Capital Gains on House - Special Situation Please Help!?

Question

Grandma owned her house free and clear (in PA). Her grandson was living with her while he went to school from 1998 until 2004. In 1999, she added her daughter (who never lived there) to the deed.

In 2005, she became unable to live on her own, left her home and moved into her grandson's house.

Before leaving her home, she transferred her remaining half of the house to him, so that he now shares ownership with his mother.

Mother and son now want to sell the house, which has been empty (not rented) since grandma left (she had a lifetime tenancy written into the deed and recently died).

With no mortgage and no purchase price paid, is the entire selling price considered capital gains?

Also, we're aware of the 2 year ownership/living stipulation. Does it matter at all that the grandson lived in the house for 6 1/2 years, but only owned it for two and it wasn't his primary residence during those two years? Is there anyway to reduce CGT? (and what is the current rate anyway?). Thanks much

Answer 1

This is difficult, and I recommend further research. Here is what I believe. I am interested to read what others say.

When the grandmother added her daughter to the deed, what she really did was "gave" her daugher half of her house. This is a gift may be subject to a gift tax return which I will not get into here. When one receives a non-cash gift, the basis (explained later) is the same as the givers basis (assuming the house was worth more than the basis when it was deeded over...which is a fair assumption).

What does that mean? It means if the grandmother's basis in the house was $20,000 when she deeded 1/2 to the mother, and if the house was worth more than $20,000 then the mother's basis is $10,000.

The same thing happens to the son. The son's basis is whatever remaining basis the grandmother had in the house when she signed it over to him.

Basis is basically what she paid for the house (including closing costs) plus improvements (not repairs) she has paid for over the years. It also involves other items, but this is a start. When the house is sold, the gain is the selling price of the home minus closing costs divided by two (two 50% owners) minus the basis of the individual owner.

So, if they sold the home for $100,000 and paid $6,000 in commissions /closing costs and their basis is $10,000 each, then their gain is:

100,000 - 6,000 = 94,000
94,000 / 2 = 47,000
47,000 - 10,000 = 37,000 (gain of each person)

To do qualify for the 2 year gain exclusion, the son needs to live in the home for any 24 months in the 60 months preceeding the sale and own the home for any 24 months in the 60 months preceeding the sale. The ownership and residense months need NOT be concurrent. Your information is vague as to when the home was sold and when he lived it in to say for sure if he qualifies, but for sake of agrument, let's say he does. Besides, there are exceptions to the rule for unexpected life events, and death is certainly one of them.

The mother does not qualify since the home was never her primary residence. She will pay 15% tax on the gain (5% if she is in the 10% or 15% tax bracket).

Figuring the basis can be complicated, especially if the grandmother acquired the house through marriage, improvement records are missing, etc. Don't spend more money figuring out the basis than you would pay in tax assuming the basis is $0. What do I mean? Let's use the previous example except replace the $10,000 basis with $0. The son still pays no taxes, whereas the mother pays 15% of $42,000 or $6,300. If you spend $2,000 to determine the basis is $10,000, the son saves nothing, whereas the mother saves $750 in taxes. It isn't worth losing $2,000 to save $750. The general rule with the IRS is, if you can't figure out or document the basis, the basis assumed to be zero. Just some food for thought.

Answer 2

House has to be primary residence for 2 out of the last 5 years. I would say that the period of 2002 - 2004 for grandson meets that requirement, however, he didn't own it during that time, so that doesn't work. And daughter never lived there, so she can't meet the requirement. Since there was a transfer of the house for no money, the basis that the daughter and grandson would have in the house would be what the grandmother purchased it for, plus improvements over the years. Hopefully there is some record of that. Also, capital gains are maximum of 15% federal. Don't know what state this is involving, so can't give you the state tax effect. And doesn't look like any way to reduce the Capital Gains Tax.

Answer 3

You need to know when your grandmother bought the house and how much she paid for it. Her cost basis transfers to the daughter and grandson. You should be able to get an idea of how much she paid from the title (go to your county govt. offices). Then, you can get an appraiser to give cost estimates of any remodeling done during her ownership.

You might be able to shave a little of the taxes if your grandmother bought the house prioe to (I think June, 1971). Check with a local tax expert, preferable one that is relatively old. (It's been a while since I was a tax examiner for the PA Dept. of Revenue.)

The good news is that the total tax burden is less than 20%. The bad news is that if the gain is large enough and a big enough portion of income for the daughter and son, they could wind up in the Alternative Minimum Tax (AMT). Under AMT, items taht are normally deductible aren't allowed (includes state income taxes, real estate tax, miscellaneous deductions). Try to get the infomation together well before the end of the year. A competant tax person could then run some scenerios to see if the grandson & daughter should prepay taxes to Pennsylvania or wait until April 15th.

Answer 4

Do any of the owner's of the property want to live there for two years and take the exclusion at that point?

If the grandmother were to have willed the property to her heirs', then they would have received a step up basis equal to the fair market value of the property when received. If the heirs sell the day they receive the real estate then there would have been no taxes due.