Parents Deeded Home To Daughters While Still Living

[RBLSD]

Parents bought home in 1986 for $29,500, then 

recorded a warranty deed to their 3 daughters in 2009.

parents still live in home and pay utilities, property taxes and homeowners insurance.(no mortgage)

Daughters have never claimed home on their tax returns nor collected rent.

now - home is being sold and parents relocated to different city to be closer to family and daughters are buying a condo for parents to live in there, again no mortgage and no rent will be collected.

1. How do daughters show this sale on tax returns? (2nd home)?? (Vacation home)?

2. Can we deduct the improvements that have been done over the years which is around $60,000, to offset some of the long term capital gains?

3. When calculating long term gains, do we use price parents bought for or value of property when it was deeded to us?

4. I assume the 3 daughters need to file tax returns this year in the same format etc

5. Since parents are in their 80’s, if they pass away within 2 years, do daughters have a penalty?

6. Is there a dollar amount the IRS doesn’t require to show receipts of improvements?

thank you

[KNDavis]

Hi RBLSD,

I’ll assume that when the parents transferred the home to their daughters, the daughters did not pay for the house and that the transfer was treated as a gift.  If that’s correct, then the daughters’ cost basis in the home after the transfer was the same as the parents, which is $29,500 plus any improvements that the parents made while they owned the home. 

If the daughters made improvements to the property after ownership was transferred to them, then those costs would add to the cost basis too.  You don’t deduct improvements; instead, capital improvements add to your cost basis and reduce the gain when sold.

Each daughter will report 1/3 of the sale on her personal taxes on Schedule D as a capital gain from investment property.  It would not qualify as the sale of their primary residence because the daughters did not live in the home. 

When calculating the gain, the daughters will use their cost basis, which equals the parents’ basis, plus any capital improvements the daughters made while they owned the home.  You can’t use the value of the property when deeded to you.  This step-up in cost basis applies when you inherit property after the owner dies.  Because the parents deeded the home to the daughters while they were living, it is considered a gift, and the donors’ basis carries over to the recipients.

There would be no penalty if the parents pass away within 2 years.   

All capital improvements require receipts and documentation if audited by the IRS.  There is no de minimis amount that does not require receipts. 

I want to bring up gift tax, because it may apply in your situation.  Because the daughters did not collect rent, the IRS could consider the value of rent as a gift from the daughters to the parents.  If that gift exceeds the 2024 annual gift tax exclusion of $18,000 per person, then potentially gift tax would be owed by the daughters.  Since each daughter is allowed to give each parent $18,000 per year, gift tax may not apply, but it’s something to be aware of.  The concept of free rent being a gift to the parents would continue to apply if the daughters purchase a condo for their parent to live in.

Thanks for participating in today's Ask The Expert event!

Kimberly, CPA for over 30 years

[RBLSD]

Hi

Are we able to do a 1031 exchange then if this is considered an investment property?

 
thanks

[KNDavis]

In order to qualify for 1031 exchange, the property must be used in a trade or business or held for investment. I think you would have a hard time meeting this definition because family members live in it.  It would likely fall into the category of a second home.