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Ed Johnson
Ed Johnson, Tax Preparer
Category: Tax
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Experience:  GPHR Cert; U.S. Treasury Tax Advocacy Panel appointee
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my mother sold me her house for a dollar 20 years ago under ...

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my mother sold me her house for a dollar 20 years ago under the agreement that she would live in the house until her death and pay all costs etc. I live in another country and someone told me it was a bad idea because when she dies I will have to pay a tax. They said it would have been better had she just willed me the house. The reason behind her decision was to avoid having all her assets taken away from her should she have to go to a nursing home. What will be the consequences for me when she dies?
Submitted: 6 years ago.
Category: Tax
Expert:  Ed Johnson replied 6 years ago.

DearCustomer

Thank you for you question.

This will be a discussion of how this sort of thing is handled in the U.S.

1. When she sold you the house for 1 dollar, technically, because she sold it to a relative, the Internal Revenue Service would have considered the balance of the Fair Market Value, a gift, a gift of equity in the home. As a gift, you would technically retain her adjusted cost basis as of the date of the gift. The one dollor is insignificant.

2. When she gifted you the equity in the home, a gift tax return should have been prepared; Because the gift was less than one million, she would not have to have paid a gift tax, but she would have still been required to file the return.

3. When she dies, since you already own the home, and when you sell the property, you will be subject to capital gains tax. The formulas for capital gains tax follow:

If you use the price you paid for the property, 1 dollar:

Capital Gains = Sale price - (what you paid for the property, + improvements, + major repairs) - cost of selling.

As you can see, if you sell the home for 250,000 dollars, you will have a 249,000 dollar capital gains, on which you have to pay 15% tax. (more about this in your situation later).

Capital gains on a Gift: Now, as I said, you can consider this a gift of equity. So on the gift portion, as of 20 years ago, the cost basis is the adjusted cost basis of the donor, your mother. for aurguments sake lets say the home, is now still valued at 250,000 if you sold it. And assume that property doubles about every 10 years on average. We can then assume that on a 250,000 dollar home, the property may have cost in the range of 62,000 when it was first purchased. In the time she owned the home she may have made improvements and major repairs, so lets pout the adjusted cost basis at 75,000. Your formula now looks like this:

Capital gains for selling a gifted property= 250,000 - (75,000 + improvements in the pst 20 years, + major repairs in the pst 20 years) - cost of selling.

So now, in this scenario, you are paying capital gains of 15% on not more than 175,000 (minus the other expenses I mentioned).

NOW If you inherited the property instead: When you inherit property, there is, in the United States no inheritance tax on the federal side. Her state may have one, but there are exclusions and reductiosn for amounts of inheritance by close relatives. Not every state has an inheritance tax. But since I do not know your state, I am only going to address the primary issue,the capital gains tax.

When you sell an inherited property, your cost basis is either the Fair Market Value or the Appraised Value of the property as of the date of death. If the propery is sold in close proximity to the date of death or date of inheritance, there is likely to be little if any rise in FMV, and so it will be sold, most likely, in the range of slightly below, at, or slightly above its FMV, leaving very little if any capital gains tax exposure.

so now your capital gains on this property, that we are assuming may sell at 250,000 dollars looks like this:

Capital gains on inherited property that is sold = 250,000 -( 245,000 (FMV at time of death), + Improvements, + major repairs)- cost of selling.

You can see your capital gains exposure is now only 5,000 dollars and will actualy be nil, because...the cost of selling will be bout 6% in realtor fees and advertising.

So, as you can see, how you received the property makes a big deal for you later on.

What should have been done? There are ways that a property could have been placed in a trust that she had no direct control of, which would have served the purpose she needed. It may not be too late to unwind this deal and to accomplish the same end. You would need to sit down and have a talk with a trust attorney in the United States to discuss how this might be done.

What can be done now: In the U.S., you can get a capital gains exclusion from the sell of a home if you can make the home your primary residence for 2 of the past five years, while you also own it. Those two years do not have to be consecutive months.

I do not know what your mobility is, but if you could come to the U.S. for a few months each year and make this your primary residence for those months, then over the next 5 years you might total 2 years worth and be able to take a capital gains exclusion when it becomes time to sell.

Another possiblity is to gift the property back to her after visting the attorney I mentioned earlier.

By the way, are you a U.S. Citizen?

 

 

Customer: replied 6 years ago.
I am a US citizen but I have lived in Denmark with my Danish husband for 41 years. I never filed US income tax returns while living here (but earned my money and paid taxes here).
I usually visit my mother in Pennsylvania twice a year (3-4 weeks per visit) but I don't see how this can this be put together as primary residence since I need to maintain residence in Denmark, mostly for medical reasons.
I understand that you recommend that I contact a trust lawyer in the US. But do you recommend that I
gift the property back to her or try to create a trust?
Expert:  Ed Johnson replied 6 years ago.

DearCustomer

Thank you for the feedback and additional follow on question.

About your extra questions:

1. two trips a year for 3-4 weeks: This will, unfortunately not be sufficient to meet the requirement of a primary residence.

2. Recommendation: If you want to avoid the capital gains tax, my recommendation is to create a trust and gift the property back to your mother to the trust or directly to the trust. The trust would sell the property and pay all taxes and you could draw the money out as you needed it, and then only pay taxes on the money as you draw it out. OR a trust can then rent the property out for a few years so that it can provide additional revenues and certain rental property tax benefits. I can not tell you what kind of trust will give you the best protection and help you achieve those goals. I know that they exist, and have clients who use them. This is the best solution to avoiding, reducing, or deferring the taxes on this property when you sell it.

Keep in mind, that my recommendation assumes you also want to make sure that your mother does not lose or have reduced benefits because of acquiring to many assets. There are trust forms that can help with this. YOu have to have the trust set up first.

I would like to discuss another issue for you. It has nothing to do with your question, but has to do with your situation.

Never filing taxes. That can be an issue. The problem is, that the U.S. taxes its citizens on world wide income. Even so, the U.S. allows a generous foreign income exclusion. But, to get the exclusion, you are required to file your taxes. So, technically, you are, like so many hundreds and thousands of others, out of compliance with the IRS requirement to file your taxes.

There is a tax treaty between the U.S. and Denmark, that you would, as you say pay taxes to Denmark for personal services income earned in Denmark first, but the U.S. still wants you to file, and they would give you the foreign income exclusion, plus any tax credits for foreign taxes on any income in excess of the exclusion amount. (per treaty requirements).

As I said, you are in good company as hundreds and thousands of U.S. citizens living abroad do not file taxes. You will however, see a increase of enforcement in this area over the next few years. The initial process will be through opportunities of discovery, such as this...where you suddenly are filing taxes in the U.S. after having not filed for many years,even decades.

Please do not be alarmed. I am sure this would not represent a tax liability in your case. It would depend on the level of your earnings in Denmark.

 

Ed Johnson, Tax Preparer
Category: Tax
Satisfied Customers: 10760
Experience: GPHR Cert; U.S. Treasury Tax Advocacy Panel appointee
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