Primary Residence Exclusion/Divorce

[jasdlm]

Taxpayer sold primary residence in November of 2006 (w/ former spouse). Basis: $500,000, 1099S(s) total 800,000. My client received a 1099S for her 1/2 of the proceeds: $400,000. The divorce decree specified that she was to get 1/2 of the husband's 1/2 of the proceeds as part of the property settlement. (He received other property.) The title company sent another 1099s in my client's name for $200,000 (her 1/2 of husband equity as dictated by the property settlement).

Summary: In thoery, the entire gain should qualify for the exclusion. However, in reality with the way the 1099s were issued, it seems that my client would have a gain of $100,000 ($600,000 proceeds reported on 1099s less $250,000 exclusion less 1/2 of the basis $250,000). This doesn't seem right. The $200,000 from husband is property settlement (nontaxable) even though sent through on 1099S. Client has to file single because the divorce was final in 2006.

Question: Can I add the $200,000 property settlement to my client's basis? Would this be legitimate? Does anyone else have an idea about how this should come out? I don't want to do anything that is not appropriate, but it doesn't seem like the client should have to pay tax on the property settlement.

Thanks.

jas

[jainen]

The settlement as such

>>the client should have to pay tax on the property settlement<<

The settlement as such is not taxable, but if she received property with a built in capital gain (it has gone up in value) then she might have a tax bill. Is that what happened--he gave her the property and then she sold it, or did he sell it together with her and then give her the money? Look through the papers and see if there is a deed from him to her.

I couldn't follow your numbers very well, because you are not drawing a clear distinction between the sales proceeds and the capital gain.

[jasdlm]

Thanks for replying

The property was still in both names when it was sold. The title company used the divorce decree to determine the payouts. They were both still owners of the property. The property settlement agreement states that they will split the proceeds equally, but then goes on to state that husband shall pay 1/2 of his share of the proceeds to wife.

Gross sales price: $800,000
Basis: $525,000

Amount in 1099s to wife: $600,000 (instead of $400,000)
Wife's 1/2 of basis: (250,000)
Wife's Sec. 121 exclusion (250,000)
Taxable gain: $100,000

Am I thinking about this correctly?

Thanks again.

jas

[Lion]

Basis

Did she get 3/4 of the house in the divorce, thus her basis is $375,000 and she gets 3/4 of the sales proceeds, too?

[jainen]

explain it to them too

>>Amount in 1099s to wife: $600,000 (instead of $400,000)<<

Sure that's what the 1099's say, but she isn't responsible for that mistake. You might find support in the escrow instructions that the title company apparently violated. File a formal complaint with the state real estate board to get their attention.

If you can't get that second one corrected, treat it as nominee income -- she received the money that belonged to her old lover.

She sold her half for $400,000, and received $200,000 in CASH as a property settlement. Report it that way, and if the IRS sends a letter you can explain it to them too.

[George Boutwell]

The title company used the divorce decree to determine the payouts.

No, the title company used the escrow instructions to which both parties agreed. Then the title company screwed up when they issued the 1099s. It would probably be futile to argue with them, so report the 1099 amounts on her return and then add the $200K to her basis, attaching an explanation of what happened.

[jainen]

I do not agree

>>report the 1099 amounts on her return and then add the $200K to her basis, attaching an explanation of what happened<<

I do not agree with this approach, although I admit it is common. My problem with it is that it ignores IRS instructions for the forms, isn't based on any normal accounting theory, and mischaracterizes the true economic substance of the transaction.

[GIMoe]

Rework the basis...

Taxpayer sold primary residence in November of 2006 (w/ former spouse). Basis: $500,000, 1099S(s) total 800,000. My client received a 1099S for her 1/2 of the proceeds: $400,000. The divorce decree specified that she was to get 1/2 of the husband's 1/2 of the proceeds as part of the property settlement. (He received other property.) The title company sent another 1099s in my client's name for $200,000 (her 1/2 of husband equity as dictated by the property settlement).

Summary: In thoery, the entire gain should qualify for the exclusion. However, in reality with the way the 1099s were issued, it seems that my client would have a gain of $100,000 ($600,000 proceeds reported on 1099s less $250,000 exclusion less 1/2 of the basis $250,000). This doesn't seem right. The $200,000 from husband is property settlement (nontaxable) even though sent through on 1099S. Client has to file single because the divorce was final in 2006.

Question: Can I add the $200,000 property settlement to my client's basis? Would this be legitimate? Does anyone else have an idea about how this should come out? I don't want to do anything that is not appropriate, but it doesn't seem like the client should have to pay tax on the property settlement.

Thanks.

jas

Basis Joint = $500,000
Basis per settlement = 1/2 orig basis + 1/2 Husbands basis - $375,000


Gross Proceeds = $800,000
Proceeds per settlement = 1/2 orig proceeds + 1/2 Husbands proceeds $600,000


Adj Proceeds - Adj Basis = $225,000 Capital Gain which is less than the allowable exclusion of $250,000.

[George Boutwell]

>>report the 1099 amounts on her return and then add the $200K to her basis, attaching an explanation of what happened<<

I do not agree with this approach, although I admit it is common. My problem with it is that it ignores IRS instructions for the forms, isn't based on any normal accounting theory, and mischaracterizes the true economic substance of the transaction.

I agree with everything you say, but will defend with my life the rights of taxpayers to try to get around the trained monkeys at IRS who spew out CP-2000's if the total proceeds reported by escrow agents do not match up the total proceeds on Schedule D.

[jasdlm]

Thank you all very much. I collected a check for what I estimated to be due, filed a 4868, and am going to try to get the title company to reissue the 1099s. I am already concerned about the tax returns filed in previous years (by husand and wife). Husband is a very successful developer in town. He has 10 different LLCs and from what I can tell hasn't paid any income tax in the last several years. (Large pass-thru losses.) He has, however, been able to accumulate all sorts of high-dollar assets. I want her return to be crystal clean.

Thanks again for all your advice.

jas

[jainen]

Divorce is dirty

>>I want her return to be crystal clean<<

I can't recommend a "clean" return. First of all, it is certainly an impossible goal. What your client signs is only one part of the deal. Other elements are just as important--such as that 1099-S. And if you think the TITLE company is going to fix that, you just don't understand your own words when you say, "a very successful developer in town."

Besides, you don't really know what went down. You aren't an attorney, and even if you were you could only offer one interpretation of that divorce decree. So do the tax return in the way that best serves your client and assemble excellent support documents and arguments. Don't worry about "clean." Divorce is dirty.

[Roland Slugg]

Really makes no difference

Dear jasdlm

If the facts are as you stated them in your original post, and the house was owned by H and W equally at the time it was sold, then neither spouse's gain exceeded $250k. If that's the case, the title company should not have issued that second 1099-S form to W for $200k. But it did, so what to do?

Well, the W might want to ask the title company if it issued a 1099-S to H for $400k, or only for $200k. If it was for $400k, then point out that there were three 1099-S forms issued, totaling $1,000,000, for a sale of only $800,000, and ask that it issue a corrected form reporting $0 instead of that $200k issued to W. If instead it issued a 1099-S to H for only $200k, then simply treat the home as owned 75% by W at the time it was sold, even though this may not be factually correct. The title company may have considered there to have been a transfer of half H's interest to W concurrent with the sale. If the title company won't rescind that second 1099-S by issuing a corrected one for $0 instead of $200,000, it really makes no difference. That second 1099-S, for $200k, implies that W's interest in the house was 75% when it was sold, and, therefore, her basis was 75% of the $500k total basis ... or $375k. Using those numbers her gain was $225k ($600k proceeds, less $375k basis) still less than her $250k exclusion.

In the unlikely event the IRS ever questions this or challenges it, suggesting that she had a taxable gain of $100k ($600k reported on two 1099-S forms, less $250k basis, less $250k exclusion), she simply has to point out that if she only gets $250k of basis, then she only had $400k of proceeds, and that the other 1099-S for $200k was issued in error, improperly reporting a property settlement transfer, not proceeds from a sale.

Since sales of residences don't have to be reported by taxpayers at all unless the gain exceeds the §121 exclusion amount, this will probably never become an issue.