Sale of second home with joint ownership

[smw4]

In 2010 my wife and I purchased a condo in Mass. In the same year we added our son as an owner (and primary resident) for "a consideration less than $100". This condo is held as joint tenants. In 2024 we are in the process of selling this condo. Starting in 2010 and for each subsequent year my wife and I have been gifting to our son our maximum annual individual gifts in the form of our share of ownership. We are estimating that in tax year 2024 there will be a capital gain of about $200,000.  (Purchase of $180K plus renovations of $85K and closing costs of $30K; with selling price at $600K). Do we need to file also file a Gift Tax return in 2024 or do we now have no capital gains on this sale since our 2/3rds ownership has since past to our son (by year 2022)?

Thanks

[M-MTax]

If you and your wife have been gifting the maximum amount to your son in the form of a fractional interest in the condo you probably have it covered by now.......he would own the property in severalty. You should execute a QC deed and find a lawyer to handle that.

[Opus 17]

You may need to see a tax professional.

Assuming your adjusted cost basis is $295K as you say (but be careful, not all closing costs from the purchase are allowable adjustments to basis, see publication 523). https://www.irs.gov/pub/irs-pdf/p523.pdf

And assuming your total gifts of equity are $194,700 (exactly 2/3, but you need to determine how much it actually is).

Then at the present time, your son owns 2/3 the home and you own 1/3 the home.  If you sell for $600K (and assuming a 6% commission) the adjusted selling price is $564K.

But your son owns 2/3.  So he reports a capital gain of $372K (2/3 the proceeds) minus $194K (2/3 the basis) equals $178,000.  Because he does not live there, he owes full capital gains tax on this gain.  Your gain is 1/3 the total, because you own 1/3, and your gain is covered by the $250,000/$500,000 exclusion on gain from a  personal residence.

And, if your son lives in a different state, he will need to file a Mass non-resident return to report this income in Mass because it is Mass-source income.  He will also report the gain in his home state.  His home state should give him an offsetting credit for taxes paid in Mass to reduce the impact of double taxation. 

[M-MTax]

I'm not sure how you did the math but in 2010 the annual gift tax exclusion was $13k. For both parents that would be $26k. In 2011 and 2012 you might add another $26k per year. The total at the end of 2012 could be $78k. From 2013-2017 the exclusion would have been $28k per couple (total of $140k) and 2018-2021 it would have been $30k per couple. I'm not going to continue because I think it's clear that by 2024 they would have given away their entire interest in the property to the son.

Might want to execute a QC deed to the son before the sale. No gift tax return if the 2/3 interest had been entirely gifted under the exclusion each year since 2010.

[Opus 17]

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@M-MTax wrote:

I'm not sure how you did the math but in 2010 the annual gift tax exclusion was $13k. For both parents that would be $26k. In 2011 and 2012 you might add another $26k per year. The total at the end of 2012 could be $78k. From 2013-2017 the exclusion would have been $28k per couple (total of $140k) and 2018-2021 it would have been $30k per couple. I'm not going to continue because I think it's clear that by 2024 they would have given away their entire interest in the property to the son.

Might want to execute a QC deed to the son before the sale. No gift tax return if the 2/3 interest had been entirely gifted under the exclusion each year since 2010.

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The gifts add up to more than the cost, but not more than the FMV at the time of sale (stated as $600,000).  My tax calculation relies on their statement that the son owns 2/3.  That may or may not be correct, it's up to them to support that with evidence.

The real problem is that giving the property to their son turns a non-taxable sale of a personal home for the parents, into a taxable sale for the son.

I would rather suggest the son give the home back to the parents, so they could sell the home and use the exclusion, and then parents give their son whatever amount of money they think is appropriate.  The gifts must be reported but won't be taxed unless the parents' lifetime gifts are more than $13 million.  Unless the parents already have gifts more than that amount, in which case they really should be working with a tax professional.

The parents probably should see a tax professional ASAP if they want to find a legal way to avoid hitting their son with $25,000+ in capital gains taxes.  

[M-MTax]

The gifts add up to more than the cost, but not more than the FMV at the time of sale (stated as $600,000).  My tax calculation relies on their statement that the son owns 2/3.  

Nope and Nope.

     They said that their son owns their 2/3 as of 2022...."our 2/3rds ownership has since past to our son (by year 2022)".....as they had given away an incremental part of their ownership over the years of JT starting in 2010. Based on that the son is the sole owner now.

     The parents didn't say how much they gifted each year but if was the maximum exclusion each year starting in 2010 that would add up to more than the FMV at the time of the sale. 2010-2017 alone could be a total of $218k if you do the math. Then add another $120k for 2018-2021 plus $32k for 2022. Don't know about you but I'm coming up with $390k by the end of 2022 which is very close to $400k.

     But $400k or $600k wouldn't be what they are gifting because they had already made incremental gifts since they bought the condo in 2010. In the beginning years, each maximum gift would have conveyed more as a percentage of ownership because the gifts would have been based on the FMV at the time of the gifts.....not the current FMV of $600k. 

[M-MTax]

I think they should run this by a tax pro, too. They should really get a tax lawyer since they should consider executing a QC deed to the son and have it recorded if they never did that.

[Opus 17]

@M-MTax 

You're making unproven assumptions as well.  What would really be needed (I suppose) is to determine the actual percentage of ownership that was gifted each year.  Something like this (which also takes into account the improvements, which are added to the basis when made).

Year	FMV	Amount of gift	Percentage of FMV transferred	Basis	Amount of basis transferred
2010	$185,000	$26,000	14.0%	$185,000	14.0%
2011	??	$26,000	??	??	??

and so on.

[M-MTax]

You're making unproven assumptions as well.

     Not really. Your very own table provides a lot of insight. I mean, I think you get the idea. If 14% had been transferred the first year in 2010 then the calc can be carried out each year through the date where the entire ownership in the condo had been gifted to the son. 

     It has to be kept in mind that each year the parents own incrementally less in terms of percentage of ownership after the gifting. So the FMV may increase over the years but their percentage of ownership is decreasing. I think you get the point. That second year in 2011 for example they would own 14% less than the year before but would still be gifting $26k and what would the FMV have been in 2011?

     What they should do is create a table such as the one you posted to determine when full ownership passed to the son. They're going to need the FMV for each year but that shouldn't be too hard to determine. 

[M-MTax]

Year	FMV	Amount of gift	Percentage of FMV transferred	Basis	Amount of basis transferred
2010	$185,000	$26,000	14.0%	$185,000	14.0%
2011	??	$26,000	??	??	??

     Also needs to be kept in mind that the following year in 2011 they then owned 86% of the condo BEFORE the 2011 gift (the parents' basis would be $159,000 at the end of 2010, not $185,000).

     In 2011 they're down to an 86% interest in the property which is the max they could gift to the son and the son would get an incremental increase of any increase in the FMV because he now has a 14% ownership interest. At some point the son has 100% and the parents 0%.