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Potential Home Sale -- any ideas?

Mom and Dad bought a 2 family home in what is now a "trendy" area of NY City for $25,000 in the 1970s. They retired in the '90s and eventually moved to what had been their vacation home. Their son (one of 3 kids) took over the owner's unit and the other unit remained rented. They treated it as still family occupied, and Dad continued to deduct taxes (Mortgage was already paid off) and expenses re: the rental unit.

Over the years, they made something like $200,000 of improvements/ renovations to the property.

Mom has Parkinson's disease, and about 5 years ago they changed the title to put 58% ownership in Dad's name alone, and gifted 14% ownership to each of the 3 adult children, including the son who actually lives there. A Gift Tax return was filed by the lawyer who did the deal, but Dad continued to claim all deductions for the house since he was nominally paying the bills (although Junior actually paid some of them).

Mom and Dad are in their late 80s, both still alive although Mom's need for care is increasing. Now they want to sell the house, which is worth about $2.5 Million in today's market. Dad turned green at the thought of taxes (Fed + State) on the sale in the $500,000 neighborhood (about $300,000 fr him and about $80 for each of the kids).

How to report/tax the sale...

Should the sale be reported on the individual returns, or should wereport the sale as being made by a "partnership" and then distribute the sale proceeds?

Should the inocme tax returns be amended to allocate the deductions for prior years among the 4 owners?

Obviously it was not the primary residence for two sisters, or for Dad, but can Junior (and Mrs. Junior) claim the $500,000 exclusion against at least his share of the profit?

Any other ideas to reduce the tax bill?

Reply to
Jeff
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It's probably best to hold on until Dad dies. His portion of the basis will get stepped up to fair market value. Unfortunately, because of the gifting that has already been done, the kids' basis will NOT get stepped up. How this will impact the total tax depends on the parents' other assets, which might cause an estate tax liability. This is a complex enough issue that you'd be advised to seek the assistance of a good estate attorney and a tax pro to sort out the options.

Reply to
Tom Healy CPA

If the sale is for ALL of the property - the owner's unit and the rental unit - then the son who lives there can use the $250,000 per taxpayer exclusion. If he's married THEN it jumps to $500K.

There is a provision in Subchapter K of the Internal Revenue Code (which I cannot site off the top of my head) that allows multiple owners of rental real estate to forego a partnership return and report their respective shares of the income and expenses on their personal returns. This election is supposed to be made on the FIRST partnership return, which would be filed with all zeros - as an information return letting the IRS know about this election.

I could make several arguments about who owns what portion of the rentals, but before I get into specifics I will tell you that I would NEVER post them here. They are way to convoluted for the uninitiated to appreciate. I will tell you that if all the income and expenses have been reported on Dad's returns and no partnership return was ever filed YOU NEED PROFESSIONAL HELP.

How much of the cost basis goes to Dad? This gets reduced by the accumulated depreciation allowed OR ALLOWABLE. The difference between this and the adjusted sale price (the sale price minus settlement costs) is gain - some of which is subject to depreciation recapture (and taxed at 25%) and some subject to long term capital gain tax rates (currently taxed at

15% - and don't bet that we'll get to keep that rate forever. I fully expect that the capital gain tax rate will be increased in the not too distant future).

The remaining basis gets divided between the sisters and Jr. and each will get a portion of the cash from settlement (which also has to be allocated to all the owners). The sisters will get to pay tax at the long term capital gain tax rates - they should NOT get hit with any depreciation recapture since they reported on rental activity. Jr. and Mrs. Jr. should be able to use the Section 121/122 exclusions for their share.

One of the tricks here is how to split up the reporting correctly - money that goes to Dad becomes an asset that must be spent down before Mom can get Medicaid. Money that goes to the kids, and which can be justified based on ownership percentages, is beyond the reach of Medicaid.

Lastly - tell Dad to buck up. He and the family are going to NET $2M off an investment that cost them $25K - what's NOT to love here? His other choice is to do without the $2M and wait till he dies - at which point HIS share of the property will step up BUT the portion already gifted away will remain the same. It will save HIM $300K in tax (assuming your numbers are accurate) but it will DEPRIVE him of A MILLION DOLLARS. Frankly, I'd rather have the MILLION.

Gene E. Utterback, EA, RFC, ABA

Reply to
Gene E. Utterback, EA, RFC, AB

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