Claiming property tax exemption

[MMD]

What is the name of your state? CA


Hello,

I was wondering if someone here might be able to help:

My understanding thus far is that if I have a 25% undivided interest on the deed to my parents' house and I paid all of their property taxes (~$15K) I deduct all of it even if it's in a different state than the one I live in. However, once my parents sell the property, I will get 25% of the proceeds and have to pay taxes on it (as I'm not a resident at the location).

My thought is then to change the deed so I have a <1% interest so that the amount I get will be very limited yet I will still be able to claim the tax exemption for paying the property tax. Alternatively, I could change the deed before the sale of the property.

Is my basic understanding of the current situation and should I pursue either of my two course of action or perhaps a third? Is this something that might trigger a red flag for an audit?

Thank you so much in advance for any help you might be able to provide.What is the name of your state?

[LdiJ]

Originally Posted by MMD

What is the name of your state? CA


Hello,

I was wondering if someone here might be able to help:

My understanding thus far is that if I have a 25% undivided interest on the deed to my parents' house and I paid all of their property taxes (~$15K) I deduct all of it even if it's in a different state than the one I live in. However, once my parents sell the property, I will get 25% of the proceeds and have to pay taxes on it (as I'm not a resident at the location).

My thought is then to change the deed so I have a <1% interest so that the amount I get will be very limited yet I will still be able to claim the tax exemption for paying the property tax. Alternatively, I could change the deed before the sale of the property.

Is my basic understanding of the current situation and should I pursue either of my two course of action or perhaps a third? Is this something that might trigger a red flag for an audit?

Thank you so much in advance for any help you might be able to provide.What is the name of your state?

In order to take a property tax deduction, you must be liable for the taxes, and you must actually pay them. You are clearly liable for the taxes, and if you truly are the one paying them, then yes, you can deduct them.

Because you are not living in the house, you would be subject to capital gains tax on 25% of any GAIN when the house is sold, not on 25% of the proceeds.

Basis = original cost of the property plus improvements

Gain = proceeds minus basis minus selling expenses

Example:

Home cost 200,000 when purchased. Improvements totaling 50,000 were made over the years. The house sells for 600,000. Realtor's commission and closing costs are 50,000.

The gain is 600,000 minus 250,000 minus 50,000 = 300,000. 25% of that is 75,000.

The long term capital gain rate is 15%, so your tax is 11,250.00

Playing games with the ownership of the property would indeed raise red flags, as well as potentially raising gift tax issues.

[MMD]

Upon hearing your reply, I have decided that the tax deduction my parents have been trying to give me is not worth it. Is it possible for me to return the 25% ownership of the house back to them this year and waive any gift taxes associated with the transaction? Or would the IRS consider it two separate gifts and tax us twice? They first changed the deed to include me about 6 months ago without consulting an accountant or tax attorney.

Does the local state registrar keep track of all of this and does it automatically report it to the IRS? Being taxed on the gift twice would be a fairly large burden for our family to bear right now.

Thank you for the help you have already provided and any additional help you could provide on this issue.

(And yes, I have actually paid the property taxes this year as they're having financial hardships, having bought a house more than they can afford and have extra deductions above what they are currently making)

[tranquility]

You would also have a state tax to pay in CA, but you would get credit if you had to file in the state of the house sale.

LdiJ's example is correct, but I wish she used different numbers for basis. At first glance, I though she meant something else.

[tranquility]

The giver pays the tax and has the necessity of filing a return if the gift is over $12,000. Since each person has a lifetime exemption of gift of $1 million, it is unlikely a 25% interest would require paying a tax.

The deed change was indeed a gift and your parents have the gifting requirements above. They have one year from the date of the gift to file the return. It would be a "double" gift to give it back. However, depending on the wording of the deed and the purposes of the gift there could be other avenues.

[MMD]

Might you be able to elaborate a little on these other avenues? It would be much appreciated. Thanks.

[tranquility]

The other avenues depend on the facts. We have represented people who have gifted property in a manner to indicate an estate planning technique who realize the basis problem and want to reverse the gift. The IRS has accepted our explination. The few times have been in a mutual corporation, but the same technique could be used if the gift had similar indications in normal real property. This is something which requires a professional to help you determine the facts.

[MMD]

Thank you, we've since contacted a friend's CPA who has set up a free consultation this afternoon. (Do you think that we should reach out to a tax attorney instead? I'm not sure of the distinctions and what the situation warrants)

Also, in speaking with the County Recorder's Office, they notified us that we hadn't submitted a form for a parent-child transfer exemption and they were going to reassess the property value for a 50% increase in property taxes if we did not file a form today.

Given the situation, would it be fair to be in panic mode and try to get everything resolved as quickly as possible (additional fees to CPA/attorney to give us a result faster?). Or should we file the parent-child transfer exemption and then just slow down?

[tranquility]

See the CPA. This is not as big a deal as you seem to think it is. I bet he will suggest you keep the gift as is and file the exemption form. He will then help your parent's file the gift tax return for a fee.

Maybe not, but that's what my take is on this superficial set of facts.

[abezon]

1. File the transfer exemption form immediately & have the recorder's office time stamp your copy so you have proof of when you gave them the form.

2. If the property has already gone up 50% in value, you will definitely have some gift tax issues. It might be easier to leave everything the way it is & just take the tax hit when mom & dad sell.

3. The problem with reversing the gift is that you can't then deduct the property taxes you paid. I see 2 possible ways to deal with this. First, you might consider having parents give you a lien for the amount of the taxes. That way you get paid back when they sell. If you get any interest, it's taxable. Also, your parents could "capitalize" the property taxes each year. This would increase the basis of the home & reduce the eventual profit when they sell. Capitalizing expenses that are normally deductible is a good option when you don't need the deduction in a particular year, due to low income.

Without a whole lot of numbers from you & your parents, we can't say what course of action would be best, other than filing the parent-child transfer paperwork immediately.

[MMD]

I did end up calling a few attorneys and explaining my situation to see if any of them wanted to meet. One of them said to just file a quit claim deed and a written notice saying that I reject the gift in case the IRS audits us at some point (which they likely won't supposedly) and that there wasn't anything further necessary. A couple of them wanted to meet for initial consultations of between $100 and $300 per hour.

Current plan is still to meet with the CPA.

I guess it bothers me because my parents only have a set amount of gift tax exemption and so it deducts from that in case they want to actually pass me a house in 20 years when they're financially stable. It also bothers me that we'd have to pay (short-term?) capital gains tax on my portion of the house even though my parents have lived here the whole 2 years while I was at school/work. I guess such is the price of having parents do things they hear from their friends without checking with an attorney..

[MMD]

Oh I am happy to forget about the deduction if that makes the matter simpler. I expected to file standard before. I am far more concerned about the gift taxes and the capital gains taxes on the house since they pretty much have to sell in the next ~6 months.

Financially, I think they made pretty poor decisions. Here are all the details I know:

They sold their old house for some amount (not sure how much, probably around $400K) about 2.5 years ago.

They used the money to pay down ~$400K on a $1M dollar house whose property taxes are ~$15K. (I suppose that means the County values it at $1.5M? Sounds off since Zillow shows it being ~$1.3M)

My parents cannot afford to pay the house payments/interest plus the property tax (they've been drawing down their savings apparently)

I came home for the holidays from my first year at work to check their finances since they said they were having a few difficulties. Found 11.5K in expenses per month, 4K in actual income (not sure what their gross is yet), savings almost gone, and this added surprise that my brother and I each have 25% interest in the house which they added in August without telling us. They wanted to "surprise" me with an extra tax deduction gift for Christmas. But when I learned we had to sell the house, I started reading about taxes.. and here we are. My salary is ~$60K if that helps, I'm pretty sure the deduction amounts to very little compared to the other taxes we'd pay on the property when we sold it.

I'm leaving for the CPA in ~20 minutes. Hope she helps and thank you so much for all of your help guys. I really really appreciate it. I'll check back in a few hours.

[MMD]

Wow... so I just spent 1.5 hrs speaking with a CPA and after going through all of our tax returns and having her educate us on all aspects of taxes, she told us that we should just file a grant deed form before we sell the house and not file the gift tax return based on "intention" - parents wanted to gift us the house for deduction purposes, we didn't take deductions, hence no gift.

Does this sound kosher? She didn't exactly strike me as the most knowledgeable CPA so forum thoughts are much appreciated. Thanks.

[tranquility]

The problem of "intention" is that the gift was accepted when the deed delivered. There is proof of the acceptance from the recordation. The "intention" claim may be related to our estate planning purposes only claim in that in each case the the intent of the gift was not accomplished. However, in our situation there was no attempt to gain an advatage beyond a regular transfer of property at death. In yours, there is a benefit meant to be coveyed. Because of this difference, the law we based our reasoning on may not be applicable. I know I wouldn't give such advice without research, but maybe the CPA has some prior knowledge on the same issue.

Tough call. I tend to go with the professional who has access to all the facts. But...when you see it in writing on the internet--it MUST be true! (Sarcastic attempt at humor.)

[LdiJ]

Originally Posted by tranquility

The problem of "intention" is that the gift was accepted when the deed delivered. There is proof of the acceptance from the recordation. The "intention" claim may be related to our estate planning purposes only claim in that in each case the the intent of the gift was not accomplished. However, in our situation there was no attempt to gain an advatage beyond a regular transfer of property at death. In yours, there is a benefit meant to be coveyed. Because of this difference, the law we based our reasoning on may not be applicable. I know I wouldn't give such advice without research, but maybe the CPA has some prior knowledge on the same issue.

Tough call. I tend to go with the professional who has access to all the facts. But...when you see it in writing on the internet--it MUST be true! (Sarcastic attempt at humor.)

After thinking about this some more, I think that I agree with the CPA, but not on the same basis. I do think that you should deed it back to mom and dad, but I think that rationale of refusing the gift is more appropriate. Since mom and dad did not need your cooperation to file the deed, your only method of refusal is to deed it back.