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Tom Talks Taxes - May 13, 2022
What are the tax consequences from the part-sale, part-gift of property?
It is a common occurrence that property, specifically real estate, is sold for below fair market value (FMV). The difference between the FMV and sale price is not always a gift; for example, property may need to be sold quickly, so the difference exists to facilitate a speedy sale.
For there to be a gift of equity, the difference between the FMV and the sale price must meet the definition of a gift for federal tax purposes. In Comm. v. Duberstein, 363 U.S. 278 (1960), the Supreme Court said:
A gift “proceeds from a 'detached and disinterested generosity,'… 'out of affection, respect, admiration, charity or like impulses’… the most critical consideration… is the transferor's 'intention.'“ A payment is not a gift “if the payment proceeds primarily from 'the constraining force of any moral or legal duty,' or from 'the incentive of anticipated benefit' of an economic nature…”.
Let’s look at three core tax issues assuming there is a true gift of equity in a property sale:
What is the gain or loss recognized by the seller?
Is a gift tax return required?
What is the adjusted basis of the property to the buyer?
Question 1 is answered by Treas. Reg. §1.1001-1(e). The seller realizes gain to the extent that the amount realized exceeds the property’s adjusted basis. The seller does not recognize loss if the amount realized is less than the property’s adjusted basis. The seller can use any exclusions available to offset any gain realized, such as the §121 primary residence exclusion.
Question 2 is answered by §2512(b). When property is sold for less than adequate and full consideration, then the amount by which the property’s FMV exceeds the consideration is deemed a gift and included in computing the total gifts made during the tax year.
Question 3 is answered by Treas. Reg. §1.1015-4(a). The unadjusted basis to the buyer is the greater of the amount paid by the buyer or the seller’s adjusted basis in the property at the time of transfer. If the seller pays gift tax, then the gift tax amount is added to the property basis. For determining loss, the buyer’s unadjusted basis cannot exceed the property’s FMV at the time of initial sale.
Let’s look at an example to demonstrate these principles.
Adam, who is single, sells his primary residence, which he bought in 2012, to his daughter Beth for $600,000. The property has an adjusted basis of $300,000 and a FMV of $900,000 on the date of transfer. Adam's gain realized is $300,000, which is the $600,000 amount realized less the $300,000 adjusted basis.
Adam makes a gift of $300,000 in the transaction, which is the $900,000 FMV of the residence less the $600,000 amount realized. He must file Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return to report the gift of equity.
Assuming Adam qualifies for the §121 exclusion, he excludes $250,000 of gain and recognizes $50,000 of long-term capital gain.
Beth’s unadjusted basis in the property is $600,000, which is the greater of the $600,000 purchase price and the $300,000 adjusted basis to Adam.
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