Q: My parents quitclaimed their home to me and my brother 15 years ago. Their only condition back then was that we could not sell the home until both of them had passed.
Well, our parents have not passed and we have just accepted an offer on the house. We are trying to figure out what we will owe in taxes. We really don’t know the cost of the original house since Dad built it in the 1950s. The sale price now is around $400,000, and we are paying a 5% commission on the sale. Our parents no longer live there, and we’ve used the home as a second home and never rented it out. My brother and I both have our own primary residences. Any insight?
A: It’s a good question. To figure out the answer, you need to know the cost of the house when it was built (including the land), the costs of selling the property, and the costs of any major or structural improvements made over time.
People are also reading…
Let’s start with where you are today: the sale of the house. You certainly know the costs of the sale: the real estate broker’s commission and any other expenses you’ve incurred in the sales process.
You may have also made improvements to the home over time, like adding onto the property or replacing the roof or mechanical systems. Depending on those improvements, you might be able to count some of them toward your cost for the home. You can go to the Internal Revenue Service’s website (IRS.gov) and search for Publication 523 to get a list of permissible improvements and expenses on the sale of the home that you can use to reduce your taxes.
Publication 523 lists many examples of allowed improvements, including additions to the home for bedrooms, bathrooms, garages, decks, porches and patios. Some installations of kitchen modernization, new flooring, wall-to-wall carpeting, new insulation, heating systems, new roof, new siding, new storm windows and doors, water filtrations systems, security systems and lawn sprinkler systems are also allowed.
You’ve likely made some of these improvements over the years, and you’ll have to get your receipts together to figure out what you put into the home over the last 15 years.
Publication 523 has a section on whether you received the home as a gift. This section tells you to record the fair market value of the home at the time you received the gift. Under some circumstances, that fair market value will be what you will use to determine your “cost” to compute your profit on the sale of the home.
(There are certain exceptions to this rule, depending on whether your parents paid gift taxes and a determination of what your parents’ “basis” was in the home. Basis for IRS purposes generally means what it cost them minus the expenses and costs as shown in Publication 523.)
If we assume that your parents had $200,000 into the home in land and building costs and the home was worth $200,000 when they gave it to you, you will start with that value. Add up the cost of the allowed expenses and improvements and the costs of sale, and add that to the value of the home when it was quitclaimed to you. Subtract that amount from the sales price. That’s the amount of profit on the property.
Given tax law complexity, you may need to use tax preparation software to walk you through the process. And, if you end up determining that you have made a substantial profit from the sale, consider talking with a tax professional.
Tax professionals such as tax accountants, enrolled agents and other tax experts may find items you missed that would reduce your tax liability. We suppose you and your brother shared all expenses with the home over the 15 years. If this is the case, you and he should wind up splitting the proceeds from the sale.
One last thought: If it likely cost your parents more than $400,000 to build the home and the market value of the home when it was given to you was $400,000 or more, you might not have any federal income taxes to pay on the sale as you may not have had any profit on the sale even through you received the home as a gift. Again, talk to an expert and go over your specifics with them. Good luck.
(Ilyce Glink is the author of “100 Questions Every First-Time Home Buyer Should Ask” (4th Edition). She is also the CEO of Best Money Moves, an app that employers provide to employees to measure and dial down financial stress. Samuel J. Tamkin is a Chicago-based real estate attorney. Contact Ilyce and Sam through their website, bestmoneymoves.com.)