exclusion allowed would be $250k (the max allowed for single taxpayers) less the $10k already used. This article explains it pretty well:
https://www.journalofaccountancy.com/issues/2002/oct/thehomesalegainexclusion.html
You also need to decrease basis by the depreciation taken on the property while it was rented out. The calculation can get pretty complicated so I do recommend hiring a CPA to prepare your 2021 tax return. I talked with my boss yesterday and she said we’re not taking on any new clients at this time so you’ll need to search around locally for someone. Just make sure you go with a CPA and not H&R block or the like, RE sales are complicated and takes experience to get it right.“
Hope that helps.
@curiousminds wrote:David will also be required to file a 706 gift tax return.....
I hope that is a typo (or you misunderstood) because the form that would be filed in this instance would be Form 709. Form 706 is an Estate Tax Return.
Ya, while the two aren’t completely unrelated I’m sure it was an innocent mistake, classic case of knowing enough to mix them up.
Please help! Dealing with this now.
- purchasing home from parents for 1.6m
- doing 300k gift of equity
- so sales price to me would be 1.3m
accountant is saying my parents would have to pay capital gains tax on that 300k gift of equity so they shouldn’t do it because of that
is the accountant correct?
Accountant is mostly incorrect. Thing is, there is probably nothing you can say to convince your accountant otherwise, you just need to find another one who is on the same page as you, they will know how to do file taxes properly.
Yes, the accountant is correct. It is possible that the gift of equity could result in a bigger capital gains. Let's give an example.
Let's assume your parents cost basis in the house is $500,000 and the sales price is $1.6M. Your parents will have to pay capital gains tax on the difference between their cost basis in the home and the $1.6 million sale price. Since they have given you the gift of equity, they are paying additional capital gains on that $300K. The gift of equity itself is not subject to capital gains tax, but it does affect the overall sale price, which is used to calculate the capital gain.
Additionally, gift of equity can be subject to gift tax. When your parents sell you the home for less than its market value, the difference (in this case, $300,000) is considered a gift. The IRS allows individuals to give up to $18,000 per person per year without having to file a gift tax return. Since the gift of equity exceeds this amount, your parents will need to file a gift tax return.