Real estate and inheritance and 1099 S and exemption or step basis?

[pityocamptes]

Very long story short... wife and her sister inherited a house back in 2012 upon the death of their mother. My wife had a DPOA from her mother and transferred the deed into both her and her sisters name. Due to the sibling not having a place to stay they agreed to have them live in the house.... fast forward and the house has been sold. I have a bad feeling I am going to get hosed on taxes... maybe someone can shed some light.

I am not sure that this matters or not, but the title company said that their was an issue with the DPOA and technically the deed was still in her moms name. So we had to hire an atty and push the property through probate and get the courts to bless a new superseding deed effective a few weeks ago (so ALL other documentation other than the original deed of purchase from the deceased was superseded).  I see that the IRS has a Topic 703 Basis of Assets which states: The cost-basis figure is usually the fair market value when the estate owner dies or when the assets are transferred.

From the time of death until now, the sibling has been living in the house since they had nowhere to go. The house was appraised at 300k sold for 284k and both siblings after fees are receiving around 115k (less mortgage, etc.) .

Not sure where to start and should this be addressed next tax season, or immediately? I normally use the Business line of products, where do I enter this? The escrow company did say that they were filling out a 1099 S but also indicated that exemptions on living in the property etc. might apply. Help appreciated. Thanks.

[tagteam · Accepted solution]

You need to consult with a local attorney or tax professional as soon as practicable.

See https://www.avvo.com/estate-planning-lawyer.html

See https://taxexperts.naea.org/listing/service/estates-gifts-trusts

A couple of general notes, however.

1) A DPOA terminates upon the death of the principal (it typically will only become effective upon the principal's incapacity). As a result, if your wife used the POA to transfer title after her mother's death, the transfer was technically ineffective and, as the title company indicated, title was still in her mother's name.

2) The language of Topic 703 is couched in very general terms. Here the cost basis would appear to be the fair market value on the date of death of your wife's mother (in 2012). The date the actual transfer occurred is irrelevant. Rather Section 1014 of the Code is applicable. See https://www.law.cornell.edu/uscode/text/26/1014

3) Your wife's sister may meet the requirements of Section 121 (the home sale exclusion - see https://www.irs.gov/taxtopics/tc701), but your wife will not since she, apparently, has not used the home as her main home for at least two years out of the last five years prior to the date of the sale.

Again, you should consult with a local attorney and/or tax professional.

[Mike9241]

I agree with @tagteam that since your spouse never used the property as a principal residence she would not qualify for the home sales exclusion. the complex question is that of ownership. since the original title transfer was invalid does the new titling result in ownership taking in the year it occurred or in 2012.  there may even be different answers for income tax and non-income tax purposes.

the IRS could take the position that ownership by your wife's sister did not occur until the title was properly transferred. this would mean her sister did not own the property for the required two years before the sale and thus is not entitled to any home sale exclusion. 

there is also the question of who was entitled to deduct the real estate taxes and mortgage interest if there was a mortgage. 

[tagteam]

@Mike9241 raises an excellent point; since the initial title transfer was (most likely) invalid then, depending upon state law, ownership might not have vested in your wife's sister until such time as there was a valid transfer for the purposes of the Section 121 (home sale) exclusion.

You should consult with a local tax professional (or attorney) for this matter.