Real Estate Capital Gain Question

[Jerry1]

There’s property in our family held in trust between DW and her two sisters. Their parents gave the property away with the goal to shield it from Medicaid if it came to that. It didn’t. Anyway, now the two sisters want out. DW doesn’t want the land at the price being asked, but I was wondering if there was a way to avoid the capital gains for the sisters which would allow them to take less for the property and still be whole. Note, because the property was gifted to them, the basis is minuscule so practically all gain.

But - what if they gift their share to DW and DW and I gift them money? I’m guessing this isn’t proper, but I’m not sure how it can be regulated. Is there some way this could work given that it’s all within the family? I realize there’s a substance over form issue here, but I’m not seeing what would prevent us legally from doing this. We all have the right to give money and property away. And, the basis would stay the same so if we ever sold it, then the gain would be taxed. Of course, my hope would be that we could hand it down to one of our daughters and give them a stepped up basis.

Thoughts?

 

[SecondCor521]

There’s property in our family held in trust between DW and her two sisters. Their parents gave the property away with the goal to shield it from Medicaid if it came to that. It didn’t. Anyway, now the two sisters want out. DW doesn’t want the land at the price being asked, but I was wondering if there was a way to avoid the capital gains for the sisters which would allow them to take less for the property and still be whole.

I don't understand what you mean by "still be whole". If they were gifted the property and I pay them a $1 for it, they're ahead by $1.

Note, because the property was gifted to them, the basis is minuscule so practically all gain.

But - what if they gift their share to DW and DW and I gift them money? I’m guessing this isn’t proper, but I’m not sure how it can be regulated.

You guessed correctly.

It's regulated by where you sign your tax return. Above your signature is where you sign under penalty of perjury that your return is accurate.

It's also regulated by the IRS offering a bounty of 15% to 30% of the taxes owed paid to anyone who snitches on you.

Is there some way this could work given that it’s all within the family?

It's not clear what you mean by "work". If you clarify the requirements, maybe people can offer solutions. You already indicated you don't mind paying the capital gains (below), or holding for a step up in basis. Those are basically the two options and you're OK with them, so I'm missing what else must be true for DW and the sisters to say that it "works".

I guess if the sisters wanting out are expecting a certain price and your DW doesn't want to pay it, that's just a situation where a deal can't be made. Your options there, I suppose, are having DW sell or quit claim to the other sisters, or any of the sisters selling their piece at a price they're happy with to some other party.

What they'll probably find out is that the actual market value of 1/3 of a family property is very close to $0. Your DW and the sisters don't even want to own the property together, why would some stranger want in on that deal?

I'm guessing here, but probably DW and the sisters will eventually agree to sell the whole thing to a stranger for market price, split the proceeds, pay the capital gains, and be done with it. That will probably take some time and angst and may stress the sibling relationships since there appears to be disagreement already.

I realize there’s a substance over form issue here, but I’m not seeing what would prevent us legally from doing this.

See the earlier comments about perjury and the IRS snitch program.

We all have the right to give money and property away.

Sure we do. But you know you're trying to justify a position which isn't kosher.

And, the basis would stay the same so if we ever sold it, then the gain would be taxed. Of course, my hope would be that we could hand it down to one of our daughters and give them a stepped up basis.

Thoughts?

Well, to the extent that your DW and/or her sisters die while owning the property, then that portion gets a step up in basis, sure.

 

[Jerry1]

The property is indeed worth money. Our goal is to keep it in the family and the sisters just want out. If there’s a legitimate way to avoid the sisters having to pay capital gain tax, they could be made whole for less money than if we sold it on the market outright.

I get that double gifting isn’t kosher but I’m wondering if there’s some way that it can be done since it’s in the family. I smaller example, in Michigan, if I give my child a car, they don’t have to pay imputed sales tax. When I transferred a house to my daughter, there were no tax implications on that transfer.

 

[RetiredHappy]

It fails the sniff test all way around because the intention is the cheat IRS out of their money. Anything that is above the gift limit, $18K for this year, the law is that you need to report it, i.e. file Form 709.

 

[SecondCor521]

The property is indeed worth money. Our goal is to keep it in the family and the sisters just want out.

Sure, but they "want out" at a price higher than your DW is willing to pay, right?

Your DW can offer them a price she and you are willing to pay. But if they want more, then it seems you are stymied.

If there’s a legitimate way to avoid the sisters having to pay capital gain tax, they could be made whole for less money than if we sold it on the market outright.

The legitimate ways to avoid capital gains tax that I can think of:

1. They can gift their shares to anyone, including your DW.

2. They can gift their shares to charity.

3. They can hold the property until they die.

4. They can sell it at their cost basis or at a loss.

It doesn't sound like they like any of those options.

I get that double gifting isn’t kosher but I’m wondering if there’s some way that it can be done since it’s in the family. I smaller example, in Michigan, if I give my child a car, they don’t have to pay imputed sales tax. When I transferred a house to my daughter, there were no tax implications on that transfer.

Sure, as mentioned above, the sisters can avoid the CG tax by gifting. Again, if the sisters want to both (a) get money for their share and (b) avoid CG tax, I think that those are contradictory goals and impossible to meet both of them.

ETA: Technically option 4 above meets both goals, but they probably aren't happy with that option.

 

[Jerry1]

It fails the sniff test all way around because the intention is the cheat IRS out of their money. Anything that is above the gift limit, $18K for this year, the law is that you need to report it, i.e. file Form 709.

If reporting was the limiting factor, we’d be all set. Since me and DW can give $18K each and, each of her sisters is married so each of them can receive $18K, that means “we” can give each couple $18K x 4 or $72K which would more than enough to make this work.

 

[SecondCor521]

If reporting was the limiting factor, we’d be all set. Since me and DW can give $18K each and, each of her sisters is married so each of them can receive $18K, that means “we” can give each couple $18K x 4 or $72K which would more than enough to make this work.

Again, it's not a gift to the extent that the siblings "gift" their shares of the property in return for the gift. You know this, and there isn't really a legitimate way that the IRS is not going to look at the mutual gifting as anything other than what it really is: a sale.

 

[Jerry1]

Again, it's not a gift to the extent that the siblings "gift" their shares of the property in return for the gift. You know this, and there isn't really a legitimate way that the IRS is not going to look at the mutual gifting as anything other than what it really is: a sale.

Right, that’s what I meant when I said the if reporting was the constraint . . . It’s not.

For the sake of discussion, what about if they give us the land and we give their children a gift? Or, we give to some charity they care about? I’m just making those scenarios up wondering how far gifting can be regulated.

 

[SecondCor521]

Right, that’s what I meant when I said the if reporting was the constraint . . . It’s not.

For the sake of discussion, what about if they give us the land and we give their children a gift? Or, we give to some charity they care about? I’m just making those scenarios up wondering how far gifting can be regulated.

Here's the IRS definition of a gift:

Gift tax | Internal Revenue Service

Learn about the gift tax and how it applies to the transfer of any property.

www.irs.gov

You mentioned regulation again. The way it works is that everyone does their taxes and their finances essentially on the honor system. Audits, guilt, penalties for perjury (jail / fines) and the snitch program are the enforcement mechanism. Generally low priority (except guilt) but high cost.

 

[pb4uski]

Any quid quo pro is likely to be problematic from a tax fraud perspective. The only thing keeping you from doing it is potential loss of freedom.

I think you are looking through this backwards. If the sisters want out then they need to sell the property or at least their share of the property and then they will owe capital gains tax on the gain. This applies whether they sell the property to you or if the trust sells the property to you or a third party and distributes the proceeds to them. So the tax is their problem not yours. If they are unwilling to pay capital gains tax then they have no choice but to keep the property or gift it to someone.

What does the trust say should be done with the trust assets once the grantors die?

This may be a good example of Medicaid LTC planning gone awry in that the property didn't get a stepped up basis which would have been a big deal.

 

[Sunset]

If reporting was the limiting factor, we’d be all set. Since me and DW can give $18K each and, each of her sisters is married so each of them can receive $18K, that means “we” can give each couple $18K x 4 or $72K which would more than enough to make this work.

The way I read this , the property is not worth a huge amount.

So how about you buy the property for a low price, and pay $10K per year or whatever the sister's want to get each year, with the knowledge that they could keep their income(s) below a certain tax rate vs getting then entire amount at once.
Possibly they could over a span of 4 years sell it with no capital gain depending upon their other income and the selling price.

 

[SecondCor521]

The way I read this , the property is not worth a huge amount.

So how about you buy the property for a low price, and pay $10K per year or whatever the sister's want to get each year, with the knowledge that they could keep their income(s) below a certain tax rate vs getting then entire amount at once.
Possibly they could over a span of 4 years sell it with no capital gain depending upon their other income and the selling price.

That would be an installment sale. They would still have a capital gain (presumably), but spreading it out over several years might enable them to stay in a lower (and possibly 0%) capital gains bracket.

Topic no. 705, Installment Sales | Internal Revenue Service

Topic No. 705 Installment Sales

www.irs.gov

 

[pb4uski]

True, without knowing the sisters tax situation they might well be in the 0% LTCG tax bracket or if only some gain would be at 0% you could structure an installment sale to just fill up the 0% bracket each year for x years.

 

[Jerry1]

Just thought I’d add a picture of what the land looks like. Not sure we can afford it and don’t want to let it go. Going to be a tough call.

 

[SecondCor521]

Beautiful land. I can empathize with your conundrum.

 

[pb4uski]

If you don't buy out the sisters then what happens? Would that be better in their view than selling their interests to you at a reasonable price? Has the land been appraised?

 

[Texas Proud]

I might be missing something but isn't the land in a trust?

That means the sisters do not own any land... the trust does... what they want is to sell their interest in the trust...

A big question is who is the trustee and what does the trust say about them selling the land?

 

[Sunset]

I might be missing something but isn't the land in a trust?

That means the sisters do not own any land... the trust does... what they want is to sell their interest in the trust...

A big question is who is the trustee and what does the trust say about them selling the land?

Good thought, doesn't the trust split the interest in the trust amongst all the siblings, so the 2 sister's would really be selling their 2/3 of the trust. The trust could continue to own the land ?

 

[RetiredHappy]

My guess is that all 3 siblings are the trustees. The trust spells out that the land is to be divided equally between the 3 siblings. To close the estate, the land needs to be sold.

 

[Montecfo]

Right, that’s what I meant when I said the if reporting was the constraint . . . It’s not.

For the sake of discussion, what about if they give us the land and we give their children a gift? Or, we give to some charity they care about? I’m just making those scenarios up wondering how far gifting can be regulated.

Hi Jerry,

Hey as you have heard, you can't cross gifts as a way to avoid CG taxes.

But you might be able to manage the tax ala Sunset's idea.

If they gifted the property to you that would be very kind. These sorts of things happen all the time. And you may also be a generous person wanting to fund some portion of the kids' college.

You guys may be related, but the transactions need not be linked. So don't link them. Start the payments now in 2024 and continue. Maybe they gift the property in 2026. And your gifts continue over a number of years.

Document the purpose of each transaction via a letter or other documentation.

This is not tax advice. Do your homework and consult your advisor.

But I am unsure why you need to protect them from taxes to keep them "whole". If not sure what it is worth get it appraised. You will need this anyway. Or just agree on a value.

 

[FLSUnFIRE]

Installment sale was what jumped to my mind and would be the cleanest "up and up" way.

Another thought but I'm not smart enough or motivated enough to research (would want an RE/tax attorney to write it up) could be for them to sell you an "in the money" call option (covered call) with a very low strike price for a price close to the current fair price with a long time horizon. I believe that taxes would not be due until it expired or was executed. A bit more moving parts and there may be IRS rulings/laws that make it illegal or undesirable but would give them money now and delay their tax burden but also could create a weird family dynamic later regarding when you choose to execute and they may not get more money but realize a substantial tax bill. Of course, they would still be property owners and have that liability in the meantime too so not a clean break if getting away from ownership vice getting money is their motivation.

 

[Aerides]

So for argument's sake, let's say the property is $100k.

Sisters quick deed or whatever their portions to DW - no money changes hands. That's all completely fair.

It's when DW says here's a "gift" back that we know is dodgy - that's a payment, no matter what you call it, no matter if you fund college or their next cruise. If they want money to walk away, they have to expect to pay taxes on it, not you. Just as if it was sold.

I get wanting to keep it, it's pretty!

So I guess what you're saying is if they sell it, they'd get say $200k, and you can't afford to "gift" them to cover that, but if it were $100, and no one had to pay gains, then, kinda even? Yeah I don't think there's a really non-dodgy way to do that, other than a direct sale/transfer/payment.

 

[Jerry1]

If you don't buy out the sisters then what happens? Would that be better in their view than selling their interests to you at a reasonable price? Has the land been appraised?

The land has been appraised. $225K but the sisters think it's worth $300. I'm not sure what would happen if we don't buy them out, but I don't think we can prevent the sale.

I might be missing something but isn't the land in a trust?

That means the sisters do not own any land... the trust does... what they want is to sell their interest in the trust...

A big question is who is the trustee and what does the trust say about them selling the land?

Good thought, doesn't the trust split the interest in the trust amongst all the siblings, so the 2 sister's would really be selling their 2/3 of the trust. The trust could continue to own the land ?

My guess is that all 3 siblings are the trustees. The trust spells out that the land is to be divided equally between the 3 siblings. To close the estate, the land needs to be sold.

I think RetiredHappy has the correct framework. When DW's mom passed (both parents now passed), DW had a new document prepared that mirrored the old trust so I think they need to do something to "settle" the trust. The new document re-affirmed that the land would ultimately pass to our daughters, the only grand children. The sisters balked at that now that they have a say in the matter. I guess it doesn't matter to them what their mom and dad wanted (the land to stay in the bloodline), but that's another matter.

It's also been asked what is meant by "keeping the sisters whole". Let's say we could settle on $210K. That would be $70K to each. If they have to pay capital gain on that, they might net $60K. If I could buy them out for $60K and no one had to pay capital gains, then they'd be made whole. Still above our number, but it would help. I'd hoped there was some framework given that it's a trust and all members are family that we could do something to eliminate the capital gains, but the installment sale seems to be about the only option and that option depends on the sisters tax situation on whether it would even work. I appreciate everyone's input.

Our number is $50K to each. That is the amount of money we received from the other money in her parents estate. So basically, we'd trade our inheritance to preserve the land in the family. Even that is high but we'd do it. The problem with the land is that, being raw land, it's basically a camp ground. Mom and dad had a camper on it and used it in the shoulder months. They used to take our daughters there because they watched our girls while we worked. The land has the most meaning to our girls. That all matters, but going beyond $100K for a piece of land that DW and I will never use, isn't something we think is prudent.

Obviously, this isn't helping the family dynamics but I'm sure we're no where near the only family that's had to deal with these issues that joint ownership creates.

 

[pb4uski]

Since there are different views on the value of the land ($300k by sisters and $225k appraised value) see if you can agree to the trust giving your wife a right of first refusal to match any competing offer.

But from what you wrote, the larger overriding issue is that if the trust states that the land is to be passed to the grandchildren then it can't be sold... it can only be passed to the grandchildren. Once it is passed to the grandchildren then the grandchildren can sell it and do what they want with the proceeds. IOW, trustees have a fiduciary duty to adhere to the provisions in the trust and can't just do whatever they want if they don't like what the trust requires. A letter from your lawyer to the trustees should be sufficient to clarify the trustees' fiduciary duties.

From what you wrote, it sounds like the grantors wanted the land to pass to the grandchildren and stay in the family and IF that is what is specified in the trust, then the trustees can't sell the land and keep the proceeds from the sale and if they try to you could challenge the sale in court and the court would likely remove them as trustees. It isn't any different than if the parents had bypassed their children and bequested the land to their grandchildren in a will... the children then have no say on their being bypassed if that is the decedents wish.

WADR, if the appraisal is $225k, then $50k to each is unrealistic and I can understand why the other trustees are not agreeable. OTOH, if the trust provisions are as you describe, the sisters should receive $0 from the land because it can't be sold even to begin with.

To be clear, I'm not a lawyer and this is not legal advice, but I am trustee for a couple trusts and that is how it works.

 

[Jerry1]

All that you said makes sense, but I think there’s a need to close out the old trust now that the parents are both gone. As we sit, the terms of the trust are still in force, but something is requiring a sale or agreement on new trust language.

At some level, I agree that the $50K each is low but when this all started, no one thought the land was worth more than maybe $100K. The appraisal changed that as well as an unethical real estate agent that claimed they could get $300K for it. Greed has now entered the equation.