Capital Gains

[terimac4]

I purchased a home last year in October of 23 from my parents. The remaining mortgage was $65K. At the time, the home was worth $330,000. The house went to my husband and I, and we got a loan to pay off the remaining balance that my parents owed. We want to sell the house and buy another house. Supposedly the house is worth around $350K and we want to purchase another home around that $350K price. Will I have any capital gain costs if I reinvest the majority of the gain into a more expensive house? I know about the $500k exclusion if I am married but wasn't sure about selling before a year and if I am calculating my cost basis correctly. I am assuming the $350-65K is my cost basis, so my gain is almost $300k. Thank you!

[xmasbaby0]

Re-investing in another home is irrelevant.   You have not owned the home long enough to qualify for the $500K exclusion.

SALE OF HOUSE

If your gain was more than  $250,000 filing Single, or more than $500,000 filing Married Filing Jointly the sale must be reported on your tax return.  Whether you re-invested the gain in to another house is irrelevant.  If you  have a Form 1099-S go to Federal>Wages and Income>Less Common Income>Sale of Home (gain or loss)

If you owned and lived in the home as your primary residence for at least 2 of the last 5 years on the date of the sale, you do not have to report the home sale if the gain is less than $250K filing Single, or less than $500K filing Married Filing Jointly (and you both owned and lived in the home for at least 2 years).

• If you are using online TT, you need Premium software to report the 1099-S

NOTE:   If you have ever used the home as rental property or claimed a home office, you have more information to enter

[tagteam]

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@terimac4 wrote:

I purchased a home last year in October of 23 from my parents.

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How much did you pay your parents for the house?

If you paid full fair market value at the time of the transfer, then that would be your basis for calculating any gain (or loss). 

Did you happen to take the property subject to the mortgage? 

[terimac4]

I paid them $65K. It was recorded that I bought the house from them for the $65K. (That was the remaining amount they owed).

[Opus 17]

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@terimac4 wrote:

I paid them $65K. It was recorded that I bought the house from them for the $65K. (That was the remaining amount they owed).

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Part of the value of the home was a gift to you.  Suppose the market value was $300,000 last year, with a $65,000 mortgage.  Their equity was $235,000.  If you only assumed the mortgage, then you paid $65,000 to your parents, and you got a gift of equity of $235,000.  This has implications for your parents and yourself.

Parents: They must file a gift tax return to report the gift.  This is form 709, and was due April 15, 2024 for a 2023 gift.  Payment of gift tax is not actually required unless your parents total lifetime gifts are more than $13 million, but the report must be made.  Form 709 is filed separately, not part of a regular tax return.

Yourself: Your cost basis in the property is whichever is greater: the price you paid, or your parents's adjusted cost basis, but never more than the fair market value at the time of the transfer.  Your parents' adjusted cost basis is the price they originally paid, plus any improvements they made, minus any casualty losses or business use depreciation they claimed.  (If your parents do pay gift tax, the amount of the gift tax is also added to your basis.)  Your parents' cost basis has nothing to do with the value of the property or the amount of outstanding mortgage.

https://www.law.cornell.edu/cfr/text/26/1.1015-4

When you sell, your capital gains is the difference between the selling price and your adjusted cost basis.  If you sell in less than 1 year, that is a short term capital gain taxed as ordinary income. If you sell after one year, that is a long term capital gain taxed at a lower rate.  If you are selling for one of the reasons listed in publication 523, you may qualify to exclude part of the gain from taxation. 

https://www.irs.gov/pub/irs-pdf/p523.pdf

The provision to postpone your gain by reinvesting in another house was eliminated from the tax code in 1997 and replaced with the personal exclusion using the 2 year/5 year rule. 

[tagteam]

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@terimac4 wrote:

.......I am assuming the $350-65K is my cost basis....

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Your cost basis is likely your parents' adjusted basis in the house at the time of the transfer (the greater of $65,000 or your parents' basis, the latter is most likely higher).

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@terimac4 wrote:

Will I have any capital gain costs if I reinvest the majority of the gain into a more expensive house?...

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The "reinvest rule" was eliminated in 1997 and essentially replaced with the two out of the last five year ownership and use rule (up to $500,000 exclusion).

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[tagteam]

Also, note that you can use your parents' holding period for the house, plus your holding period (called "tacking"), since your basis is likely to be your parents' adjusted basis. 

However, you cannot use tacking to qualify for the home sale (2 out of 5) exclusion.

@terimac4 

[terimac4]

Does this mean I should wait 2 years before selling? This appears a bit more complicated than I thought. Bottom line is can I reinvest at this point into a more expensive home or are there still tax affects? 

[terimac4]

Thank you so much!! This is the answer I needed.

[tagteam]

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@terimac4 wrote:

Does this mean I should wait 2 years before selling? 

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Yes, if you want to take advantage of the home sale exclusion (up to $500,000).

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@terimac4 wrote:

.......can I reinvest at this point into a more expensive home or are there still tax affects? 

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No. It does not matter whether or not you reinvest; that was the old rule which was replaced in 1997.

[Opus 17]

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@terimac4 wrote:

Does this mean I should wait 2 years before selling? This appears a bit more complicated than I thought. Bottom line is can I reinvest at this point into a more expensive home or are there still tax affects? 

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That depends on too many other factors.  

For the lowest capital gains tax, you need to use the home as your main home for 2 years and own it at least 2 years.  This counts when you lived in the home as your main home, not necessarily when you owned it.  So if you lived in the home before your parents gave it to you, you can count that time.  However, to meet the 2 year ownership test, you must also actually own the home.

I agree that for the capital gains tax, your holding period is combined with your parents, so you probably get the long term rate even if you sell today.  But that doesn't help with the $250,000/$500,000 exclusion rule, which requires your own actual ownership.

If you planned to live in the home more than 2 years, and are being forced to sell due to certain specified or general "unforeseen circumstances" as described in publication 523, you can get a partial exclusion.  That might be enough.  For example, if you do qualify for the partial exclusion rule and you sell in July, you can exclude up to 10/24 (months) of the normal limit of $250,000 single or $500,000 married, which would be $104,000 or $208,000.  That would make most or all of the gain excludable, assuming you meet the conditions for that partial exclusion, and depending on your parents's basis.

You also have opportunity cost to think about.   Suppose your basis really is just $65,000 (it is probably higher) and your gain will be $265,000.  The tax on that is $39,750 for most people.  What would you do with the money?  If you can invest it and make more money, then paying the tax is still worth it.  Or, if you have a 2 hour commute each way and want to move closer to work, that $39,750 of tax you would pay might save you 600 hours a year in time, plus gas and tolls.  If your time is worth $50 an hour, that comes out a lot closer than it seems at first.  Or the house is right next to the train track and 10 trains a day go past the house, waking up your new baby.  Moving early and paying the tax would be like paying $10 per train for peace and quiet.  

There's no right answer for everyone.  

[tagteam]

@terimac4 

Do you know what your parents actually paid for the house as well as the cost of any improvements they made during their period of ownership? 

That figure will likely be an important component with respect to your decision.