Real estate sale question

[Jim-from-Ohio]

I posted this on the fb ProSeries users page and still getting opposing answers.  Anyone ever see something like this:

Husand and wife owned a home for 50 years. Husband died 20 years ago so wife was on the deed alone. Someone told her 20 years ago to add her three children to the deed. So at this point four people on the deed, 25% each.

Fast forward to tax year 2022. Mother still alive and house sells for $ 400,000. Total basis in house was $ 150,000, Gain was $ 250,000 which under normal situation would be totally tax free. The twist is there were four 1099s issued, each for $ 100,000.

On mothers tax return there is no issue. On the three children the IRS will be looking for the proceeds of $ 100,000 and the question of basis of course comes up. The spirit of the gain exlusion was met but the three children did not live in that house. Should these 1099s even have been issued?

The fact that there were 1099s issued though is there any leg to stand on to put the cost basis to equal the selling price for the three children so the gain is zero on the three childrens' returns.

The total gain was not more than $ 250,000 so if mother did not follow that advice 20 years ago this would be a totally tax free event. I know the two of five year rule and all that. I am just asking if anyone has ever seen this before and if there is any leg to stand on to showing the three children break even on the 1099. Thank you.

Since I posted that at fb someone mentioned inceasing cost basis of children by 1/2 of the step of in value when father passed away.  

[BobKamman]

We see it all the time from practitioners of hillbilly probate.  Whenever the story starts with "someone told her," you know there is not going to be a happy ending.  When you write "the spirit was met," a better way to say it would be "substance over form."  Did Mom continue to make all the payments on the house -- taxes, insurance, maintenance, mortgage if there was one?  That shows substance. 

Whenever the story doesn't include "before the sale the family asked us how to avoid potential tax consequences," you know there is not going to be a happy ending.  The kids signed the deed, and asked no questions.  The kids cashed the checks, and asked no questions.  (Did they deposit the funds in Mom's bank account?)  When they received the 1099-S, did they then issue a nominee 1099-S to Mom?  

[TaxGuyBill]

You need to figure out if there is an Implied Life Estate.

Was the understanding that the mom had full control and responsibility of the home, without the kids input?  Did the kids use the home? Did the kids receive any of the proceeds from the sale?  

[Jim-from-Ohio]

Thank you Bob for your insight.  The mother continued to make the payments and keep up the house.. The children really had nothing to do with the house.  I think they got bad advice 20 years ago.  The  $  250,000 rule was in place already by then so whoever suggested that as an idea should have known about it.  There was no 1099-nominee issued.  I will check if the children received the funds.  

[Jim-from-Ohio]

Thank you Bill for your insight.. mom had full control of the house without the kids' input.  Kids did not use the home.  I think they got some of the proceeds.. will check with client.

[TaxGuyBill]

Edit:  I was multi-tasking and was responding as if mom had died.  It would still be taxable to the kids even if it was a Life Estate, according to their percentages based on the actuarial tables.

Receiving some of the proceeds may mess things up.  It may be difficult to claim a Life Estate when the kids benefited from the sale (in other words, it was not 100% mom's property).

*IF* it was a Life Estate, it all goes on mom's return, nothing on kids' returns (other than the possible reporting the 1099-S and backing it out to avoid an IRS notice).

If it was NOT a Life Estate, it is split between the owners and kids pay taxes.  But not at 25% each - it is divided based on the IRS actuary tables for a Life Estate.  As you mentioned, there would be step up in Basis when the dad died (either 100% or 50%).

[BobKamman]

It was not a life estate if the kids each got the same amount as Mom.  But even if it were a life estate, they would have been paid something for their remainder interest -- not just 25% of the total selling price.  

[TaxGuyBill]

Oh, I was messing things up.  I shouldn't be multi-tasking.  😂

Bob is right, that a Life Estate would have still made it taxable to the kids because mom didn't die. 

[Just-Lisa-Now-]

Did the stepped up basis from Dads date of death get factored in here?   Is it a Community Property state?

[Jim-from-Ohio]

 this is Ohio, not a community property state.  I am not sure how to get the new basis 20 years ago.

FMV then or just half of increase?  

[BobKamman]

Was it even in both names?  Back then men were men and women were often not even on the deed.  

[Jim-from-Ohio]

i will ask if both mom and dad were on deed 50 years ago or just dad

[BobKamman]

If the kids kept the money, why shouldn't they pay tax on it?  Use your best estimate for basis.  They had several opportunities to deny it was their property.  

[qbteachmt]

A skunk in a rose patch doesn't smell any sweeter, even if you name it Rose (pretending to think like Bob).

"Did the stepped up basis from Dads date of death get factored in here? Is it a Community Property state?"

From Dad's death, only the Mom has any step up potential and only for that one-time event. The kids on the deed with Mom, when no one died since, means nothing steps up for them. The kids have a 1/4 of Mom's basis at the time the deed was split. She gifted them that value at the time, and now has a 1/4 share, as well. That's the sequence:

Dad dies

Revalue based on Common Law or Community Property, for Mom's basis

Split Mom's basis 4 ways.

Subtract each 1/4 from $100k, and each kid has taxable gain.

[BobKamman]

I had the impression that the deed to the kids was done after Dad's death.

[Frustrated-in-IL]

I don’t have anything substantive to add to this discussion.

However, my first thought was this is really messing up Jim’s average of one tax return every 10 minutes!

[Jim-from-Ohio]

that it did

[qbteachmt]

"the deed to the kids was done after Dad's death."

Unless there is a finding that Dad owned it alone and without consideration to the spouse, then none of the kids inherited it. Mom signed them on, afterwards.

Which means someone needs to be able to identify Title at Dad's death, Dad's will, and legal transfer prior to the kids being listed.

It's very simple, really.

[IRonMaN]

It doesn't matter if the kids inherited it.  Mom got a step up in basis when dad died and the kids got a percentage of her basis when she gifted them each with a portion of the house.  The kids got ownership to the house years ago because someone took some bad advice.  They got a portion of cash when the house was sold so it's time to pay some tax.  The only question is, how good of a stab in the dark can we make when we estimate the basis from that long ago.  But the bigger issue relates to Mr Frustrated's post.  How in the world is Jim going to get back on track for the week with this big bump in the road?

[Jim-from-Ohio]

I am trying to get some more details on who was on deed and when, FMV, etc.