Just another step-up question

[Snaggletooth]

...and I don't look for favorable results this time. Too simple. Zero tax planning.

Father buys land in 1950 for $10,000. Unimproved land - no buildings, certainly not his residence. Father and Mother live in a residence OTHER than on this land, so no application of residence exemption.

Father dies in 2002. Land is now worth $200,000 upon his death. Mother is joint tenant and becomes the sole owner.

Mother gifts the land to two sons late in 2002. Son 1 buys out Son 2 share for $20,000, and incurs certain unspoken and unrecorded responsibilities. The only thing recorded is the $20,000 sale.

Mother is still alive. No further transfer upon death.

Son 1 will sell this land in January for $300,000. What is his basis?

a) $30,000 - Father's original cost of $10,000 plus another $20,000 paid to Son 2.
b) $130,000 - Same as above, except basis is increased for half of the stepped up value.
c) $80,000 - Same as $30,000 in a) above, except there is an estimated $50,000 attached to the "certain unrecorded responsibilities."

[jainen]

$114,500

There was a 50% step up when father died, so Mother's basis is $105,000. That basis carries over in her gifts. Son 1 pays $20,000 for a share worth $100,000, so Son 2 reports an $80K gift to Son 1. Son 1's basis is his half of mother's $105,000, plus 80% of Son 2's half, plus $20,000. That adds up to $114,500.

[OldJack]

Well... I could agree with Jainen except that the so called "gift" could be much more or less as we don't really know if the unmentionables make the value of the property worth more or less than the current value stated as $200,000, especially when it will sell now for $300,000. Any amount you select could be right or wrong unless you have an appraisal valued as of the date son 1 bought out son 2.

[jainen]

The facts as given

>>if the unmentionables make the value of the property worth more or less<<

The facts as given in the original post are that "Son 1 buys out Son 2 share for $20,000." It may imply that the unmentionables are part of the deal, but it actually only says that they arose at the same time. Under law, the terms of a real estate transaction must be in writing or they are not valid, so you can't add to the basis in such a secret way.

[Snaggletooth]

Unreported Responsibility

The "mystery" responsibility which accompanies the bargain price of the land is an unstated agreement that Son 1 would use the value of the land to pay nursing home expenses for mother in the event this was needed, and Son 2 would be relieved of this financial responsibility until such time as the proceeds were exhausted. Doesn't sound like much of gift, but I suppose the question would be whether the bargain sale gift could be avoided if this unstated agreement were not recorded.

I suppose my big concern is whether the death of the father results in a one-half step up since this is a tenancy-by-the-entirety state.

Jainen and Jack, thanks. Hope others will respond too.

[OldJack]

Under law, the terms of a real estate transaction must be in writing or they are not valid, so you can't add to the basis in such a secret way.

Well... not exactly. Verbal agreements are valid as long as all parties agree they are valid. Since there are now mentionable liabilities attached to the price of the sale by the son we have to consider the value less the hugh probability of the liabilities attached to the deal. As a non-related party would you purchase the property at $100,000 with the assumption of liabilities so stated or would you consider the fair market value to be $20,000?

[Snaggletooth]

Uncertain

The payment of $20,000 for land valued at $100,000 is clearly the case, but this happened four years ago. The mother was expected to be in bad health, but remained out of the nursing home until the last year. There is no way to tell how long the situation will last, or to fix a dollar amount on the potential liability as of four years ago.

I believe, however, that there is enough of a factor to conclude that the bargain sale was clearly not a "gift."

[OldJack]

>> I believe, however, that there is enough of a factor to conclude that the bargain sale was clearly not a "gift."<<

However, there is the question that the cost basis value of the land should still be $100,000 instead of the $20,000 as the difference was a personal liability with a related party that actually had nothing to do with the fair market value of the land in the sale transaction.

[jainen]

no place on the tax return

>>Verbal agreements are valid as long as all parties agree they are valid<<

This is not correct for real estate deals. Every state has a Statute of Frauds which requires that real estate contracts must be in writing.

>>we have to consider the value less the hugh probability of the liabilities attached to the deal<<

How do we do that? Is there some combination of actuarial table, time-value-of-money, and probability theory that you can recommend? The proposed support is too undefined to be enforceable, and it has no place on the tax return.

[OldJack]

This is not correct for real estate deals. Every state has a Statute of Frauds which requires that real estate contracts must be in writing.

Acknowledge that real estate deals require contracts in writing, additional deals not mentioned in the real estate contract are still valid if the parties agree they are valid. What is there about having an additional agreement that you don't think is valid.

[Snaggletooth]

Capital Loss

Going back to one of Jainen's earlier responses:

Mother's basis immediately upon Father's death is $105,000. She gave (split) this property between Son 1 and Son 2. At that point, the basis for each son was $52,500.

Son 2 later sold his share to Son 1 for $20,000. Absent any gift tax consequences, it appears Son 2 has a capital loss of $32,500. Since the sale was to a related taxpayer, Son 2 cannot report the loss. However this loss of $32,500 imparts to the buy and becomes part of his basis.

Basis for Son 1 after all this mess is the total of:

a) $52,500 for his half of mother's basis
b) $20,000 for cash paid to his brother
c) $32.500 for deferred capital loss not reportable by his brother

or, $105,000.

Where (other than possible failure to recognize gift tax) does this go wrong?

[jainen]

it's the law

>>What is there about having an additional agreement that you don't think is valid<<

It's not me, it's the law. Of course, if the other terms aren't actually part of the real estate transaction--well that's what I'm trying to say. You can't make a basis adjustment just because you have a secret unsecured promise that you might pay some bills in the future.

[OldJack]

>> You can't make a basis adjustment just because you have a secret unsecured promise that you might pay some bills in the future. <<

I have no disagreement with that as you are talking about uncertain amounts and most likely personal non-deductible, non-basis items.

[jainen]

making a gift

>>$32.500 for deferred capital loss not reportable by his brother<<

Your position is that he lost the $80,000 value, rather than gifted it? Your answer would be the same if he sold it for $1.00? Or if he abandoned it for zero compensation? Is there any circumstance under which a person would not suffer a loss but would be making a gift?

[Snaggletooth]

Gift is outside scope of the question

My position is that he had a "quantifiable" loss of $32,500. He sold land with a basis of $52,500 to his brother for $20,000. He could not claim the loss, however, because of the related party. The example (as presented) begs the question outside the scope of gift taxes.

It seems to be the wisdom of others that the "gift" implications cannot be quantified, because this party also bailed out of financial responsibility of paying for his mother's long-term care. At the time of the transaction, there was no way to quantify this liability, and the prevailing sentiment seems to be that the "strings" attached should not appear in any format on the tax return.

Since it is a real estate transaction, the Statute of Frauds requires the transaction to be in writing, and this implied responsibility was never stated or formalized -- therefore the so-called "agreement" has no substance.