What is My Cost Basis for Primary Residence With Gift of Equity?

[mrmood6007]

I purchased my parent's house about 5 years ago when they were having financial difficulties. Here are the key amounts that were part of that transaction:

Purchase Price: $535K

FMV: $580K

Gift of Equity: $150K

Loan Amount: $396K

Parent's Tax Basis: $200K

The difference of ~$10K between the purchase price, gift of equity, and loan was due to title and escrow fees, in addition to homeowner's insurance reserves and property tax reserves.

I believe that this transaction would fall under the following guidance: § 1.1015-4 Transfers in part a gift and in part a sale. Therefore, I believe my cost basis would be the loan amount, as that is what I actually paid out to pay off my parent's loans (i.e. primary and LOC - total of $190K), pay off my parent's liens (i.e. total of $17K), and pay out my parents in cash (i.e. total of $175K). The remaining amount of the loan relates to title and escrow fees.

Could you help confirm what my cost basis is for this transaction?

[NCperson]

@mrmood6007 - while I won't answer this directly, I will try to simplify for others who post..

If the purchase price was $535k and the gift was $150k, then the loan was $385k. 

While the loan was actually $396k and you state that the $11k difference was for title (which adds to the cost basis), escrow (the agent or atty which adds to the cost basis), insurance reserves (which do NOT add to the cost basis) and property tax reserves (which do NOT add to the cost basis). 

what do you think the cost basis is based on the reference you provided. Note there is no reference to the loans in this definition:

The Greater of:

(i) The amount paid by the transferee for the property, or

(ii) The transferor's adjusted basis for the property at the time of the transfer,

[Critter-3]

Actually the basis needs to be considered with and without the gift ... technically the house was partially bought for an amount  and a portion was gifted. 

So you have the straight up cost basis portion for the purchase price  and then a basis for the gift.  This is where is gets tricky as  a computation needs to be made for the gift basis using both a portion of  the original purchase price and the fair market value at the time of selling.  Gift basis used for the sale of the home would depend on if there is a profit or loss on the sale later when it is sold.  Either get help from a local tax pro who can do the math for you  and/or  explain it to you   OR   read up on this subject on the IRS site :   https://www.irs.gov/faqs/capital-gains-losses-and-sale-of-home/property-basis-sale-of-home-etc/prope...

[mrmood6007]

@NCperson I think the "amount paid" would include all amounts to pay off my parent's debts and any cash paid to them, which is why I would consider the loan amount my cost basis. However, that is what I am trying to clarify, and I stated this in my initial post.

[Opus 17]

First you ignore anything that paid into escrow.  That's your money, just held in a different place.  Some part of it  might become a tax deductible property tax payment whenever the tax bill is paid, other parts of it are non-deductible hazard insurance payments.

Assume the selling price as listed with the county clerk's office (on which transfer tax was paid) was $535K.  Your parents essentially gifted you the amount of the down payment, in the amount of $150K.  That means that what you paid was $385K.  That's your starting cost basis.

Then, you can include the following closing costs.

• Abstract fees (abstract of title fees),

• Charges for installing utility services,

• Legal fees (including fees for the title search and preparing the sales contract and deed),

• Recording fees,

• Survey fees,

• Transfer or stamp taxes, and

• Owner's title insurance.

Other closing costs are not adjustments to basis.  See here for more

https://www.irs.gov/publications/p523#en_US_2021_publink100010751

Those closing cost adjustments might add up to the full amount of the loan, or they might not, because I don't know what else was included in the loan.  The loan might have included unallowable costs, such as an application fee, bank attorney fee, cost of obtaining a credit report, and other items also listed at the link above.  

Since your cost was more than your parent's cost basis, and they (presumably) didn't pay gift tax, that's as far as you need to go.  

If you bought the home from strangers for $175K cash to the owners plus $207K in lien payoffs, your cost basis would be the same or close (I get $382K, maybe the numbers are not precise) plus the same adjustments above.  You have to get into the "gift of equity" situation because the home was worth more than you were providing in funds and your parents are related to you.  But if you were buying the home from strangers, they have no legal requirement to maximize their profit and they could sell to you for less than market rate and I don't even think you would have to call the difference a gift, because they aren't related.  (But I could be wrong about that.)

In any case, your basis really is the same as it would have been if you had bought the home from strangers for the same loan payoffs plus cash, plus adjustments for those closing costs which are allowed in publication 523.

[NCperson]

@mrmood6007 

if I use this statement from your source: 

The Greater of:

(i) The amount paid by the transferee for the property, or

(ii) The transferor's adjusted basis for the property at the time of the transfer,

The amount paid by the transferee (you) for the property is $385,000 (The purchase price less the gift)

The transferor's (your parent's) adjusted basis for the property at the time of transfer: $200,000

since it is the greater of those two figures, then $385,000 is the cost basis, which is what @Opus 17 determined 

To that $385,000 cost basis, the cost of the escrow agent and title can be added to that (that is imbedded in the $11,000 additional loan), the reserves for taxes and insurance are not part of the equation. 

Note that 'cost basis' (or capital gains for the same reason) never includes the debt (the loans), it's always about the assets.  

[mrmood6007]

Thank you @Opus 17, your explanation is exactly what I had in mind, but I wanted to confirm that made sense. Just to clarify, could you please let me know which of the following fees would be included in the cost basis:

Title Fees - I think these would be included

Settlement Agent Fee - I think this would be included as it is not part of escrow

Escrow Prepayments (i.e. Homeowner's Insurance, Property Taxes, Prepaid Interest) - I do not think these would be included

Appraisal - I do not think this would be included

Mortgage Broker Fees (i.e. Processing, Underwriting, Closing, Document Preparation, Admin Fee.) - I think these would be included

[Opus 17]

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@mrmood6007 wrote:

Thank you @Opus 17, your explanation is exactly what I had in mind, but I wanted to confirm that made sense. Just to clarify, could you please let me know which of the following fees would be included in the cost basis:

Title Fees - I think these would be included

Settlement Agent Fee - I think this would be included as it is not part of escrow

Escrow Prepayments (i.e. Homeowner's Insurance, Property Taxes, Prepaid Interest) - I do not think these would be included

Appraisal - I do not think this would be included

Mortgage Broker Fees (i.e. Processing, Underwriting, Closing, Document Preparation, Admin Fee.) - I think these would be included

---

It's all there in the link I gave.  The answers are yes, I don't know, no, no, and no.

I don't know what is included in "settlement agent fee."  If that is a person who prepares documents and helps you close the loan, the answer is yes if you are paying them (similar to a buyer's attorney in most states) but no if this is the bank's attorney or someone not working for you.   

 

 

 

Fees and Closing Costs

Some settlement fees and closing costs you can include in your basis are:

• Abstract fees (abstract of title fees),

• Charges for installing utility services,

• Legal fees (including fees for the title search and preparing the sales contract and deed),

• Recording fees,

• Survey fees,

• Transfer or stamp taxes, and

• Owner's title insurance.

Settlement costs don’t include amounts placed in escrow for the future payment of items such as taxes and insurance.

Some settlement fees and closing costs you can’t include in your basis are:

• Fire and casualty insurance premiums,

• Rent for occupancy of the house before closing,

• Charges for utilities or other services related to occupancy of the house before closing,

• Any fee or cost that you deducted as a moving expense (allowed for certain fees and costs before 1994),

• Charges connected with getting a mortgage loan, such as:

  1. Mortgage insurance premiums (including funding fees connected with loans guaranteed by the Department of Veterans Affairs),

  2. Loan assumption fees,

  3. Cost of a credit report,

  4. Fee for an appraisal required by a lender

  5. Points (discount points, loan origination fees), and

• Fees for refinancing a mortgage.

[Mike9241]

the parents need to file gift tax returns since the gift was more than the annual exclusion