Capital gains tax on proceeds from parents home

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Capital gains tax on proceeds from parents home

Keith Andrews
Real Estate Agent · Colorado Springs, CO · Member since 2019 · 26 posts · 15 votes

I am hoping a BiggerPockets tax guru can help shed some light on things for me.

My wife’s parents added her and her brother to the title of their primary residence in 2008 (because they were paying the mortgage for them). They originally bought the home in 1980 for $100k. Throughout the years they pulled money out increasing their debt on the house to $300K. They just sold the house for $1M. My wife will receive 25% of the proceeds which equates to about $150k after everything. My questions are the following:

1. Will we have to pay capital gains on $150K or 25% of the gain from 100K to 1M? Or would it be the value of the house when she added the title in 2008?

2. Since this house was her parents primary residence (my wife hasn’t lived in the home for 15 years), is it eligible for a 1031 exchange or any other tax shelter?

Thanks!

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Michael PlaksPro Member
Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
7y

@Keith Andrews

Your question is actually more complicated than you expect.

For starters, we need to establish your wife's tax basis (investment) in the house. Let's say that the house was worth $600k in 2008. She acquired a 1/4 interest, or $150k. But what did she pay ? She paid the mortgage for some time. Was it just goodwill towards her parents? If yes, then it does not count. If she was paying their mortgage in expectation of being awarded 1/4 interest - then it does count. 

Assume the latter and assume she paid $25k towards their mortgage. The other $125k of her interest must be a gift from her parents. Her basis in that portion is equal to her parents' basis. Confusing? Yes, indeed. Their basis in the $125,000 gift is calculated as a certain ratio and will be about $20k. Your wife's total basis is $25k + $20k = $45k.

Her gain is not calculated off of the "proceeds after everything" - assuming that your everything includes mortgage payoff. Her gain is calculated off of 1/4 of the sale price, adjusted for closing costs. Ignoring the closing costs for simplicity, her number is 25% * $1M = $250k.

So your wife owes capital gains on $250k - $45k = $205k. 

My calculation is not complete, however. We have not considered what happened with the remaining mortgage in 2008. Did she continue paying it? Did she assume responsibility for 25% of the mortgage? Or for 50% of the mortgage? This will increase her basis, possibly very dramatically, and reduce her capital gain.

If I have not convinced you that you need professional help, then probably nothing will.

As to a 1031 - see @Dave Foster's answer. 

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  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    7y

    @Keith Andrews, possibly.  It all comes down to her intent.  If she was just providing a place for her parents to live then that is not an investment intent and a 1031 would not be appropriate.  But if she went on title treating it like an investment then she probably can justify a 1031 exchange with her tic % of the sale.  

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  • Basit SiddiqiBusiness Member
    Accountant · New York, NY · Member since 2015 · 8k+ posts · 3k+ votes
    7y

    @Keith Andrews

    Gain = her share of sale price less her basis.
    It looks like received her basis in 2008 when it was "gifted" to her.

    You should consult to see what her basis is.

    You may want to see if you can invest the proceeds into a qualified opportunity fund to potentially defer the taxes.

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  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    7y

    @Keith Andrews

    Your question is actually more complicated than you expect.

    For starters, we need to establish your wife's tax basis (investment) in the house. Let's say that the house was worth $600k in 2008. She acquired a 1/4 interest, or $150k. But what did she pay ? She paid the mortgage for some time. Was it just goodwill towards her parents? If yes, then it does not count. If she was paying their mortgage in expectation of being awarded 1/4 interest - then it does count. 

    Assume the latter and assume she paid $25k towards their mortgage. The other $125k of her interest must be a gift from her parents. Her basis in that portion is equal to her parents' basis. Confusing? Yes, indeed. Their basis in the $125,000 gift is calculated as a certain ratio and will be about $20k. Your wife's total basis is $25k + $20k = $45k.

    Her gain is not calculated off of the "proceeds after everything" - assuming that your everything includes mortgage payoff. Her gain is calculated off of 1/4 of the sale price, adjusted for closing costs. Ignoring the closing costs for simplicity, her number is 25% * $1M = $250k.

    So your wife owes capital gains on $250k - $45k = $205k. 

    My calculation is not complete, however. We have not considered what happened with the remaining mortgage in 2008. Did she continue paying it? Did she assume responsibility for 25% of the mortgage? Or for 50% of the mortgage? This will increase her basis, possibly very dramatically, and reduce her capital gain.

    If I have not convinced you that you need professional help, then probably nothing will.

    As to a 1031 - see @Dave Foster's answer. 

    3Reply
  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    7y
    Originally posted by @Basit Siddiqi:

    @Keith Andrews

    You may want to see if you can invest the proceeds into a qualified opportunity fund to potentially defer the taxes.

    Yes, this is something worth considering. It does not eliminate your wife's tax, but it can delay it for a few years and slightly reduce it (up to a 15% discount is possible). Competent tax advice is needed before you pursue it.

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  • Account Closed
    Specialist · Paradise Valley, AZ · Member since 2018 · 3k+ posts · 2k+ votes
    7y
    Originally posted by @Michael Plaks:

    @Keith Andrews

    Your question is actually more complicated than you expect.

    For starters, we need to establish your wife's tax basis (investment) in the house. Let's say that the house was worth $600k in 2008. She acquired a 1/4 interest, or $150k. But what did she pay ? She paid the mortgage for some time. Was it just goodwill towards her parents? If yes, then it does not count. If she was paying their mortgage in expectation of being awarded 1/4 interest - then it does count. 

    Assume the latter and assume she paid $25k towards their mortgage. The other $125k of her interest must be a gift from her parents. Her basis in that portion is equal to her parents' basis. Confusing? Yes, indeed. Their basis in the $125,000 gift is calculated as a certain ratio and will be about $20k. Your wife's total basis is $25k + $20k = $45k.

    Her gain is not calculated off of the "proceeds after everything" - assuming that your everything includes mortgage payoff. Her gain is calculated off of 1/4 of the sale price, adjusted for closing costs. Ignoring the closing costs for simplicity, her number is 25% * $1M = $250k.

    So your wife owes capital gains on $250k - $45k = $205k. 

    My calculation is not complete, however. We have not considered what happened with the remaining mortgage in 2008. Did she continue paying it? Did she assume responsibility for 25% of the mortgage? Or for 50% of the mortgage? This will increase her basis, possibly very dramatically, and reduce her capital gain.

    If I have not convinced you that you need professional help, then probably nothing will.

    As to a 1031 - see @Dave Foster's answer. 

     I love seeing tax law being exposed for what it is, Confusing! Written by lawyers for lawyers to keep lawyers fully employed.

    Thanks for the explanation @Michael Plaks your service to investing is irreplaceable or at least highly taxing to the average investor

    1Reply
  • Keith Andrews
    OP
    Real Estate Agent · Colorado Springs, CO · Member since 2019 · 26 posts · 15 votes
    7y

    @Michael Plaks

    My wife paid the mortgage prior to being put on the title.  When she moved out in 2008 her brother started paying the mortgage, this is when her parents decided to add both of there names on the title.  It was there way of saying, "Thank you" and giving her an investment interest in their home.  I really hope we can somehow figure out a way to qualify these funds as @Dave Foster suggested and use them to purchase a rental property.  It doesn't seem right that she should be liable for 25% of $1M meaning we would owe more than she even received.  

    @Dave Foster What would we have to do to pull this off?  I will talk to my CPA today, but am looking for any creative ideas you guys have.

    Thanks everyone for chiming in, I really appreciate it!

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  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    7y

    @Keith Andrews

    You won't owe $250k in taxes. You would owe capital gain on $250k income - a very different number.

    The house went from $100k to $1M, and someone owes taxes on that $900k gain. Your in-laws don't owe on their portion, due to a $500k exclusion, but your wife and her brother do.

    My calculation is far from complete, and it's complex. Which is why you have a CPA. It's your CPA's job to do the real calculation and discuss options.

    1031 is dead on arrival, because the house is already sold. Something @Dave Foster and I overlooked in our initial responses. 1031 had to be started before the sale. 

    Opportunity Zones is another option to explore, although it does not kill the tax. It delays it and possibly reduces it a little.

    1Reply
  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    7y
    Originally posted by @Dave Foster:

    @Keith Andrews, possibly.  

    Actually, no. The house is already sold. :)  

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