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Capital gains tax on sale of a 'gifted' house

Dear Tax Talk,

Hi there. My grandmother's two-family home has been in my mom's name and her brother's name for four years. There's another brother whose name is not on the deed, due to his unstable financial situation, but he will have an equal share when the house is sold someday. My grandmother recently passed away and the house will be sold in a couple of years.

They want to minimize capital gains tax, but they each have their own primary residences. Would it limit the tax if the deed is transferred into the name of my uncle and his wife and they lived there for two years before selling it, thereafter distributing the monies equally? Or, would it make sense to have the deed transferred (or gifted or sold for a nominal sum) into the name of one of the grandchildren, who would live there for two years, and then sell the house and distribute the funds to my mom and two uncles? -- Chris

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Dear Chris,
It sounds like you need more than a two-family home.

Had your grandmother not transferred the property to your mom's and uncle's names a few years ago, this probably would not be an issue. Although she meant to do well by making the gift, she took away one of the principal tax benefits afforded when you die: a stepped-up basis to your heirs. Inherited property gets a cost basis equal to the fair market value of the property at the time of the decedent's death, so that if the heirs sell it shortly thereafter, there is little or no gain to pay tax on. However, since that didn't happen, you need to try to make the best of the situation.

Although I can't tell you that the Internal Revenue Service would look with favor on the scenarios you mention, I can tell you that you wouldn't be the first to try something like this. If you transfer the property to the uncle and he later gives two-thirds of the proceeds to his two siblings, the IRS could say that the two siblings actually sold the property. Also the house is for two families, so the uncle could only exclude gain on the half he uses as a residence. A similar issue arises in the case of the grandchildren. Also, if the house is given to them for a nominal sum, then the aunt and uncle would be making a gift.

Your best bet is to have your mom and uncle sell the property and pay the 15-percent long-term capital gains rate and be done with it. The IRS could wind up putting you in the same scenario anyway after you make all the gyrations you're contemplating, and then it wouldn't be worth the 15-percent savings.

Bankrate.com's corrections policy
-- Posted: June 28, 2005
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