capital gains on jointly owned property

[adamjill98]

My husband and his sister's names were put on my father-in-laws home about 4.5 years ago. My FIL passed away in March and now his sister wants to buy our portion of the house from us and use it as a rental property. The appraised value is $197,500 so our portion (half) is $98,750. She will be paying us that at closing. How do we report this on our taxes? Since the portion that we are getting doesn't exceed the homes value, is this considered a gain or loss? The home was appraised shortly after his death so the value hasn't changed. 

[Hal_Al]

Your taxable gain (or loss) is the difference between what you sold it for and your "cost basis". Since the value hasn't changed, there is no gain or loss. You do not need to report the sale unless your receive a 1099-S tax form at closing.

The usual rule, for a gift, is that the recipient's basis is the giver's basis (what you FIL paid for it). But there is an exception for the gift of his home, where he retained the right to live there ("life estate"). "If you give away an asset and keep a life estate* in that asset..... the cost basis of the house is "stepped-up" to the value of the house on date of death [IRC 2036]")

More info: http://www.law.cornell.edu/cfr/text/26/20.2036-1

*A life estate does not have to be explicitly established in the deed. Your FIL probably had an "implied life estate." If so, that would give you the stepped up basis. There is case law on this.

[adamjill98]

A few questions - He put the home in their name in advance of him needing nursing home care. His plan was to leave it to them upon his death, which happened before he needed to go on Medicaid. Because the house was already in their name when he died, it wasn't considered inherited, right? Yes, he did retain the right to live there, per his attorney's paperwork. I'm sure he paid way less when he bought the home 50 years ago. 

Does the "stepped up basis" impact our taxes? That's where I'm confused...

[Hal_Al]

You do not pay income tax on inheritances, including assets (stocks, mutual funds, real estate [including home]) that have appreciated in value.

As your surmised, the question in your case is was the house an inheritance or a gift made 4-1/2 years ago. 

Technically it was a gift, but because of the life estate rule, it is treated as an inheritance for income tax purposes. That is, your cost basis is the stepped up value.  So, it doesn't matter what he piad for it 50 years ago.  For income tax purposes, your cost basis is half the appraised value shortly after his death. Since your sale price to the sister is also that amount, your capital gain is $0. 

If there are any expenses of sale, that result in a loss, you may even be able to claim a capital loss, as long as you, or any other family member,  did not use the property for personal use, after the date of death.

[adamjill98]

So if we get a 1099 S form from the title company doing the closing, what do we do with it? Do we have to include the appraisal documents with our taxes showing the value of the home when we sold it to his sister? I do my taxes myself on Turbo Tax each year so I don't want to mess this up and end up owing later. 

[Hal_Al]

If you get a 1099-S, you will have to include the sale on your tax return.  You report the sale on form 8949 and Schedule D. You show the sale price (assumably $98,750) and your cost basis as $98,750 + any expenses of sale.  TurboTax can handle this  (you may have to upgrade).  You do not include any attachments for proof.  That come later, if you are questioned by the IRS (unlikely).