Real Estate Sale Complex Issue-NEED HELP

[artp]

Sorry for the long background. This is a rather complex situation and I need help.

 

My taxpayer (oldest of 3 brothers) and their father operated a towing service for many years as a C Corp with all four owning equal shares in the business. The mother was the sole owner of the land and the building on which the towing service operated as well a separate parcel for the family home. Over the years there arose a heated dispute regarding the towing business and the 2 oldest brothers withdrew participation after the father passed away.

 When the mother passed away in July 2012 the ownership of both parcels passed by the provisions in the will to the sons as tenants in common 1/3 each. After the mother’s death the business (now operated by the youngest son) fell off and the properties fell into disrepair and property taxes fell in arrears. The youngest son had pulled out all of the equipment out of the building and moved to a different location. During all of this the 2 oldest sons were trying to sell all of the properties and get the whole situation settled, but the youngest son refused to sell. 

In July 2023 the parcels were sold for back taxes and the oldest son purchased the parcels for $79,000. The funds are currently held in escrow pending legal squabble over how much should each son get. My client paid for his share of the taxes each year, but the other sons did not pay their share.

 The estimated FMV at the time of the mother’s death was $99.000. To further complicate matters the oldest son sold the properties for $102,00 on November 10, 2023.

 

Questions:

Assuming the other sons’ share would be adjusted to reflect their share of the unpaid taxes, what would be the cost basis to determine gain or loss? FMV at mother’s date of death?

 Holding period over 1 year so capital gain or loss?

 How to calculate the oldest son’s gain or loss? Would his basis include any amount from what he had to pay to acquire the property at the tax sale ($79,000)?

If the escrow is not released before year end, what to report on 2023 tax return?

 

Any suggestions from more experienced preparers most welcome.

 

[kathyc2]

If I'm following this correctly, his basis at this point is 112K which is 33K from inherited and 79K from purchase.  You will want to make sure depreciation was not taken in the 11 years since he inherited.  That works out to a loss of 10K.

However, it sounds like he expects to be refunded part of the 79K? If so, that would reduce his basis. 

 

[artp]

Yes, we are waiting for the escrow settlement to be finalized to determine how much he will receive out of the $79,000. Thank you for your reply. 

Art

[DANRVAN]

6 hours ago, artp said:

In July 2023 the parcels were sold for back taxes and the oldest son purchased the parcels for $79,000.

Since the property was sold in it's entirety, as I understand it, a portion of the $79,000 should got back to him

 

6 hours ago, artp said:

My client paid for his share of the taxes each year, but the other sons did not pay their share.

So disregarding any other expenses related to the JULY 2023 sell and purchase, your client is entitled to 1/3, $26,333.  Then the unpaid taxes owed by his brothers would come out of the balance and the remainder split between them. 

Each of the two brothers would realize $26,333 from the sale, which would include their tax debt, which was paid off for them, and the actual cash they received.

The actual cost to your client for the 2/3 would be $79,000 he paid less the $26,333 he should have received from the escrow account, subject to additional cost and expenses. So as I see it, the basis of his brothers shares is $52.667.  

6 hours ago, artp said:

If the escrow is not released before year end, what to report on 2023 tax return?

 

For sure the sale November 10 transaction needs to be reported, and get an estimate from clients attorney on which direction the escrow might go.  The difference might result in a separate transaction to report in 2024 or an amendment to the 2023 tax return.

6 hours ago, artp said:

Holding period over 1 year so capital gain or loss?

I don't see why that would apply to the 2/3 from brothers held for four months or less.

6 hours ago, artp said:

oldest son sold the properties for $102,00 on November 10, 2023.

[Medlin Software, Dennis]

Sounds like a nasty mess, which should have three attorneys (with in house CPA and tax) resolving. Once settled, your client can get you the settlement agreement to file your client's return(s).

Sounds like the three TIC have not agreed on anything, so no chance to get the other 2 to credit for the 1's tax payments, without some sort of intervention.

---

Good time =for all who read this to consider their own demise and what happens to their stuff.  Sharing never seems to work out.  Not doing this to those I leave behind, and not looking forward to it - again - when an older family member passes someday (a split of all asserts, not sale and split proceeds, I have seen the documents).

[Sara EA]

I see this as two transactions, which simplifies things.  The county sold the property for $79k, and a 1099A or S should be issued.  Each brother had a basis of $33k (1/3 FMV when inherited) minus any depreciation they took since they owned it.  Their share of the sales price is $26,333.  They cannot take the loss because the property was sold to a related party.  What they did with their share is irrelevant.  When people sell a home and use the proceeds to pay off the mortgage, it doesn't affect the selling price on the 1099S at all.  Same with back taxes, water bills, etc. 

The amount in escrow is irrelevant to the selling price.  The property was sold for $79k, period.  If some of the proceeds is used to pay back taxes, the brothers can each deduct those on their Sch A (but not penalties).

The unallowed loss transfers to the buyer, so your client's basis is $79k + $20k.  His gain on the sale will be long-term, since he was an owner of the property since 2012.

 

[DANRVAN]

5 hours ago, Sara EA said:

I see this as two transactions,

I agree with you on that statement.  For the first transaction, brother A purchased the interest of his brothers B and C for consideration of $26,333 each.

B and C each had a basis of $33,000 and therefore incurred unallowable losses of $6,667 due to the related party rules.  (That is assuming there have been not been any adjustments to basis since mom's DOD).

However, for brother A, I can't visualize how he could have actually bought and sold his own share in the same transaction.  It appears he is entitled to most all of his share of the $79,000 that was placed in escrow, since the lien is against property taxes owed by his brothers. Therefore, for brother A, the transaction for the most part would be a wash.  Any expense he incurs for the transaction will increase his basis.  

5 hours ago, Sara EA said:

They cannot take the loss because the property was sold to a related party. 

 

5 hours ago, Sara EA said:

The unallowed loss transfers to the buyer,

Excellent point!

As I see it, he has a basis in his original share of $33,000.  Plus he paid each brother $26,333 for their shares. Also per sect 267(d)(1) the disallowed losses of his brothers are also transferred to him.  So he ends up with a gain of $3,000 based on the known facts.

5 hours ago, Sara EA said:

His gain on the sale will be long-term, since he was an owner of the property since 2012.

I have to disagree on that point.  He held one third of the property long term and 2/3 short term.

[DANRVAN]

On 11/15/2023 at 7:50 AM, artp said:

In July 2023 the parcels were sold for back taxes and the oldest son purchased the parcels for $79,000

Did the county actually take possession and title of the property.

18 hours ago, Sara EA said:

see this as two transactions, which simplifies things.  The county sold the property for $79k,

But if the county took possession and title, then sold the property that would change my answer.

There would then be three transactions, the first being the foreclosure by the county, which would be treated as a sale for all three brothers offset by DOD adjusted basis.

The second transaction would be the purchase by brother A from the county for $79,000.  Off the top of my head I don't think that would be treated as a related party transaction, but I would look into it.

The third transaction would be the final sale by A of $102,000 offset by $79,000 basis.

[Sara EA]

Good point.  In my experience, tax sales are usually forced sales and the county does not take possession.  Different states may have different approaches, so do find out who sold the property.  If the county, the brothers will receive 1099A.  If the brothers were the sellers, they will get 1099S. 

[artp]

Just to clarify The Nov sale was to an unrelated party. The July purchase was the result of a partition sale ordered by the circuit court in which the oldest brother gained sole title to the property.

After reading the posts here is my summary:

Oldest brother's tax basis:

33,000 from 1/3 share per mother's estate
52,667 From 2/3 share via purchase in July
85,667 Total


                         Total            LT            ST
Sales Price     102,000      34,000    68,000
Basis                85,667      33,000    52,667
Gain                 16,233         1,000     15,333

The above ignores any final adjustment from the escrow.
Agree?

Questions:

1. If the oldest brother would receive, say 5000 as reimbursement for the taxes he paid out of the escrow funds this would not be taxable to him, correct?
2. Any legal fees he incurred with respect the above transactions would be taken either as an adjustment of the sales price or added to cost basis and allocated 1/3 LT; 2/3 ST unless they could be specifically identified.

[DANRVAN]

49 minutes ago, artp said:

The July purchase was the result of a partition sale ordered by the circuit court in which the oldest brother gained sole title to the property.

So it was a forced sale and title passed directly from brothers.

 

49 minutes ago, artp said:

The above ignores any final adjustment from the escrow.
Agree?

As Sara EA pointed out, the July transaction was a related party sale, so brothers B and C have disallowed losses of $6,667 each.

The disallowed losses are transferred to brother A and reduce his short term gain to $2,000.

Agree that his LT gain is $1,000.

49 minutes ago, artp said:

Questions:

Yes to both.

[DANRVAN]

On second thought, it could be argued that expenses in respect to the July transaction are related to the acquisition of the 2/3 from brothers.

[artp]

DANRVAN,

So in your reply you are saying that the step-up basis of the other brothers is added to the oldest brother' basis since the July purchase via court partition sale is considered a related party transaction. Correct?

In reply to your second thought above there were no expenses listed as part of the July court partition sale, but when the escrow money is finally paid out we are expecting that the oldest brother will receive an adjustment for the unpaid taxes by the other brothers.  Would that be considered a basis adjustment? expense? I assume the back taxes will be taken out of the escrow so will that be a basis adjustment? expense?

[DANRVAN]

37 minutes ago, artp said:

you are saying that the step-up basis of the other brothers is added to the oldest brother' basis since the July purchase via court partition sale is considered a related party transaction. Correct?

In theory his is taking the brothers basis as adjusted immediately before the sale. $66,000.  But in practice he is taking their disallowed loss and adding it to his actually cost basis from the July transaction.  Either way the result is the same, $66,000 basis for 2/3 interest.

The result would be the same if we look at it as partial sale / partial gift since he paid less that fmv to brothers.  In that case his basis would be the greater of the amount he paid for the 2/3 of the basis of the transferors (brothers), or again $66,000.  However I don't think we can call it a partial gift since the transaction lacks the element of gratuity.

48 minutes ago, artp said:

we are expecting that the oldest brother will receive an adjustment for the unpaid taxes by the other brothers

Are you saying he has paid some of his brothers' share of the taxes and is expecting reimbursement from escrow?  If so, has he previously deducted the amount paid for his brother's share?

[DANRVAN]

8 minutes ago, DANRVAN said:

In that case his basis would be the greater of the amount he paid for the 2/3 of the basis of the transferors (brothers)

Meant to say " greater of the amount he paid for the 2/3 or the basis of the transferors"

[artp]

He paid his 1/3 share of the real estate taxes each year. This was shown on Sch A, but he did not itemize for any of the years in question.

[Sara EA]

The escrow amount has nothing to do with it and is confusing you.   The sales price is the key factor.  Money is held is escrow all the time.  It doesn't mean the seller won't get it ever; it just means that some contingency must be met before it is released.  In your case, the contingency is the payment of back taxes, which affects the brothers but not your client.  He paid $79k and got the property.  The brothers will get their share of the proceeds minus the taxes THEY owe.  They each received $26,633 in the transaction.  It doesn't matter if they used that money to pay their back taxes or to take a cruise. 

[DANRVAN]

22 hours ago, artp said:

but when the escrow money is finally paid out we are expecting that the oldest brother will receive an adjustment for the unpaid taxes by the other brothers. 

So are you saying brother A will receive an additional amount for the unpaid taxes of his brothers; and then take the responsibility to pay the county?

If that is the case, it becomes a wash for him.  No additional income or deduction.

[artp]

On 11/15/2023 at 8:07 PM, Sara EA said:

I see this as two transactions, which simplifies things.  The county sold the property for $79k, and a 1099A or S should be issued.  Each brother had a basis of $33k (1/3 FMV when inherited) minus any depreciation they took since they owned it.  Their share of the sales price is $26,333.  They cannot take the loss because the property was sold to a related party.  What they did with their share is irrelevant.  When people sell a home and use the proceeds to pay off the mortgage, it doesn't affect the selling price on the 1099S at all.  Same with back taxes, water bills, etc. 

The amount in escrow is irrelevant to the selling price.  The property was sold for $79k, period.  If some of the proceeds is used to pay back taxes, the brothers can each deduct those on their Sch A (but not penalties).

The unallowed loss transfers to the buyer, so your client's basis is $79k + $20k.  His gain on the sale will be long-term, since he was an owner of the property since 2012.

 

Finally got the escrow settlement statement on the partition sale $ 79,00 for back taxes. There were legal fees on the settlement which I am deducting from the proceeds and showing the resulting disallowed losses for each of the brothers. When brother A subsequently sold the property to an unrelated buyer I added the disallowed basis to his purchase price at the partition sale and calculated a capital loss per the attached spreadsheet. Is this the correct reporting based on the previous discussion above? Want to get this right so I really would appreciate any feedback form more experienced tax preparers.TAX CALCULATION Sale of Property 11102023.xlsxTAX CALCULATION Sale of Property 11102023.xlsx

[DANRVAN]

19 hours ago, artp said:

escrow settlement statement on the partition sale $ 79,00 for back taxes. There were legal fees on the settlement which I am deducting from the proceeds

Are you saying the sale price was $79,000, of that $19,908 went to attorneys, and the remaining $59,092 went to the county to cover back taxes per the settlement statement?

[DANRVAN]

On 11/15/2023 at 7:50 AM, artp said:

My client paid for his share of the taxes each year, but the other sons did not pay their share.

So was the county sale to cover back taxes owed by the two other brothers and related legal expenses of the county?

If older brother did not owe anything to the county, then it sounds like he bought out brothers share by paying off their debt.

That would change my answer from previous post.

[DANRVAN]

9 minutes ago, DANRVAN said:

he bought out brothers share by paying off their debt.

That is what it really boils down; to substance over form, even if some of the taxes were owed by him.

[artp]

1 hour ago, DANRVAN said:

So was the county sale to cover back taxes owed by the two other brothers and related legal expenses of the county?

If older brother did not owe anything to the county, then it sounds like he bought out brothers share by paying off their debt.

That would change my answer from previous post.

Let me clarify. The total back taxes of $8398 was owed  by brothers B and C. Brother A had paid his share each year. I ignored the tax payment adjustment between the brothers but reduced each brother's share of the escrow settlement by the attorney fees that were charged as part of the court order disbursement. Was this not the correct way to calculate each brother's loss?

[DANRVAN]

 

12 minutes ago, artp said:

The total back taxes of $8398 was owed  by brothers B and C. Brother A had paid his share each year.

So there was cash paid above what was owed to the county for taxes and legal fees.

How much did brother A actually receive from the court ordered sale?

[artp]

4 minutes ago, DANRVAN said:

 

So there was cash paid above what was owed to the county for taxes and legal fees.

How much did brother A actually receive from the court ordered sale?

After the tax settlement from his brothers his share was $34,731 less $6636 for attorney fees a net of $28,095.