Tax issue!

13 Replies

I had to purchase my primary residence with my parents credit, at the time I couldn't get approved. While I know it does not matter I paid all the closing cost, down payment, taxes and mortgage payments each month. We purchased the home in 8/2011. My wife and I are ready to sell the home and purchase a new home. We are being told that if we sell my parents will have to pay capital gains taxes (I would pay) This would really hinder our ability to purchase our next home because we need the equity for the down payment. Is there anything I can do to fix this? Could my parents refi with me on the new loan and add me to the deed? We stay in the home for two more years and be ok? Any other ideas?

I'm no expert, but I thought someone could own a house for 2 years and then sell without paying capital gains tax.

Another option would be to transfer the deed into a family trust, then change the beneficial interest to you - but you may want to consult an attorney on this.

@Damien Clark You didn't make it clear. First, you said with your parents credit, implying the purchase/deed were in your name. Then you mentioned being added to the deed. Do they use "trust deed", as opposed to a "mortgage" as the name of the instrument to secure the loan there? Maybe this is where the confusion is. Whose name is on the tax bill and in the county records? If the Ownership was in your parents name, then yes there would be capital gains. If so, adding you now would technically only "bring you in" at the current value, not the previous sales price I believe, so the current "spread would still be a cap gains issue for your parents. If the Ownership is in your name, then the gain is exempt.

Capital gains will apply if your parents are the deeded owner and did not use it as a primary residence 2 of the last 5 years. So who is the deeded owner right now?

My MIL just did the same thing last year. Only she paid cash and lent additional funds to the family member who is living in it and fixing it up. Instead of buying in the family member's name and recording a loan against it. I said it was a bad idea but my husband didn't want to push it too far (understandably). This will be a flip with some profit and the capital gains will be a shock for both her and the family member. It will use up a chunk of the profit that was supposed to benefit the family member. The whole point of the buying them the house was for them to make money on the re-sale so they could move on to something else.

I don't know any way around it except to change the ownership and start the two year clock again.

Summoning @Steven Hamilton II to see if there is another way.

My apologies for not being clear. My parents own two homes. Their home which is paid off. They also own the house I live in but I pay for everything. They are on the loan (the loan is a primary residence loan) and the title of the home. When I asked my parents to help me out I completely spaced on the capital gains issue. The idea was for us to get into a house for a few years in a very nice area knowing my credit would be fixed and we would have enough equity in the home to sell and use the equity as a down payment for our next home which would be in my name only. The capital gains really makes this more difficult to accomplish.

Did your parents live in this house at one time? If not, they should not have taken out a primary residence mortgage. A primary residence mortgage (owner occupied mortgage, I assume you mean) requires the borrower occup the property.

The tax issue may be even more complex than you think, unfortunately. If the property wasn't a primary or secondary house for them then it may be that they should have been taking depreciation on it. Whether they did or didn't, the IRS will assume they did. This decreases the basis on the property. When its sold, there is tax on that unrecaptured depreciation. The rate on that is 25%. The remaining gain is subject to long term capital gains tax.

Perhaps your folks can transfer ownership of the house to your, subject to the existing loan. You continue paying for it and live there for two more years. Better still might be for you to buy the house from them. Get a new loan in your name. Set a price that's income neutral for them and accounts for the money you've spent. You will need a down payment. May not have been your plan, but it may be the price you have to pay if you want to avoid the taxes. There may be tax issues with the transfer, though.

You really want to see a tax professional who specializes in real estate.

Originally posted by @Jon Holdman :
Did your parents live in this house at one time? If not, they should not have taken out a primary residence mortgage. A primary residence mortgage (owner occupied mortgage, I assume you mean) requires the borrower occup the property.
The tax issue may be even more complex than you think, unfortunately. If the property wasn't a primary or secondary house for them then it may be that they should have been taking depreciation on it. Whether they did or didn't, the IRS will assume they did. This decreases the basis on the property. When its sold, there is tax on that unrecaptured depreciation. The rate on that is 25%. The remaining gain is subject to long term capital gains tax.

Perhaps your folks can transfer ownership of the house to your, subject to the existing loan. You continue paying for it and live there for two more years. Better still might be for you to buy the house from them. Get a new loan in your name. Set a price that's income neutral for them and accounts for the money you've spent. You will need a down payment. May not have been your plan, but it may be the price you have to pay if you want to avoid the taxes. There may be tax issues with the transfer, though.

You really want to see a tax professional who specializes in real estate.

Not entirely correct. It does not have to be depreciated especially in cases where the costs were paid; however, the parents could end up with an underreporting issue for income and the deductions could be relatively limited.

However, my questions for @Damien Clark , Who deducted the interest on the loan? Who paid it? Was there any contract? If so you would be in a correct situation to avoid the capital gains. Remember it is only on the difference between purchase price and sale price.

Originally posted by @Steven Hamilton II :
Originally posted by @Jon Holdman :
Did your parents live in this house at one time? If not, they should not have taken out a primary residence mortgage. A primary residence mortgage (owner occupied mortgage, I assume you mean) requires the borrower occup the property.
The tax issue may be even more complex than you think, unfortunately. If the property wasn't a primary or secondary house for them then it may be that they should have been taking depreciation on it. Whether they did or didn't, the IRS will assume they did. This decreases the basis on the property. When its sold, there is tax on that unrecaptured depreciation. The rate on that is 25%. The remaining gain is subject to long term capital gains tax.
Perhaps your folks can transfer ownership of the house to your, subject to the existing loan. You continue paying for it and live there for two more years. Better still might be for you to buy the house from them. Get a new loan in your name. Set a price that's income neutral for them and accounts for the money you've spent. You will need a down payment. May not have been your plan, but it may be the price you have to pay if you want to avoid the taxes. There may be tax issues with the transfer, though.

You really want to see a tax professional who specializes in real estate.

Not entirely correct. It does not have to be depreciated especially in cases where the costs were paid; however, the parents could end up with an underreporting issue for income and the deductions could be relatively limited.

However, my questions for @Damien Clark , Who deducted the interest on the loan? Who paid it? Was there any contract? If so you would be in a correct situation to avoid the capital gains. Remember it is only on the difference between purchase price and sale price.

Steven: can you explain a little more about the correct position to avoid capital gains in this case? Can the OP deduct costs AND claim the capital gains exemption, even though he is not the borrower or the owner?

The OP says he paid all costs (mtg, taxes, etc) and was the primary resident for the last 2 years. How does that allow the parent owners to avoid capital gains? If there was a contract or agreement where the parents agree to sell to a primary resident and the terms of the sale are having the buyer pay the costs, is that sufficient for the parents to be exempt from capital gains?

@Steven Hamilton II I pay for all cost associated with the property. My parents write off the interest of the loan. My parents would be willing to do a contract if its not too late..

Originally posted by @Damien Clark :
@Steven Hamilton II I pay for all cost associated with the property. My parents write off the interest of the loan. My parents would be willing to do a contract if its not too late..

Since you are paying it they cannot deduct the interest unless they include the income on their tax return.

A contract should have been in place from the beginning stating the property was yours etc. You assuming the loan and so on. If he had been the owner based upon that contract he could have qualified for the exemption. The fact you paid the interest and they were deducting it does not show that kind of transparency.

Regardless of him being the borrower, he truly does not have a stated contract interest in the property. They could have added him to the deed shortly after closing; however, they did not.

Next issue is: It should have been treated as though your payments and maintenance of the property was you paying them rent, (depends upon if FMV or not for deductiblity of their costs and if depreciation would have been taken.)

No exemption in this case. Day late and dollar short. This is why I stress tax planning in all cases.

@Steven Hamilton II So there is nothing I can do going forward to avoid the capital gains? Also, can I send you tax returns so you can see how we and my parents taxes were done?

Do some sort of subject to contract now and live there another two years.

Sounds like you need a tax pro to help you correct the previous years tax returns for both you and your folks.

Damien: at this point don't do any DIY deeding or contracts or tax returns. Someone needs to look at the entire picture for both your parents and you. If your parents are in the lower income brackets during the year they sell, they may owe no capital gains. There are lots of variables.

Originally posted by @Damien Clark :
@Steven Hamilton II So there is nothing I can do going forward to avoid the capital gains? Also, can I send you tax returns so you can see how we and my parents taxes were done?

Feel free to send me a PM if you want to talk about the situation further. Perhaps I can explain it a bit better.

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