Capital gains tax and basis consideration

[Richard1024]

Client purchased parent’s home with siblings about twenty years ago.  Due to family circumstances at the time, the three kids decided to buy out one parent (50%) interest in the home.  The resulting transaction was that one parent would still have ownership of 50% and the three kids would have a 1/6 interest in the property.  Fast forward twenty years, the remaining parent (with 50% interest) have now passed on and with skyrocketing home values, children have all decided to sell the property at a significant gain.  As there were no estate tax planning during the preceding years and no consideration of gifting property interest, etc., I wanted to get some insight on the resulting tax consequences.  There would be capital gains based on the basis when the property was acquired by children compared to current sale price; however would that now be capital gains based on a 1/3 ownership interest and how should measurement date for basis be best determined (based on acquisition of initial interest, parent 50% FMV interest at time of death, etc.)?

[TaxGuyBill]

The kids' Basis is the amount they paid (1/6 of the total FMV when they bought it) plus 1/6th of the total FMV on the date of death (1/3 of the 50% of the recently deceased parent).

[joshuabarksatlcs]

I would add:

Plus the improvement costs, if applicable, paid by the owners after the first parent's death.  (1/6 of the costs assuming paid on a pro rata basis.)

[BobKamman]

But I don't want to fast-forward 20 years.  I want to go slowly, and find out what happened to the parent who was bought out.  Let's call him Dad.  Did he then qualify for taxpayer-financed nursing-home care, while Mom got to keep the house?  What did he do with the "sales" proceeds, anyway?  Who was paying for the taxes, insurance, maintenance and repairs for the last two decades?  Was anyone else living in the house?  

[joshuabarksatlcs]

Oops.  Just realized I somehow misread the facts and "killed" the parent.  It should say "after the buy-out from the parent  twenty years ago." 

I sometimes fast forward faster than other fast-forwarders...

[Richard1024]

Greatly appreciate the feedback.  I further inquired just to make sure my understanding of facts of the situation is correct as sometime having a written narrative provides more clarity that verbal.  Update to the scenario:

There are three siblings.  Only one parent is included in transaction as follows: 

One of the sibling and mother purchased property back in 1980 (50/50% interest each).  Years later due to health concerns, mother 'gave'*** her 50% share to each of the three children (includes a portion to the initial sibling purchasor).  The sibling that initially purchased the property with mom is not my client.  The portion received by my client would be 1/3 of the 50% that was transferred from mother.  

Mother passed away years ago and the three children continued their ownership interest in the property until now and have decided to sell.  Gain would be 1/6th of net gain measured against date of death basis? 

***I will clarify on the term 'gave'.  Initially it was mother sold interest at a very small amount to children.

[BobKamman]

Did the mother continue to live in the property until her death?  Otherwise (and maybe even then) the basis for the three who share 50% is a third of Mom's basis (cost plus improvements).  

[joshuabarksatlcs]

I previously added my comment about "don't forget the improvement costs" and was going to end there.

Maybe because I accidentally "killed" the mother (at the time of "the gift"), or perhaps 10/24 and two to the power 10 both meant something to me - but then also maybe I'm in denial of being very behind for the 10/15 drop dead date - I'm pouring out my mind as follows. 

You said: The resulting transaction was that one parent would still have ownership of 50% and the three kids would have a 1/6 interest in the property.  Fast forward twenty years, the remaining parent (with 50% interest) have now passed on and with skyrocketing home values, children have all decided to sell the property at a significant gain. 

So, FORM: Sibling A owns 2/3; Sibling B and C: 1/6 each.    (Your client is B or C or both, but NOT A)

Substance: ???

There were a few pieces of facts that could make substance different from FORM.  Examples:

*  Did A pay the 50% original cost and the annual costs?  If NOT what was Mother's and the family's intent/understanding?

*  Who paid for the cost / improvements over the years.  (IF mother put in significant improvements, should the improvement costs basis be split 1/3???)   IF mother paid the property taxes over they years, any way to equalize???

*  Did mother stay in the house?  Was it relevant, as I inferred from the point by @BobKamman ? 

* .....

Now, if you were to take Substance over FORM, you would need to first make sure it had reasonable basis to support the position for taking Substance.  The tax authority at time would take the best position for the government and disagree with TP's treatments.  In many cases, to protect the government 's interest, when TP takes form, the government takes substance, and vice versa.  Thus, it could be tricky and all factors should be considered.

Even if TP could the position of Substance over FORM, or whatever, the key question I would ask my client in a case similar to this is:

What did the siblings agree on?

We could sit here and analyze the case to kingdom come, but if there is an argument/fight by the siblings, it could put your conclusion or tax recommendation in a very awkward position.  My experience is that when it comes to money, inheritance... etc., even siblings otherwise in good terms could turn on each other.  If they were still very amicable, there would always be that one spouse who would do the wedge-driving thingie.  Before my client gives me a clear indication of what the siblings have agreed on, in writing (email communication comes in handy in this), I would NOT finalize the tax position, as it could be part of the bone of disagreement or even litigation down the road.

Remember, the tax positions for A B and C would also imply their ownership of the funds from the sale.  Also, their tax positions should be consistent.  For the love of harmony, I wish they are in total agreement in the deal. 

I always let the client decide how to treat the SUBSTANCE.  Once that is done and if the Substance has substance, applying the tax law should be a breeze.  

For me to look at the facts - even if I had all the facts, let alone the facts in this case were presented piecemeal and partially - and decide on the tax treatment, without getting the clear understanding of the clear understanding among the THREE siblings, it could  just be my sheer arrogance.  

Perhaps I sound cynical, but this is from my years of dealing with families, especially with inherited properties, and also from the weekend bourbon that has not gone away from my system.

Hope I'm not infringing too much.  Or too cynical.

I wish you the best.

[Richard1024]

Thank you! Yes mom continued to live in the house until her death.  Cost of improvements were split among the three siblings after mom's portion was transferred to them.  Prior to moms transfer, any improvements were split between the one sibling and mom (the initial 50/50% purchasers).

[BobKamman]

Was this a completed gift?  Seems to me that Mom "gave" the kids the property (probably, so the taxpayers and not they would have to pay for her nursing-home costs) in return for the right to live there for the rest of her life.  I don't have time to research the rules on when a gift is completed, but you should do it because maybe you can use DOD FMV after all.  

[qbteachmt]

"Seems to me that Mom "gave" the kids the property"

"I will clarify on the term 'gave'. Initially it was mother sold interest at a very small amount to children."

It's like watching a ping-pong game.

[BobKamman]

Maybe a quitclaim deed that recited $10 as consideration, because someone back in the 16th Century thought consideration must be shown, and nowadays we don't use peppercorns.  

[Richard1024]

Yes you are correct, there was a quitclaim deed involved that had a consideration of about $10k paid from each sibling to mom.