Taxable Sale OR Gift?

[JuneBug75]

I am reposting this from the Deductions & Credits page, which wasn't the appropriate place to ask about gain on sale of property vs. gift.  So, here goes...

2 children (brother and sister) inherited their father's residence who died intestate in 2010. Sister made it her primary residence some years later. In October 2023, brother transferred his 1/2 interest in the real property to his sister and brother-in-law by quit claim deed so that his sister could then use the property as collateral for a mortgage loan. The loan proceeds were received about 7 months later in May 2024. The sister used a portion of the loan proceeds to pay her brother for his 1/2 interest in the property at the FMV established by the lender’s appraisal and used the remaining loan proceeds to make home improvements. The question is whether the quit claim deed of 1/2 interest in the real property from brother to sister in 2023 and the subsequent payment from sister to brother in 2024 should be considered

(1)  one sale transaction requiring brother to report a capital gain in 2024 (there was no written sales agreement between brother and sister) OR

(2) are they 2 separate gifts requiring a Form 709 gift tax return - first a gift of property from brother to sister in 2023 and then a gift of cash from sister to brother in 2024?

The only documentation is the October 2023 quit claim deed of 1/2 interest from brother to sister with no consideration at the time, then a wire transfer of cash from sister to brother 7 months later when she received the mortgage loan proceeds in 2024.

[DaveF1006]

it depends. it could either be construed as a gift or sale. Without a written agreement, it is hard to determine the nature of the transaction and would involve a legal interpretation that we are not allowed to comment on. 

I can say though that this could be construed as a sale if the sister intended to pay her brother but without an agreement, this is a gray area at best and more likely may be considered a gift than a sale from an IRS perspective. My advice is that as a safe practice, to file 2 separate gift tax returns one for the transfer and one for the gift of cash. i say this because there is no clear IRS guidance on how to handle a situation of this type of transaction.

[M-MTax]

My one and only comment, @JuneBug75, is that it doesn't appear as if there was donative intent when the quitclaim deed was drafted (when the transfer was made).

Rather, it appears as if the brother expected something in return (i.e., to be paid for the share the brother purportedly transferred to the sister). If that's the case, then the brother (and sister) can dispense with filing gift tax returns (709s) and proceed with a different approach, such as a sales transaction.

[JuneBug75]

@DaveF1006 Thanks for your input.   Based on the fact that brother executed the quit claim deed to sister and her husband so that they could then get a loan against the property in order to pay brother for his half share, evidenced by the actual payment to brother upon receipt of the loan proceeds, that would probably be construed by the IRS as an expression of intent in the absence of a written agreement, thereby connecting the two events as on step transaction.  I guess the real question is level of risk as to whether the IRS would ever connect the dots and know that sister paid brother 7 months after the quit claim deed was executed and that such payment was intended to be for his half of the property as opposed to out of sisterly love.  Filing late Form 709 gift tax returns might call the IRS' attention to the matter???

 Another twist to this is that brother was in the process of buying a new residence in 2024 when sister paid him some funds from her mortgage loan, so perhaps there's an argument to be made that she did in fact make a gift to brother to help him with the purchase of his new residence.  But neither party filed a timely Form 709 as an expression of their intent to gift the property or the money.  

[JuneBug75]

Yes, @M-M , that is the way I was leaning also.  But see my reply to @DaveF1006 for another wrinkle that could affect the outcome.

[M-MTax]

It would be unlikely for the IRS to "connect the dots" in this scenario. 

A sales transaction would clarify the receipt of proceeds from the sister by the brother and would establish a firm basis for the sister (rather than some sort of carryover basis if the transaction is considered to be a gift).