Can we use the gift of equity to minimize the impact of the capital gain on a home?

[jashaw569]

We purchased a home for our daughter and her family. Now that their credit is fixed, they want to purchase the home from us. We will be facing a capital gains tax of approximately $28,000. We want to eliminate this gain by a gift of equity $14,000 from me and $14,000 from my wife. Is this possible and how is this reported on our Tax Returns?

[Hal_Al · Accepted solution]

Yes. You simply report the actual sales price (after the $28,000 "discount") on form 8949 and sch D. You are not allowed to show a loss on the sale. 

Since the gift is less than the gift tax rule, you do not need to file a gift tax return. "Gift Tax" is somewhat of a misnomer.  Even though a gift tax return may be required, very few people ever actually pay federal gift tax. So, you could make an even bigger gift of equity to avoid capital gains. But keep in mind that long term capital gains are taxed a lower rate than ordinary income and at 0% for many people.

The purpose of the gift tax return is usually only to document a reduction in the allowable estate tax exemption.

See https://turbotax.intuit.com/tax-tools/tax-tips/Tax-Planning-and-Checklists/The-Gift-Tax-Made-Simple/...

[michelle-cammara]

Isn't this an investment and so when sold to the daughter, the parents will have a short term gain on that investment, since they never lived in it?

[Hal_Al]

The never lived in it part does not govern whether the gain is long term or short term. That's determined by when they bought it.
The fact that they never lived in it,, only means they don't qualify for the rule that allows an exclusion (up to $500,000 for a couple) of the capital gain of a primary residence.
Also. when making a gift  of a capital asset, you shift the capital gain to the recipient, at a later date.  But because the daughter will use it as her primary house, she will be eligible for the $500,000 exclusion.

[leapy88]

Hi Hal_Al - Can you clarify your post above. I’m in a similar situation.  I want to sell my rental property to my sister at the at the remaining loan balance and do a Gift of Equity up to the FMV.   I’m getting confused on the Capital Gains (if any for the giver). Scenario to put some figures:

Basis $410k
Loan Balance $180k
FMV $650k

Gift $650k minus $180k net $470k

Capital Gains ? = $650k minus $410k = $240k or is it ZERO since my Cost Basis will be transferred to my sister. And she will pay any capital gains when she sells ?

What would the 1099-S show. The title company I had talked to said the 1099-S would show the FMV.

I was reading this "<a rel="nofollow" target="_blank" href="https://www.law.cornell.edu/cfr/text/26/1.1001-1#e"">https://www.law.cornell.edu/cfr/text/26/1.1001-...> and from this <a rel="nofollow" target="_blank" href="https://ttlc.intuit.com/questions/3357256-does-gift-of-equity-create-capital-gain-or-add-to-cost-bas...> Which you had contributed to the conversations as well.   Obviously, I’ll be consulting with a Tax Lawyer or CPA, when we do this, but Really want figure out or at least understand the Capital Gains (if any).  If I have to claim CG, then what’s the point of gifting it when I have to pay tax on something I’m not receiving.

Thank you.

[Hal_Al]

leapy88 - You will have no capital gains to report. You are shifting the future tax burden to your sister. The link to the other AnswerXchange question (post) explains how to handle the 1099-S. Your sale price is $180K. Your cost basis for reporting is $180K. You may not claim a loss, since you are selling to a related party. Your sister's cost basis in the property is $410K. Your accumulated depreciation also transfers to your sister and she will continue depreciating on the same schedule you were using. She will have to "recapture" (pay tax on) the depreciation when she sells. If your sister uses the home as her primary residence, for the required 2 years, she can avoid tax on the ordinary capital gain (up to the limits) but not the depreciation recapture. You will be required to file a gift tax return (explained above).

[leapy88]

Hal_Al - Thank you. That was how I interpreted in the 26.1 code. But I'm still confused as to how to report the 1099-S.  Are you saying that the 1099-S is going to reflect the FMV but I should only report that the Basis as $180 and Sale as $180? I would assume the Gift of Equity Letter should state all the Details of Depreciated value used, cost basis, and gifted amount at the least?

[Hal_Al]

I don't know how much the 1099-S will be for. You'll have to ask the closing agent that question. It could be $180K or it could be the FMV. Based on other postings I've seen here, in this forum, If the mortgage Co. handles the closing it probably will be the FMV. The gift of equity goes no where  on your tax return. That's a side issue.

What ever amount is on the 1099-S is both your sale amount and your basis for form 8949, as you want the gain/loss to show as 0.

[btkean92]

Ok in that case we just bought home from my mom that we have been living in. 150k was purchase price but total cost was 153k Appraised at 170k (not sure if relevant). Gifted 34k and our loan was 120k. Her orig cost was 134,700. So how would that math work?

[AmyC]

See my math below. 

• Your mom's basis is what it is for the sale to you.
• I am not sure if you paid $153,000 and the gift got you the lower mortgage of $120k.
• It does not make sense for the gift to go from $170k to $150k.
• Did something else happen?

Without the gift, you would not have gotten the mortgage, financing and house is what it sounds like to me. This gives you a basis of $153,000.

@btkean92

[curiousminds]

I am in a situation where A. I don’t know how todo my own taxes. And B, 3 different CPA’s have all told me the same thing which is that I have to pay capital gains taxes on an investment property I sold to family with a gift of equity.

Details:

- I originally payed 150k for the house.

- House appraised at 200k when sold.

- My sell price was 175k.

- Gift of equity was 25k.

- Purchase price was 200k.

I’ve repeatedly been told now that I will have to pay capital gains taxes on 50k, and not the 25k I expected and still believe is correct. Why should I have to pay capital gains taxes on money I didn’t actually get? Not only that but everything I have read says that the gift of equity should lower the cost basis of the buyer, which makes me paying capital gains tax on the full 50k difference make even less sense.

How can I make these lazy and uninformed CPA’s see the light?  

[jdt-65]

@curiousminds, I am investigating the exact same issue right now. Can you tell me what you ended up doing? Much appreciated.

[curiousminds]

Unfortunately nothing too specific as I was asking the question for someone else I know. But I can tell you that their accountant got it done, meaning, they were able to make an adjustment to lower the sale price of the home based on the gift of equity. I will tell you though, it was a struggle. Even people who do this professionally are incredibly either ignorant about this, or just stuck in their ways. There is legal precedent set for tax code being interpreted this way, yet the majority of accountants, and tax lawyers won’t want to agree with you, or won’t engage you on this. It’s probably easier and cheaper to just file it yourself. There are probably more correct and less correct ways of lowering the sale price of your home based on a gift of equity, but it’s more important I think to know that it can be done and it is 100% legal todo so. I went through hell to find an accountant who specializes in real estate who actually knows wtf he’s doing to confirm my interpretation was correct. Unfortunately my friend couldn’t use him because he wasn’t taking in anymore clients, but he found someone on his own. So just know know that if you are needing someone to file your taxes for you, there exist people who know how todo it properly and save you a ton of money.

[jdt-65]

As I'm sure you felt at the time, I feel like I've stumbled upon the biggest tax "blind spot" in existence. I fully agree that the regulations are clear, you do not pay capital gains tax on "unrealized" gains, i.e., a gift of equity.

The closing company just fills out the 1099-S with the sale price, without any consideration for the gift of equity. The CPAs just want to plug in whatever number is on the 1099-S and not risk making perfectly valid adjustments. I guess I just need to find a better CPA as I doubt I will be able to convince the closing company to adjust the 1099-S.

I have a feeling the IRS is well aware of this and simply doesn't bother to clarify how it should be handled in a more direct way. I can't imagine how many people are paying the extra tax because they just don't bother to look further into it.

Thanks for the follow-up. Hope it helps someone else out there in the same situation.

[curiousminds]

Very eloquently said, that is exactly it. And ya I tried the route with having the 1099-S changed, I even expected the current closing company to give me a hard time so I called some others just before things were really finalized, and I was basically laughed at by everyone I spoke to. All of these people are machines, and evidently gift of equities don’t happen enough for anyone to actually care enough to make them do something differently. Meanwhile lenders are perfectly aware of it and will push for this direction when anyone wants to sell their house to someone below market value.

It really is the most frustrating thing, that can have you thinking that you are, in fact, a crazy person. But ya, no telling how much extra tax revenue the IRS is making because of everyone else’s closed mindedness. Sometimes I think it’s a classic case of it being the idea of the uninformed, and therefor the automatic reaction of no, you can’t do that, not how this works. I get that a lot with police for example, they don’t like it when something is my idea. So maybe try a little bit of reverse psychology haha.

but seriously, just be patient, either fill out the taxes yourself, or keep looking. If you remind me, I can dig up the response I got from the CPA who actually knew what they were doing. Might help you.