Capital Gains on Jointly-Owned Property

[mjfales]

My husband and I purchased a home for my parents to live in 10 years ago.  They lived in House #1 for 5 years then moved to House #2.  We took the net proceeds from House #1 into House #2.  House #2 was co-owned between me and my mother for 4 years. House #2 was sold and she moved into a new home (House #3) that she and her husband jointly owned.  Our original agreement was that all proceeds from the home(s) were to belong to me and my husband.  This has not been an issue.  

My confusion is coming in on Capital Gains taxes.  

When we sold House #1, I paid Capital Gains taxes on the net proceeds (sales price - capital improvements - original purchase price). As mentioned before, the remaining amount was put into House #2.  

When House #2 was sold, the proceeds were split between me and Mom so that she could take $75,000 to use toward the down payment of House #3 (which I had no ownership in).  So, basically a 'loan'.  I paid capital gains on my portion of the proceeds from the sale of House #2.

Now, House #3 has been sold and the $75,000 I 'loaned' Mom has come back to me.  

A couple of questions --

  1. Do I owe Capital Gains on this $75,000?  And if so, how do I report it?  Our names were added to the security deed via a QCD after the purchase of House #3.  Do I just report it like I had the other two homes?  Like the sale of an investment property.

  2.  I'm not sure if this plays into the calculations of Capital Gains at all, but does any cash we put into the properties (House #1 and House #2 such as down payment and loan paydown) get subtracted from the amount of Gain we realized?  Or is that already calculated in the numbers and I'm not realizing it.

Hope this isn't too confusing.  Help!!!

[rjs]

You need to sit down with a local tax professional and go over all the details of the various transactions. (At least for houses #2 and #3. House #1 is pretty much water under the bridge at this point.)

Here are a few points for you to be aware of, but don't try to clear up any confusion here. You can discuss these points with the tax professional.

When you sell a house you can do whatever you want with the money that you get. But the tax is based only on the details of the sale. Putting the money into a new house does not affect the tax on the sale. (There used to be a rule that you could defer, not eliminate, the tax on the gain from selling your principal home if you used the money to buy a new home. But that option was removed from the tax law about 25 years ago. In any case, it does not appear that you sold your own principal home at any point.)

It's not clear where the $75,000 came from if the proceeds from house #2 were split between you and your mother. It's also not clear whether it was really a loan. If it was, there are additional tax considerations.

A QCD has nothing to do with a deed. A QCD is a Qualified Charitable Distribution, a distribution to a charity from an IRA. So it's not clear what you did with the deed.

A home that you own, partially or entirely, that a family member lives in is not an investment property.

[Opus 17]

The provision to postpone the capital gains on the sale of a home by buying a new home was removed in 1997, and even then, it only applied to your main residence.  It appears that you handle the situation correctly. You paid capital gains tax on the sale of House 1 when it was sold, and you paid capital gains tax on your half of the capital gain from house 2 when it was sold.  Because House 3 was not owned by you, you are not responsible for any part of the capital gains tax on the sale of house 3.

The $75,000 could be treated as a gift or loan. If it was a gift, then you would be responsible for filing a gift tax return to report the gift in the year it occurred, although gift tax is not actually owed unless your lifetime total of all gifts is more than $11 million. Likewise, your mother has just given you a gift of $75,000, and your mother would be required to file a gift tax return. 

If the $75,000 is treated as a loan, the IRS requires you to report interest income on that loan, and if you don’t charge interest, you must report interest income that you would have received if you charged interest at a market rate.  This is called imputed interest. For the past several years, the appropriate market rate has been 2% or less but it is recently gone up. It is a variable rate and can be calculated on a monthly, semiannual, or annual basis depending on what is appropriate for the type of loan.  You are required to pay tax on imputed interest because the IRS position is that if you are going to make a loan, you must conduct your business in a businesslike manner and that includes charging interest, even to a family member.

I don’t see any real harm in treating this as a gift that you made it to your mother several years ago and that your mother has made a gift to you now. However, the gift tax returns would be required to be filed.  It would certainly not hurt to have a professional review all of this, because some of the things you describe were not in quite the right language, so I am not 100% confident that I understand the situation and the ramifications.

[mjfales]

Opus 17, thank you!  This is helpful. 

I want to add a little more detail around the same of house 2 & house 3. As mentioned, house 2 was co-owned by Mom and me. At closing, instead of the seller’s amount due being split 50/50, we had $75K go to her via wire transfer from the closing attorney. The remainder went to me, which I paid capital gains on. 

She took the $75K & used it toward House 3. She and her husband were on the loan for the remainder and on the warranty deed at closing of the sale. She added my name & my husband’s name to the warranty deed via a quit claim deed (QCD) so that the house would go to us upon their death. They are now divorcing and house 3 has been sold. At the closing of house #3, the closing attorney wire transferred $75K to me, and split the remainder between mom & her soon-to-be ex husband. My concern is that my name was on the deed. So, does that mean I sold real estate and now have to report it as capital gains?   I guess I’m looking at it like, if Mom had not been in the equation at all, I would have had to pay the gains on all net proceeds from house 2 and somehow I just kicked that can down the road, but the same rules apply. 

By the way, I’m looking for a local tax pro to have a conversation with about this as well. You seem to have a good handle on what I’m doing though so I wanted to clarify a little more. 

thanks again! 

[Opus 17]

@mjfales 

Regarding house 2, on the face of it, you and your mother were each responsible for 50% of the capital gains and 50% of the capital gains tax, regardless of how the proceeds were split.  Your mother probably qualified for the capital gains exclusion on her half.  If you and your mother wanted to split the ownership and the capital gains in a different way, such as 30/70 or 60/40, you probably could have done so, but you should have the situation review to make sure you pay the proper tax.

Regarding house 3, on the face of the transaction, you, your spouse, and your mother each own 1/3 share of the property and you are each responsible for 1/3 of the capital gains.  Your stepfather did not own anything, according to you. A money transfer between spouses as part of a divorce is not taxable or deductible to those parties, but that doesn’t change the fact that you and your husband each owned 1/3 of the house, at least on paper.

It would have been much better to consult an attorney or tax professional before the house was sold. It is possible that you and your husband could have quit-claimed the house back to your mother before the sale, so that you would not have been property owners.  (Incidentally, when your mother quit-claimed 2/3 of the house to you, she was probably required to file a gift tax return.)

House 3 is where you definitely need professional advice.  It is likely that you owe capital gains tax on 2/3 of the house.  If that means that the $75,000 is not an equitable share, because of the tax, you would have to discuss this with your mother and stepfather.  

I’m not trying to, and can’t, give legal advice. The points I raise are things you should ask your own professional. It’s possible that my views on those topics are incorrect.

[rjs]

You said that your mother's husband was on the deed when they bought house #3. They then added you and your husband to the deed. So, unless the deed says otherwise, it would appear that you each owned 1/4 of the house. That means that, as far as capital gains tax is concerned, you each received 1/4 of the proceeds of the sale. You and your husband each have capital gain on your individual shares of the house. As Opus 17 pointed out, your taxable gain is determined by your ownership percentage, even if the money from the sale was not distributed according to those percentages. It doesn't matter how much money the closing attorney sent to each party. But if the money was not distributed according to the ownership percentages, someone might have made a gift to someone else, and might have to file a gift tax return.

Even if the four of you are responsible for equal shares of the sale proceeds, it's possible that you do not all have the same amount of taxable gain, because you may not all have the same basis. This is something else to discuss with your tax pro.

Hopefully your mother and her soon-to-be ex are also getting expert tax advice. Divorce attorneys often know less about tax law than they think they do. We often see questions from people whose divorce attorney put something in the divorce decree that is illegal or impossible under the tax law. Your mother and her husband also need tax professionals.

After I thought about this for a while, I realized that when you said QCD you might have meant quitclaim deed. But in the context of taxes it has a completely different meaning.