My mom and dad who I invest in real estate are getting a divorce best way to proceed to avoid capital gains?

Question

Hello all, we own two rental properties in Nevada and a house in California with no mortgage. We inherited the house when my moms parents passed away back in 2008. My parents are getting a divorce and mom wants to take the two homes in Nevada and give my dad and me the house in California. THE PLAN IS TO SELL THE HOME IN CALIFORNIA AND WE HAVE A BUYER INTERESTED. I heard that in California if you live in a house two of the last five years you don't have to pay capital gains taxes when you sell it. What is the best way to proceed legally to avoid problems and taxes? Should my mom sign a quit claim deed prior to sale and give my dad the home? Then I guess he would sell it from his name to the buyer? Or would my mom sell the home first then give the money to my dad? AND THEN AFTER ALL THIS SIGN AN UNCONTESTED DIVORCE? 
Also my dad wanted to put the proceeds from the sale into my bank account for me to invest the money in some rental properties. Can he simply wire the money into my account? Or will this cause a big tax problem? Maybe better to keep it in a joint account?   Thanks for any advice.  Have a good weekend.

Dave Toelkes · Answer

Gifts are never taxable events for the recipient.  Gift tax return, if required, is filed by the person making the gift.

Steven Hamilton II · Answer

Cam,

The issue here is your involvement. The transfer from one spouse or ex spouse to another is not taxable under the section 1041 exchange.

As long as the property was the primary residence  of one of them then there is no gain on the sale up to 500k of gain of they remain married through the end of the year. This is 250k If they are single.

If one of them gives you over 14k in any one year a gift tax return must be filed even if there is no liability due.

Cam Smith · Answer

Hi Jay, Dave and Steven thank you for the additional info.

Steven Hamilton II · Answer

Just to notate this Dave T,  You are generally correct; however, in some cases if the gifter fails to pay the gift tax, the Fed can turn to the receiver if the tax return was failed to be filed.

This RARELY happens.

Jay S. · Answer

Here is a little on how the law works.  Given the complexity though, I would consult a tax professional.

General Requirements:

1. Generally, a single person may exclude up to $250,000 of gain resulting from the sale of his or her principal residence once every two years to the extent certain ownership and use requirements (described immediately below) are met (as potentially modified by the special rules in a divorce situation described further below). 
2. A married couple who file a joint return may exclude up to $500,000 of gain resulting from the sale of their principal residence once every two years if: 
    a. The married couple have owned and used the home as their principal residence for a period of time aggregating at least 2 of the 5 years immediately prior to the sale (the "ownership" and "use" requirements). The two year period is satisfied if such ownership and use is for 24 full months or 730 days (365 x 2), which need not be consecutive months or days. If a joint return is filed in the year of the sale, either spouse's ownership of the home will satisfy the ownership requirement but both spouses need to also satisfy the use requirement to obtain the full $500,000 exclusion. 
    b. The married couple has not excluded gain on the sale of a former principal residence within the two years immediately preceding the current sale. 
    c. If the married couple do not together meet the requirements above (e.g., one spouse does not use the home for the requisite 2 year period), the husband and wife may still qualify on their own to determine if they are each separately eligible for the $250,000 exclusion (as if they were not married). If one spouse did qualify, any gain on the sale of their principal residence that did not exceed $250,000 would be excluded. Even though the requirements are applied separately in this instance, for purposes of the ownership requirement, if the property were owned by one spouse and not the other, they both would be viewed to own the property for applying this rule.
3. If a home is used both as a residence and for business purposes, the exclusion will not be available to the extent the home was depreciated (if rented out or used as a home office). Gain that would otherwise be excluded would need to be taxed in an amount equal to the depreciation taken. 
4. To the extent the exclusion is not available or is insufficient to offset the entire gain on the sale of the principal residence, any remaining gain will be subject to tax at the 20% federal income tax rate plus the new 3.8% tax rate, as well as any applicable state and local taxes. 
Separation / Divorce:
1. The transfer of a principal residence by one spouse to another is a tax free transaction. In addition, the general principal residence exclusion requirements outlined above are modified by the following special rules in a divorce/separation setting. 
2. If the principle residence is owned solely by one spouse and was transferred from such spouse to the other pursuant to a divorce decree, the recipient spouse (who did not previously own the home) can include the holding period of his/her former spouse to determine if the ownership requirement has been satisfied. 
3. Separately, if one spouse is granted sole use of the home under a divorce instrument (essentially divorce decrees, separation agreements), such spouse's use of the home is attributed to the other spouse to determine if the use requirement has been satisfied. If one spouse moves out prior to such divorce instrument being executed, the other spouse's use of the home during this period is not attributed to the spouse who moves out. Therefore, it is important either to stay in the home if possible until a separation agreement is executed to allow the spouse who has moved out to still potentially qualify for the use requirement when the residence is sold and the couple have divorced (filing separate returns and trying to meet the requirements for the exclusion on their own). See attached example that illustrates this point in the context of the situation you have described.
4. If the general requirements are not met to exclude gain on the sale of a principal residence (even after application of the special rules discussed above), there is a minimum exclusion that applies to various unforeseen situations, one of which is a divorce situation.

Cam Smith · Answer

Hi Bill, Steven, Mark and Joel.  Thank you for your answers.

Bill Gulley · Answer

So Joel, how do you address the contribution to capital  and the income gained by the partner who has no financial interest when the property is sold? There is always an issue of income or a gift, a business entity doesn't disguise the benefits. :)

Joel Owens · Answer

No clue on this one but what if the house is given to the dad who sells the California home tax free (up to the exclusion amount) and then him and his daughter form a partnership or corp to buy properties?? Then the daughter and father set up a partnership together with the properties etc. and the daughter has ownership as well.

Mark B. · Answer

Cam,
Something to talk with your accountant & attorney about is the when the title changes the assessor will want to reassess the California property and give it a new base year.  You need to be very clear if you are able to demonstrate that there should be no reassessment or limited reassessment if in fact you can demonstrate that.  Clearing that up after the fact is laborious even if it is a title company error. Look at the final paperwork and make sure they didn't botch it.

For those outside CA - At the time of purchase/title transfer the property is assessed a value which is the base year. The most the assessor can raise the value of the property is 2% per year even if the actual value is much higher. This is a good reason to never trust the online calculators and tax info for CA properties in listings.

Bill Gulley · Answer

First, a quit-claim deed is the proper deed to convey interests in a divorce situation. Who grants title to who depends on who is willing to pay the taxes. Mom sells, she pays, dad sells, he pays, if both sell they can both pay. The property that is not to be sold should be conveyed by the QCD. The deed doesn't have to be made (but can be) from your mom to your dad, but she can sign a Special Power of Attorney to you (or your dad) with the power to contract and sell the property, doing this puts the tax burden on both owners. This should be recited in the divorce agreement as the POA can be terminated, as agreeing to provide the POA or a QCD.

As to funds, your dad giving you money can be a gift and a taxable event for you. Depends on the amount, using a joint account can cause problems later if something were to happen to you or or father, that has many variables. What could be done is for your dad to loan the money to you, at a nominal rate, and then gift payments under the limits to stay away from a tax liability.

I understand that this seems to be a DIY divorce, but if your parents are looking to you for advice and you are asking us, I really suggest you visit an attorney or at least a good accountant familiar with divorce issues, they can save you more than it could cost you doing it yourself. Here, I believe an uncontested divorce with an attorney is less than $500! They will advise in the matter as well, but the issues must be agreed to and uncontested. Good luck!  :)

My mom and dad who I invest in real estate are getting a divorce best way to proceed to avoid capital gains?

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