Sale of Inherited Home Owned by Three Siblings & Tax Consequences

[MeeshkaDiane]

Three siblings (Peter, Joe and Mary) are trying to understand the tax implications regarding a third-party sale of our family home which we inherited equally (1/3 each) upon our mother’s death on December 23, 2020.  

ASSUMPTIONS: For sake of simplicity to understand our tax liability, assume the following:

1. The mortgage was fully paid before our mother’s death.   
2. Mary lived in the home from 11/2019-10/2022 and has been the primary caretaker.
3. Joe and Peter live out-of-state. Joe is the executor of our mother’s estate.
4. Assume FMV at the time of death = $450k ($150k per share)
5. Assume FMV of the home July 2023 $525k ($175k per share)
6. We made $15k ($5k per share) capital improvements between January 2021 to July 2023
7. Each sibling’s adjusted basis = $155k ($150k + $5k capital improvements)
8. Each sibling’s capital gain upon sale = ($525k - $465k) = $60 total gain/3 = $20k each
9. Joe wishes to gift his entire share to Mary; Peter intends to give $50k of his after-tax proceeds to Mary.

How should Peter handle his $50k gift? Should he recognize it as a loss $175k - $50k gift = $125k net proceeds versus his $155k adjusted basis, or should he handle this as two transactions: $175k - $155k adjusted basis = $20k capital gain.  Then a second unrelated transaction giving Mary $50k as a gift?

[Bsch4477]

You might want to consult a real estate attorney, but it seems to me that you and your brother could quit claim your ownerships in the home in favor of your sister. You both would report that as a gift which would be an amount equal to your capital gain but since the estate tax exemption is over 12 million, there would be no gift tax liability. Of course, your sister would then be responsible for paying the total capital gain when the home is sold. Mary could give Peter a gift after the sale of $10,000 to make him whole. No gift tax form is necessary for that amount. 

[tagteam]

It appears as if you varied the hypothetical from the one presented in the other thread you started.

See What are the tax implications of a sibling buyout… (intuit.com)

Is your brother (Peter) no longer receiving $100,000 from you for his share and gifting you the rest?

Note that in a sale to an unrelated third party, Peter's gain would be the difference between the sales price (less selling expenses) and his basis, the latter of which appears to be $155,000.

If, sometime later, Peter wants to then give you $50,000 of the proceeds he receives from the sale, that would be a separate transaction which would require him to file a gift tax return (Form 709).

[rjs]

According to the figures given, the total gain on the sale of the house will be around $60,000. It appears that Mary (who is actually the OP, MeeshkaDiane) will qualify for the Section 121 exclusion of up to $250,000. She has lived in the house and been a part owner for more than 2 years out of the last 5 years.

If Joe still owns a 1/3 share of the house when it's sold, he will have a long-term gain that he will probably have to pay some tax on, unless his income is low enough to put all of the gain in the 0% bracket. He should definitely transfer his 1/3 share of the house to Mary before she sells the house. That way neither Joe nor Mary will have to pay any tax on the gain. Joe will have to file a gift tax return in any case.

I'm not sure how this works with Peter, since he is selling most of his share to Mary. I don't think there's any legal way that he could avoid having a taxable gain from that sale, unless he sells it at a loss, but that doesn't seem to be the plan. But he should at least give Mary the portion that he intends as a gift before she sells the house.

I'm not going to get involved in calculating anyone's taxable gain, or the overall net benefit of the various options. As I said in the other thread, the three siblings should each consult a local tax professional.

@tagteam, @Bsch4477, or @Mike9241 may have some additional comments.

[tagteam]

Re the Section 121 exclusion, it may (or may not be) a partial exclusion since Mary appears to have lived there until October of 2022. Mary inherited the property in late December of 2020, so ownership would be (slightly) less than 2 years. More details are needed for that purpose.

Re Peter, the transaction, as stated, would appear to be a part gift/part sale.

If, for example, Mary pays Peter $125,000 for that 1/3 share when the FMV is $175,000, then Peter would technically have a loss against his basis of $155,000 (which loss would not be recognized due to related party rules per Section 267).

Peter would also have made a gift to Mary of the difference between the FMV and Peter's basis (which would be $50,000 and reportable, obviously). Mary's basis would then be the greater of Peter's basis or what she paid for Peter's 1/3 share (so Mary's basis for Peter's 1/3, per Section 1.1015-4, would be $155,000). 

[MeeshkaDiane]

Hello! Yes, Mary (i.e., MeeshkaDiane - me) lived in the house from June 2019- October 3, 2022, plus muliple three-to-four day visits through present day.  What else would you need to know to see if Section 121 exclusion applied to Mary's gain if the three siblings (Peter, Joe and Mary) sold the home to an unrelated third party in August 2023?

[tagteam]

@MeeshkaDiane 

You need to have owned and used the home as your main home for a period aggregating at least two years out of the five years prior to its date of sale (visits don't count).

You mentioned that you lived in the house from June 2019 to October 2022, but was this your main home during that time period? You did not technically have an ownership interest until late December of 2020 and then, purportedly, did not live there after October of 2022 (i.e., a couple of months short of the 2-year period). Is that the case and, if so, what was your reason for moving?

[MeeshkaDiane]

Yes, I lived in the home from June 2019 to October 2022 as my main home. I moved to Virginia for a contract assignment on 10/3/2022. I was in temporary housing for one month (November 2022). Then I rented an apartment. I did not change my license plate or my driver's license from NY to VA as I may go back (which is why I am asking all these questions about buying the house). On my federal income taxes, I listed the NY home as my primary residence. I still have it listed as such. Does this help to determine if I qualify for an exclusion? 

[Bsch4477]

Mary, you have not addressed the 2 year ownership requirement which has been raised. If you inherited (owned) the home on December 23, 2020 and left October 2022 you did not live there 24 months as an owner. 

[rjs]

The two-year periods of ownership and use do not have to be at the same time. You have to have owned the home for two out of the five years before the sale, and you have to have lived in the home as your main home for two out of the five years before the sale, but they do not have to be the same two-year periods.

From the IRS web site: "You can meet the ownership and use tests during different 2-year periods."

Topic No. 701, Sale of Your Home

[tagteam]

@MeeshkaDiane may (at least) qualify for a partial exclusion as a result of a work-related move. 

See Publication 523 (2022), Selling Your Home | Internal Revenue Service (irs.gov)

If that's the case, then the entire gain (at least as calculated currently) can be excluded since that gain will be fairly minimal after selling expenses (e.g., real estate commissions and closing costs) are deducted.