Reporting "Gift of Equity" Form 4797??

[kellyoakes]

My client has a niece who got into financial trouble. The client bought the niece's house from her a few years ago for the amount the niece owed on the mortgage, with the agreement that when the niece recovered financially, she would buy the house back for what my client paid. The niece owed less on the house than FMV at the time of the sale, and did not file bankruptcy or otherwise divert assets from creditors.

My client has been reporting rental income and depreciation on the house on her schedule E. In 2005, the niece was able to buy the house back from my client. Here's the problem... at the closing, my client was forced to sign a "Cash/Equity Gift Affidavit" for the difference between the sale price and the appraisal at the time of sale, and the closing statement indicates the sale price as the agreed to price plus the amount of the "gift of equity." My client has received a 1099 for the sale price listed on the closing doc.

In reality, she has no gain on this sale (except for depreciation recapture). She's been depreciating based on what she paid for the house, not the higher appraisal value at the time of her purchase. The house did appreciate during my client's ownership, and the niece did make improvements to the property at her own expense.

I would like to include the amount of the "gift of equity" under the cost of sale on her 4797, but she was required to sign the letter in order to sell the house back to the niece. What code section would support this position,OR do you have any other suggestions for the proper reporting of this transaction?

Thank you for any insight you may have!!

Kelly Oakes

[Bees Knees]

Welcome to the board Kelly

The closing statement is reporting the sale as if the niece bought the house at fair market value, with the difference between the actual purchase price and the fair market value listed as “gift equity.” I suppose they did this so that the niece could qualify for a larger mortgage and maybe even pull some cash out of the deal.

The negative side of doing this is the seller (the aunt) now gets a 1099 for the fair market value, rather than the actual cash received for selling the house.

I agree that the aunt did not sell the house for fair market value, and in no way is liable for tax on this phantom gain. Since the 1099 is wrong, I would report the full amount as gross proceeds and bump up basis on the 4797, as you suggest so that the gain reflects the reality of the situation. Keep copies of all of this as proof of basis.

This also would force your client to file a gift tax return, as the documentation is very clear a gift was included in the transaction.

[OldJack]

I have to disagree with Bees Knees conclusion that the "equity gift" increases cost basis on the sale reporting. Although it would seem reasonable, in this case, the fact is there is no tax justification to add a gift value to cost basis. The gift is just that a gift that the seller has agreed to make and is the same thing as getting the net cash proceeds and turning around and making a cash gift to the related party. If they had called it something other than a gift it might have been a closing cost, selling expense, or something else that adjusted sales price, but as a gift it is nothing but a gift and should be treated as such. I agree that the seller should not have signed a gift affidavit.

[Bees Knees]

I didn't say the gift equity increases cost basis. I said to increase basis to counter the incorrect 1099. The 1099-S should not report the gift equity under gross proceeds, because the seller never received any consideration for it. So you have a problem here, and the easiest solution is to increase basis to solve the issue. If you don't, you turn the gift into taxable income, which there is no tax justification for doing so.

[OldJack]

If you don't, you turn the gift into taxable income, which there is no tax justification for doing so.

I think you are a little mixed up in your thinking. The seller agreed to the sale price at fair-market-value and simply signed to make a gift of proceeds. I agree that was a little stupid but that is not turning a gift into taxable income. The 1099S is correct to the signed paperwork, it was not until the issue of taxes has come up that it is thought to be incorrect. That is to little to late. As you know when it comes to real estate transactions... paperwork rules rather than a tax preparer's opinion.

[kellyoakes]

Actually, the seller agreed to sell at lower than FMV. The affidavit was prepared in an amount that brought the sale price to FMV.

Kelly

[OldJack]

Actually, the seller agreed to sell at lower than FMV. The affidavit was prepared in an amount that brought the sale price to FMV.

Kelly

But the sale price changed to FMV when the seller agree and signed as such. Previous agreements mean nothing until signatures are fixed. Its a long standing legal principle that real estate paperwork is final overruling any other agreements or arrangements.

edit: This was most likely a change made by the real estate agent to get a larger commission on the sale. The agent should probably be bad mouthed around town if this is the case.

[Bees Knees]

I disagree that the sale price was FMV. The sale price was what the seller got for it, with the rest being transferred to the buyer as a gift. The only thing the paperwork did was put it down in writing. The gift is now documented. That does not make the gift portion taxable income to the giver. The 1099-S was simply filled out incorrectly. A 1099 cannot establish the tax treatment of a transaction. A transfer of property for less than full consideration is a gift. Both Section 1245 and Section 1250 say that gain recognition under those sections does not include the disposition of property by means of a gift. Do you know of a code section where a disposition of property by gift would be subject to income tax?

[Unregistered]

In a moment of weakness, I see myself agreeing with Bees. (maybe it's the beautiful fall day in NY today).

Regardless of the 1099-S, there is no "accession to wealth" beyond what the "real" sale price is. What you have here is a transfer in part a gift and in part a sale. The 1099-S should reflect the SALE price. Unfortunately, the banks, lawyers & brokers use this ploy to enable the buyers to get bigger mortgages than they should be getting.

In the case of a principal residence sold by a parent to a child, this is not always a problem due to the ability to take the exclusion of §121. If not a principal residence or in a scenario such as given by the original poster, the question is how to fix the problem. Bees offers one suggestion if you want to consider the gift a "cost of the sale"???

I would suggest something else which I've done twice and I've warned my clients to expect a letter from the IRS. Using Reg §1.1015-4 which clearly describes a TRANSFER (part sale & part gift) as my rationale I prepare Form(s) 709 for the gift portion & then on Form 1040 I use the real sale price (without the inflation of the gift of equity) and the correct basis of the property to determine any gain. I don't know if this passes muster with others on this board but it works for me. I'm confident I can win for my client in the event of audit.

New York Enrolled Agent

[OldJack]

Do you know of a code section where a disposition of property by gift would be subject to income tax?

No a gift is not subject to income taxes as well as it is not a deduction from income taxes by adding to cost basis. However, as much as you wish the sale price to be different than what it states on the paperwork, you should note that the gift amount is in the column and line associated with the net proceeds due to the seller and not as a closing cost or adjustment to the sale price. The sale price at FMV has been agreed to by the seller even though you disagree.

[Bees Knees]

The seller did not agree to sell the property at FMV. The original poster said the seller agreed to something less.

Paperwork does not change the facts. I can't imagine you would make one of your clients pay tax on a gift simply because the paperwork is wrong.

[OldJack]

Paperwork does not change the facts. I can't imagine you would make one of your clients pay tax on a gift simply because the paperwork is wrong.

As I have stated before it is a long standing principle that final real estate paperwork changes any prior facts. If the taxpayer thinks the paperwork is wrong (s)he should get the paperwork corrected. Short of a correction, the paperwork on real estate is final and the taxpayer has a sale at fair-market-value. The seller constructively received the sale proceeds and made a gift. The IRS would disagree with your opinion and the courts would disagree with your opinion. The facts can easily be pointed to as the sale price on the closing documents, the taxpayer would have difficulty point to any other fact that contradicts his final signature on the paper.

You can't claim "but this was with a related party", as a niece is not in the line of ancestors or descendants for a related party of the taxpayer. As such the real estate closing person was incorrect in forcing the FMV as the sale price when the real FMV was otherwise. However, unless the paperwork is corrected it has to stand as the legal sale price in spite of what the taxpayer or preparer thinks it should be.

As to the point about there is no "accession to wealth". A good idea but doesn't fly as the gift was evidently beneficial and of value to the purchaser and therefore a consideration by the seller in the overall sale. Were it not the fact that the seller agreed to the fair-market-value sales price and the "equity gift" in writing, I would try to justify this as a reduction in selling price such as is done with the payment of the sellers closing costs, etc. The same effect as Bees suggested adding to the cost basis. Facts that it was agree by both parties that it was a gift overrules that possibility.

[Bees Knees]

As I have stated before it is a long standing principle that final real estate paperwork changes any prior facts. If the taxpayer thinks the paperwork is wrong (s)he should get the paperwork corrected.

Well for starters, you don’t know what the paperwork says. The poster indicated the seller signed a “Cash/Equity Gift Affidavit,” whatever that means. Maybe this was a separate line item on the closing statement, indicating part of the sales price was a gift.

When I said the paperwork was wrong, I meant the 1099-S. If the gift is in fact listed on the closing statement, then the 1099-S is wrong.

Regardless, the seller obviously did not intend for it to be a “cash” gift. The seller intended it to be a “gift equity.” The affidavit title does not seem to make it clear which was which.

It is something I would suggest arguing in court. The seller’s intent is relevant, and you have provided no citations to back your “long standing principle that final real estate paperwork” rules on the matter.

The seller constructively received the sale proceeds and made a gift. The IRS would disagree with your opinion and the courts would disagree with your opinion. The facts can easily be pointed to as the sale price on the closing documents, the taxpayer would have difficulty point to any other fact that contradicts his final signature on the paper.

The seller did not constructively receive the sales proceeds because the seller never received a check. Constructive receipt means having the ability at some point to cash in the proceeds and run with the money. I doubt the seller was ever in that position.

As to your IRS assertion and court claims, once again, you provide no citation.

You are shooting from the hip, Old Jack. I would appreciate if you could back up your claims with a citation that would prove a sales contract with gift equity equates to constructive receipt of the total sales proceeds.

As to the point about there is no "accession to wealth". A good idea but doesn't fly as the gift was evidently beneficial and of value to the purchaser and therefore a consideration by the seller in the overall sale.

And where did that come from? Citation please.

The buyers beneficial value has no bearing on the seller receiving consideration. Your line of logic would make all gift transfers of property subject to taxable gain treatment, as everyone who receives a gift receives the benefit of getting something of value. That doesn’t make sense.

[sea-tax]

I personally would report the 1099-s amount and then add the "gift" amount to the basis of property netting out the actual gain. This would be similar to when a sellar gives the buyer a credit at closing to say fix the roof. As for the IRS I think it would be easy to justify and prove by showing the deposit ticket or wire transfer for the lessor amount. I would not make my client pay tax on money which they never got.

Also and maybe I misunderstood but how can some one gift something which they never had in the first place. Client never actually got the money and physically gave it to buyer. More likely than not it was a simple paper transfer.

Anyhow did not mean to get in between you two heavy hitters just my simpleton's view .
(Now each of you go to your respective corners and when the bell rings come out swinging)
DING! DING!

[OldJack]

Regardless, the seller obviously did not intend for it to be a “cash” gift. The seller intended it to be a “gift equity.” The affidavit title does not seem to make it clear which was which.

Well Bees... I am not getting paid to provide code or do research for you or this poster and I did not know posting ones opinion on this forum required the same. Maybe you are getting paid to post as part of your job? As to my not providing citations, likewise, where are your citations for your position? Whats your problem, do you just not like anyone disagreeing with you?

As to my not knowing what the closing statement says, well.. there would be no other place I can think of that the final sale price and equity gift would show other than on the closing statement. Maybe you can tell us where else it might be.

Regarding your quote on a "cash" gift verses a "equity" gift. Equity gifts are made all the time as part gifts of real estate or other estate assets and just like a cash gift they require a gift tax return if over the limit. You know better than make a statement like that.

I might also point out that if the so called fair-market-value sale price is not considered to be the true sale price, then the taxpayer may be a party to fraudulent acquiring a loan from a loan company for his niece. That is assuming the sale price was inflated intentionally without an "equity gift" and only for the purpose of getting a loan.

By the way Sea-tax... I don't consider myself as any heavy-hitter. I am just an old-fart that has been around for a long time in this business and still have a lot to learn.