Q: My father transferred a house to me in 1999 for $10 and kept a life estate. That life estate allowed him to stay in the property and rent it from me until his death in 2006. I continued to rent the property after his death until I recently sold it for $40,000. Will I have to pay capital gains tax? If so, on $39,990 or what the property’s value was in 2006 at the time it was gifted to me?
A: You would have to pay long-term capital gains tax on the difference between what you paid for the property ($10) and what the property sold for, excluding any commissions or other costs of sale that you paid and taking into account any capital improvements you may have made to the home. If you put a new roof on the home, you could exclude the cost of the new roof from capital gains taxes.
But depending on some circumstances, you might be able to pay tax on the difference between what your father paid for the property (I assume it was more than $10) and $40,000, because when someone gives you a gift, you receive it at that person’s cost basis. The question for you is whether you received the home as a gift or whether you purchased the home for $10.
It’s unfortunate that your father felt as though he had to transfer this asset out of his estate. It wasn’t a big asset, and he could have easily put it into a trust. When he died, you’d have inherited the property tax-free.
Instead, now you’ll pay capital gains tax of up to 20 percent plus any state taxes owed. For most people that purchase property for a significant amount, they would also have to pay taxes on any depreciation they took over the years. That is to say, they received a benefit on their tax return each year they owned the home based on what they paid for the home and when they sell the home, the IRS taxes that benefit back in the form of a recapture tax at the rate of 25 percent.
In your case, the $10 you paid would not have given you any meaningful amounts of depreciation benefit over the years. If you did take depreciation over the years, you should determine what value you gave the home when you received it and then determine whether you assumed you received it as a gift or a purchase for $10.
That recapture tax, too, would have been avoided if your father had simply kept the home and left the house to you as part of a living trust or in his will.
For more details, please consult with an accountant or estate attorney.
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