How can my family reduce tax on capital gain when selling a property?

[iambk]

Back in 2013, my parents bought a house in California as a primary residence. In 2020, my mother passed away and my mother's 50% ownership automatically went to my father. However, my sister and I demanded mother's ownership as inheritance. So, this year, my father transferred 50% ownership to my sister and I, so now we both owning 25% each.

My family decided to sell the house but worried about high tax on capital gain. My sister and I just received ownership this year so we do not quality for $250K Home Sale Tax exclusion. 

My question is can our ownership qualify as inheritance or is it gift? If gift, is there any way to reduce tax on capital gain?

Thank you very much!

[DanPaul02]

It is a gift.  You will pay capital gains on everything you receive from your share of the sale.

[fanfare]

very foolish to "demand" your inheritance when you could have waited for a stepped-up basis of 100% of the value of the home when your father passes.

[Hal_Al]

Q. My question is can our ownership qualify as inheritance or is it gift?

A. It's a gift. 

The cost basis of a gift is the giver's cost basis.  

The good news is that your father's cost basis is the fair market value on your mother's date of death  in 2020.

The usual way it works is that only your mother's half of the cost basis "steps up".  But, because CA is a community property state, the entire cost basis steps up.  So, your capital gain is 25% of difference between the sale price and the value in 2020 (not what your parents paid for it in 2013).  If that results in a loss (considering the expenses of sale), you are not allowed to claim the capital loss as a deduction, because it is personal use property (a relative lives in it).

Re your comment, "My sister and I just received ownership this year so we do not quality for $250K Home Sale Tax exclusion": you do not qualify for the home sale exclusion, regardless of timing, because it was not YOUR primary residence. 

[Opus 17]

1. Because California is a community property state, your father’s cost basis is 100% of the fair market value on the day your mother died.  Start by documenting that fact and saving your records until you have all sold the home +6 years after that.

2. Then, your father has gifted each child 25% of the home with his cost basis.  Assuming that is more than $15,000, your father will need to file a gift tax return form 709 to report the gifts.  No gift tax is actually owed unless your father’s lifetime gifts and estate are more than $11 million, but the gift tax return must be filed so that the IRS can keep track of his gifts against his lifetime limit. The deadline for form 709 is also April 15, but it is not included with the regular tax return and TurboTax does not prepare this document.

3. Whenever you sell the home, you and your sibling will have a capital gain equal to the difference between 25% of the selling price and your 25% cost basis.  There is no way for you to not pay capital gains tax on your gain.  However, if you sell in 2021, your gain only represents 25% of the increase in value since the day of your mother’s death in 2020.   

4. Your father will have a capital gain equal to 50% of the selling price minus his remaining 50% cost basis. Your father qualifies to claim a $500,000 capital gains exclusion as a widower, as long as he sells the home within two years of the date of his wife’s death and he has not remarried.

[iambk]

@Opus 17 Thank you very much for the detailed answer!

So if the selling price is less than the fair market value on the day my mother passed way, it's considered capital loss therefore we don't have to pay tax when selling?

And the deadline for form 709 is April 15, 2022 if the gift was made in 2021?

I really appreciate your answer. 

[iambk]

@Hal_Al Thank you very much for the answer. I worried about capital gain tax but no more now because selling price will be most likely to be less than the fair market value in 2020.

Could you please clarify "If that results in a loss (considering the expenses of sale), you are not allowed to claim the capital loss as a deduction, because it is personal use property (a relative lives in it)."? Because I expect there to be capital loss instead of gain. 

[tagteam]

---

@iambk wrote:

Could you please clarify "If that results in a loss (considering the expenses of sale), you are not allowed to claim the capital loss as a deduction, because it is personal use property (a relative lives in it)."?

---

There is actually not much to clarify. You stated that a capital loss is not allowed as a deduction, since the property is held for personal use, and that is the rule.

See https://www.irs.gov/taxtopics/tc409

Losses from the sale of personal-use property, such as your home or car, aren't tax deductible.

In order to deduct a loss from the sale, you would have to hold the property for business or investment purposes.

[tagteam]

---

@iambk wrote:

And the deadline for form 709 is April 15, 2022 if the gift was made in 2021?

---

That is correct:

Generally, you must file Form 709 no earlier than January 1, but not later than April 15, of the year after the gift was made. However, in instances when April 15 falls on a Saturday, Sunday, or legal holiday, Form 709 will be due on the next business day. See section 7503.

See https://www.irs.gov/instructions/i709#idm140535841984928

[Opus 17]

@iambk 

If you have a loss on the sale, there is no gain so there is no gains tax owed.  As noted by others, the loss is not deductible.  If you have a loss on an investment, such as you sell a stock for less than the purchase price, you have a tax deductible loss that you can deduct against other gains. Since this is personal property, you can’t deduct a loss from your other income—if you take a loss. But you still pay no capital gains tax since you did not have a gain.

Correct, if the gift was made in 2021, the gift tax return is due April 15, 2022.

[Hal_Al]

If you sell at a loss, you do not even need to report it on your tax return, unless you got a tax document, usually a 1099-S. The 1099-S may have been included in your closing documents, instead of arriving in the mail, in Jan. or Feb. of the following year.

If you get a 1099-S, you report the sale on form 8949 and schedule D and show an adjustment for the loss on form 8949 in column (g) so that you report $0 as your gain/loss.  TurboTax does this automatically if you identify the sale as a second home or personal use property.