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jgordosea
jgordosea, Enrolled Agent
Category: Tax
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Experience:  I've prepared all types of taxes since 1987.
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We purchased a home as an investment property - 12/31/12 for

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We purchased a home as an investment property - 12/31/12 for my daughter to live in with intention she would buy from us. (At the time, she was going thru a divorce so she did not want to purchase another home while still married and had hers on the market) We paid $160,000, put 40,000 down. Divorce is final and she not wants to buy the house from us, but have received conflicting advice on proper way to do that to maximize benefits for both of us. She has been living in the home, rent free.
Sell to her at $160,000 (probably $10k under market value) but give her a gift of equity for $40,000, so her loan will only be $120,000. That would give us no capital gain tax (I think but want to be sure the gift of equity won't send a red flag to IRS).
Sell her the house at $120,000, way under market value. This would give us a capital gains loss but wouldn't apply to our lifetime gift tax. Or would this be a red flag too?
We have also been told that, as sellers, we cannot give any money to buyer.
We want to do what is legally and morally correct. We want to do every thing above board, while at the same time, helping our daughter to have a mortgage she can handle.
Submitted: 1 year ago.
Category: Tax
Expert:  jgordosea replied 1 year ago.

Greetings,

 

Loss on a sale to a related party (such as your daughter) is not allowed to be claimed. Selling to her for less than you paid will not give you any allowed loss on your return, sorry.

For more information, see for example http://www.csa-accounting.com/Ace/Articles/Relatedpartysales.htm

 

So, it really does not matter for tax purposes what the sales price is on the home since in either case the amount that would be a loss to you is, basically, deemed to be a gift to her.

 

Since the advice from the mortgage company is to use the lesser sales price and there is no difference from a tax perspective that seems to be the best course of action.

 

The difference between the 120,000 sales price and the fair market value of the home at the time of sale is a gift that will be reported (if it is more than the annual exclusion amount of $14,000) and that difference will reduce your lifetime allowed gift prior to having to pay gift tax but no tax will due with that gift tax for the year of the gift.

 

Sorry if this is not the answer you wished or expected but those are the rules.

 

Please ask if you would like more discussion or you need clarification.

Thank you.

 

 

Customer: replied 1 year ago.

I feel like i'm getting a yes answer to what conflicting recommendations were getting from mortgage company.


There has to be a difference in how it would be handled, taxwise, is selling price ins$160k (market value and what we paid for it) and $120K (below market value).. if sell at 120k, why would the loss on sale automatically be considered a gift to her? Why does the difference between the market value and sale price, have to be reported? I don't understand that instead of loss on investment

Expert:  jgordosea replied 1 year ago.

Hello again,

 

You are getting the tax rules from me regarding sale to a related party. The mortgage company is also using those rules. So, there is indeed some agreement.

 

As mentioned, and as the linked article discusses, if it were possible for me to sell my assets to family members and claim that loss for tax purposes then all of us would just keep selling assets back and forth to be able to generate losses and reduce our tax due.

 

Related party sales are not allowed to be claimed as a loss because of the potential for abuse. From the IRS publication at thhttp://www.irs.gov/publications/p17/ch14.html#en_US_2012_publink1000172296

"Losses on sales or trades of property.

You cannot deduct a loss on the sale or trade of property, other than a distribution in complete liquidation of a corporation, if the transaction is directly or indirectly between you and the following related parties.

  • Members of your family. This includes only your brothers and sisters, half-brothers and half-sisters, spouse, ancestors (parents, grandparents, etc.), and lineal descendants (children, grandchildren, etc.).

  • A partnership in which you directly or indirectly own more than 50% of the capital interest or the profits interest.

  • A corporation in which you directly or indirectly own more than 50% in value of the outstanding stock.

  • A tax-exempt charitable or educational organization directly or indirectly controlled, in any manner or by any method, by you or by a member of your family, whether or not this control is legally enforceable. "

No loss is allowed on sale to a related party. Whether to sell at cost or below cost to a related party there is no gain and no loss. If you sell at a gain that gain is taxable, but it is usually at the ordinary and not the reduced capital gain rates.

 

Similarly, if I transfer an asset for less than fair market value it must be reported as a gift. Otherwise, rather than giving cash I could just give assets that are later resold by the person getting the gift for less than value and the gift tax would be avoided.

 

There are some strategies that use owner financing to sell property to a family member at full value and avoid the issue of reporting the difference as a gift. For example see the article at https://www.usaa.idmanagedsolutions.com/news/story?id=18 section called "Full-Price Sale With Seller Financing"

 

Also it may be possible for a married couple to each give 14,000 for an annual exclusion of 28,000 that will not be a reportable or taxable gift. Another expert assisted to comment on our discussion that "The wife (or husband) are each entitled to give $14,000. or one spouse can join in the gift of the other to get to the 28,000. if only one spouse holds title to the property."

 

Hope this helps to clarify the reason for these rules on sales to family and gifts.

 

Please continue to ask if you need more help or discussion.

Thank you.

 

 

 

 

Customer: replied 1 year ago.


I replied but have not received an answer.


I have received two different methods of handling from two different mortgage companies: one said purchase price should be 120k, other said purchase price should be 160k (market value) with a gift of 40k that would make the loan only 120k.


IF set price at 120k, won't that cause her to have an additional capital gains of 40k that she'll have to pay taxes on, rather than if purchase price is 160k?


Not trying to be difficult, you answer just assumed one recommendation from mortgage company and that is not the case.

Expert:  jgordosea replied 1 year ago.

Hello again,

 

No problem, we can cover the rules for both those cases. Sorry if there was problem with an earlier reply not coming through.

 

When there is a gift the recipient uses the donor's basis as their own basis when figuring gain or loss (basically).

 

So, whether there was a cost to me of 160 or a cost of 120 and a gift of 40 in either case my basis for gain will be 160 if I sell the property for more than 160 in the future.

 

This may help to understand why the donor does not claim a loss since the property and the basis in the property are both transferred with the gift (leaving no basis for loss by the donor). That is also part of why the gift is potentially reportable when more than the annual exclusion amount.

 

There is no difference or additional possible gain using either purchase price, 120 with gift of 40 or 160 when later sold for more than the value when acquired.

 

The rules for basis of a gift are a but different if the sales price was later less than 160. For more details please see http://www.irs.gov/Help-&-Resources/Tools-&-FAQs/FAQs-for-Individuals/Frequently-Asked-Tax-Questions-&-Answers/Capital-Gains,-Losses,-Sale-of-Home/Property-(Basis,-Sale-of-Home,-etc.)/Property-(Basis,-Sale-of-Home,-etc.)

 

Please do continue to ask if you need more information or discussion.

Thank you.

jgordosea, Enrolled Agent
Category: Tax
Satisfied Customers: 3032
Experience: I've prepared all types of taxes since 1987.
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