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Christopher Phelps
Christopher Phelps, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 2710
Experience:  CPA, CFP, PFS, Tax Practitioner 21 Years, Member AICPA/CSCPA Tax/Financial Planning Committee Member
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How do you calculate capital gain on a real estate gift

Customer Question

We were given property 3/25/05 valued at let's say $800,000 and we want to sell it for $850,000 right away. How much capital gain (or %) would we have to pay? Currently has a mortgage of $320,000
Submitted: 11 years ago.
Category: Tax
Expert:  Christopher Phelps replied 11 years ago.

If you were gifted the property (i.e. the donor is still living) then you assume the cost basis and holding period of the donor. For example, if your grandparents paid $10,000, 50 years ago for a property and then later gifted it to you when it was worth $800,000, then when you sell it for $800,000 you will have a taxable gain of $790,000 which will be considered long-term capital gain since they held it for more then one year. Long-term capital gains are subject to a maximum Federal tax rate of 15% ( to the extent the gain would otherwise be taxed in the 10% and 15% brackets it is taxed at 5%). If the gain is considered to be short-term (i.e. held less then one year) then the gain is treated as short-term capital gain (to the extent not offset by other capital losses) and is taxed as ordinary income subject to tax at your marginal tax rates. The donor will be required to report the gift on Form 709 by the due date of the income tax return. How were you able to be gifted property subject to debt?

Alternatively, if you inherit the property as a beneficiary of a will or living trust, then different tax consequences apply. An estate is required to file an estate tax return if the decedents assets are valued at $1,500,000 or more (before debt or mortgages). If the decedents estate owned the house, sold it and then distributed the cash to you, then you have no tax liability whatsoever (i.e. estate, inheritance or income). The estate will report the sale and bear any tax consequences.

If the estate transferred title to you BEFORE its sale, then while you will not owe an estate or inheritance tax, you may owe income tax. If you were on the title prior to sale, then the sale transaction of the property is reportable by you and any other heirs on the title in your proportionate share. Thus, the sale will need to be reported on schedule D of your Form 1040 for the year of sale.

Your cost basis in the property is equal to the value of the home reported in the decedents estate tax return (Form 706). If an estate tax return was not filed, then your cost basis is the fair market value as of the date of death of the decedent from whom you inherited the property (get an appraisal).

The reported sales price will be equal to your proportionate share of the proceeds fom the sale less selling expenses. The cost basis will be equal to your proportionate share of the date of death fair market value plus any improvements made after death but before the sale. Thus, when you inherit a property and later sell it, you will only be taxed on any post-death appreciation. Such gains are automatically considered to be long-term capital gains subject to a maximum tax rate of 15% (see above).

In either scenario you will also have to report the transaction to your state if your state has an income tax.

Thus, if you received the property by gift from a living donor, you succeed to their cost basis and holding period for tax purposes. If you inherit the property you get a step-up in th ecost basis to its fair market value and you are automatically presumed to have held the property for more then one year (i.e. you get to use capital gains rates which max out at 15%).

Christopher Phelps, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 2710
Experience: CPA, CFP, PFS, Tax Practitioner 21 Years, Member AICPA/CSCPA Tax/Financial Planning Committee Member
Christopher Phelps and other Tax Specialists are ready to help you
Customer: replied 11 years ago.
Reply to Christopher Phelps's Post: You asked how we received the property. It was a gift resulting from an inheritance trade-off with brother. The property was puchased 90% for brother, 10% for us with a loan of over 50%. The down payment was with a 1031 exchange. Is there any step-up value or is the cost basis determined by the property used in 1031 exchange? Can the loan be used as a deduction of "selling expenses"? How can we employ your services?
Expert:  Christopher Phelps replied 11 years ago.

If you gave your brother a portion of your inheritance in exchange for him "gifting" you his 90% interest in the property, then you will not get a step-up. Instead, you will step into your brother's shoes and take over his cost basis and holding period in his 90% interest.

Thus, your cost basis will likely be the property's original purchase price plus improvements less allowable depreciation taken (if it was a rental).

If you sell for $850K you will calculate your taxable gain as the difference between the $850k selling price (less selling costs) minus your above cost basis. I assume you and your brother have held the property for more then a year, thus you will be subject to a maximum Federal capital gains tax rate of 15% of the gain. California will tax at your normal marginal rate (i.e. probably 9.3%).

Your brother will be required to file a gift tax return (Form 709). Make sure he does, otherwise you may have what is know as a "disguised sale". This means that your "inheritance trade-off" may be viewed as a sale of the property you inherited in exchange for the property your brother gave you.

If you tell me what your adjusted cost basis is I can give you a more accurate answer as to the potential taxable gain. You might also want to visit with an attorney (was there a probate attorney) to review your "inheritance exchange" to make sure everything was on the up and up. Your brother may have engineered this "inheritance exchange" in order to stick you with a low-cost basis asset, while he took in exchange a high-cost basis asset (i.e. he got the inherited property with the stepped-up FMV basis), thus sticking you with the tax bill when you sell the property. If he sells he is only subject to tax on the post-death appreciation.

I hope you were compensated for the additional tax burden you took on when you received this "gift" from your brother.

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