Sale of second home part of proceeds in escrow

[ct225]

We sold a second home in 2024. There is an issue with the title (New Jersey tidelands claim) and in order for the sale to go through, we were required to put about 5% of the proceeds in escrow. The title company hold this until we go through a process with the state of New Jersey to determine how much we have to pay to resolve this issue. This process could take 2-3 years and we won't know how much of the escrowed amount will be returned to us (if any) until that process concludes. My question is whether the escrowed amount forms part of the capital gain on the property for 2024 or whether it is excluded and then taxes are paid on any amount that comes back to us at the relevant time. If it is part of the 2024 capital gain and we ultimately end up with nothing coming back to us, would we then submit an amended 2024 return to reduce the gain from the sale? 

[DianeW777]

My advice would be to consider this as part of the sales expenses simply because you have no way of knowing if any of it will be refunded in the future. This will give your the maximum cost basis to reduce the capital gain for 2024.

If in the future you actually do receive a  refund, you will report additional income in that tax year.  It will not have any special treatment, simply included and taxed at your regular tax rate at that time. Keep your records about the escrow, including reasons and potential consequences for little to no refund in the future.