Another Basis Question-This is a doozy

[momona]

Taxpayer lives in the non-community property state of Hawaii on the island of Oahu. Her father lives on Maui and owns his home which he bought with his mom who is now deceased. The mortgage shows mother and son on the note.

Her father became mentally ill and she had to take care of his finances, pay his bills and fly between islands. In 2016, he officially became the ward of the state. She thought the state would take his home but the court awarded her the title in April 2016. She now owns a tear down and assumed paying the mortgage. Her name doesn't appear any where on the note.

The father's basis is $125,000. He was supposed to have moved out when she took ownership but the state dragged their butts and since she was on another island, he was not evicted until 2017.

She did not have to give the state or her dad any funds when she got the house. So technically, her cost is the outstanding mortgage of $92,000. It is now on the market for $350,000 and it looks like it will be sold.

I have LOTS of questions on this:
1) Is her basis the amount of the outstanding mortgage or is it her dad's basis? Technically, her dad gifted her $225,000 (350K-125K) but he is in no condition to do a gift return.
2) Even though her dad was never her dependent, is there a way this could ever be considered a residential sale?

[New York Enrolled Agent]

I have LOTS of questions on this:
1) Is her basis the amount of the outstanding mortgage or is it her dad's basis? Technically, her dad gifted her $225,000 (350K-125K) but he is in no condition to do a gift return.
2) Even though her dad was never her dependent, is there a way this could ever be considered a residential sale?

I read your statement as somewhat contradictory. Technically, her dad gifted her $225,000 (350K-125K) but he is in no condition to do a gift return. How could a mentally ill person technically give her the house? If it was a gift I think you would have the amount of the gift as $350K - $92K

[Lion]

And, if a gift, her basis is dad's basis.

But, is this some sort of legal thing under your state law? Did the state take the house? You need to read the paperwork on this, talk to the lawyer that represented dad. File an extension!

Yeah, file an extension is my theme for Holy Week!

[Burke]

This is a very interesting scenario. The court awarded her the house,..... why? Do you happen to have a copy of that decree? I find it interesting that the son, who is on the note, is not considered in this situation. He would be financially responsible to the bank for the mortgage, it would seem. How did he become a co-signer? Does he have any financial basis or interest in the house? It is a residential sale, but since the father no longer owns the house, it could not be treated under 121 if that is what you mean. It is a capital asset in the hands of the daughter. I would think the assumption of the mortgage would be part of her basis, plus any other expenses she may have incurred to obtain the property. Taking care of her Dad's finances while he still lived there would not be part of that. I don't see where it could be treated as a "gift." It sounds like more like a foreclosure, or involuntary conversion. Hope the two siblings are on good terms. I could see a lawsuit looming here.

[momona]

Burke, I need to clarify the situation. The house was owned by taxpayer's father and her grandmother who died years ago. Both their names appear on the mortgage which the taxpayer assumed but the title was solely under the taxpayer's father until the taxpayer received title.

As for being mentally ill and not being able to bequeath a gift, you're right. I forgot about that angle. So basis will be the outstanding mortgage.

For some reason, the judge felt that although the taxpayer's father had become a ward of the state, the house would go to the taxpayer; not the state. Title was transferred to taxpayer via warranty deed.

So my next question: is there any way I could make the sale a sale of residence instead of a sale subject to cap gain? The taxpayer's father, although a ward of the state, lived in that home for free. It seems that even though he is a ward of the state, it could not force him into other housing.

When the taxpayer flew to Maui to check on the property to get it ready for sale, she found that he was still there and had to call the police to evict him and get him into a group home. A while ago, I did research on this and of course, I cannot find my notes. I remember something about if a taxpayer has a home where a parent lived, it could be sold as a residence. The article didn't mention the parent needing to be a dependent, either.

[TAXNJ]

Have you consider filing an extension? Sounds like a complex scenario and you need more info (your lost research and consult with the attorney).

Then you will have all the facts you need to support your final decision whether or not you can file what you state.

[Burke]

Of course, it is a sale of a residence. Just not the father's residence, so no 121 exclusion. It will be reported on your clients' tax return since the title is in her name. Your client did not live in the house, so she does not meet the 121 rules either. I would be leaning towards adding the expenses of eviction to her basis, if she paid them. But I see no way out of a capital gain for her. After all, she will be the recipient of all the net proceeds after the mortgage is paid off! And it may be short-term capital gain to boot, unless she holds the property for over one year. The tax implications are pretty clear in my mind. It might be worth her while to see an attorney. Can she delay the sale?

[momona]

Tax NJ, I did present all the facts.

Burke, I doubt she can delay the sale. Hawaii has a very hot housing market and the asking price of $350K is a deal for someone who wants to buy a teardown.

[Burke]

I am just amazed that Hawaii is willing to make him a ward of the state, and let a huge profit on the sale of his house just fly out the window without trying to recapture those funds to offset his state-paid care.....

[Snaggletooth]

NOT the mortgage amount

As for being mentally ill and not being able to bequeath a gift, you're right. I forgot about that angle. So basis will be the outstanding mortgage.

No the basis will NOT be the outstanding mortgage. Almost NEVER. Basis will be his cost plus improvements.

Clients can almost never get away from the myth that a paid-off mortgage somehow measures gain. If they sell for $200,000 and have to pay off a mortgage of $140,000 they think their gain is $60,000 because "Thass all I got." That is almost never the case.

[momona]

Snaggletooth, Clarification please

Taxpayer that I represent is female so I may be confused by your use of "he".

So you're saying that the basis should be what the mentally ill father of taxpayer paid for it plus improvements; not the outstanding note that the taxpayer assumed? Could you point me towards a pub please? Of course, I'd like to use the higher basis if I can.

[momona]

Burke, you are right. When I heard that the daughter had gotten the property, I thought she had bought it from him to keep it in the family. But it turns out she went to court and in a situation where the state usually gets the house, the judge ruled in her favor.

[New York Enrolled Agent]

Taxpayer that I represent is female so I may be confused by your use of "he".

So you're saying that the basis should be what the mentally ill father of taxpayer paid for it plus improvements; not the outstanding note that the taxpayer assumed? Could you point me towards a pub please? Of course, I'd like to use the higher basis if I can.

See if IRC §1012 and §1016 help.

[Snaggletooth]

Clarification and Response

Taxpayer that I represent is female so I may be confused by your use of "he".

No confusion. Looking at my text, I didn't use "he" but I did use "his". The antecedent is the father hence the masculine usage. Attaches to the father and not your female client.

[momona]

New York Enrolled Agent, thank you for the IRC's. I briefly read them. Will have to read more Code 1016 more closely.

So Snaggletooth, you're saying that the basis of my female client is not the mortgage balance but her father's basis?