The Peyton Place of not qualifying for sec 121

[jklcpa]

Taxpayer, spouse, and adult daughter all live in home.  Daughter was schizophrenic, unemployable, on SSI. Another child, a son, is married & lives elsewhere.  Questions relate to the SP (the mom).

1. 1996 - TP and SP purchase the home. I actually know the starting basis, and then add whatever improvements were made through to event #2.

2. 2009 - TP dies.  SP basis = SP’s ½ of #1 above + ½ of TP’s stepped up basis from his estate. This was handled poorly and not sure if county was ever notified of his estate. For many years afterward the home was still in joint name.

3. 2017 - SP physical & mental health is failing.  SP transfers home ownership to daughter, was not competent to do so, but it happened. Daughter convinced the mom (SP) to do this and lawyer made the transfer with no life estate set up as far as I know. I assume this was when county took deceased TP’s name off deed due to death in 2009. That is now what county site is reporting. No gift tax returns filed as far as I know, and son/DIL were fighting this transaction and trying to get it reversed, but that never happened either.

I think SP's basis that transfers to daughter would be SP’s ending basis from #2 above + any improvements made after TP’s death in 2009 through date of transfer to daughter in 2017.

4. Through part of 2020, SP continued to live in the home.  SP declines further, son/DIL step in and in 2020 move SP into long-term facility in memory care section as she can’t perform any ADLs without assistance.

5. April, 2021 – adult daughter dies with the property still in her name. Daughter has no children so mom (SP) inherits house and back in her name.

6. Between April, 2021 and now, storm damage, structural with tree through roof. Insurance paid ~ $180K. Son put ~ $20K of materials for additional interior upgrades after contractor finished. No known casualty gain.

Mom's last tax filing 2020 because income was under filing threshold 2021 through 23. She probably should have filed in year of insurance payout, but that didn’t happen.

House is being sold. Settlement Nov, 2024.

The transfer to daughter seems like a sham, but I assure you it was not.  Mom was in failing health, now is 93 yrs old. Daughter was same age as me, died at age 61, and no one expected mom to outlive the daughter. Daughter died as a result of liver damage from long-term use of prescribed psychiatric medicines and poor diet; basically her liver failed, followed quickly by total organ failure.

 

Questions –

1. Can SP skip all of the basis-related issued prior to daughter's death and use the stepped up basis at daughter’s death in 2021+ the $20K of improvements by the son? More on this below.

There ARE receipts for the $20K of improvements but mom didn’t have the funds so son paid and now wants to be reimbursed at closing. Daughter-in-law now has guardianship over SP’s money.

2. Am I correct that SP doesn’t qualify for the sec 121 exclusion because she inherited house back in her name in April, 2021 but was already a permanent resident in assisted living starting in 2020, and she didn't have life estate?  She wouldn’t even qualify for the exception where a nursing home resident only has to live in the home 12 months instead of 24 months.

3. I’ve never dealt with anyone having a guardianship but assume that the local court monitors the finances. I told guardian she should check with court or attorney that set this up whether or not son can be reimbursed at closing so that it isn’t a wrench in the works that holds up the closing.

Thanks for reading, if you made it this far.

[Lee B]

Reading your post was like the script for a True Detective plot

[BulldogTom]

I think you can take the DOD basis since that is the day the SP acquired the home.   I am having an issue with the additional 20K unless it gets reimbursed.   

Based on the position above, I don't see any chance for §121 exclusion applying.

Not commenting on the reimbursement - that is a legal issue.   

Tom
Longview, TX

[jklcpa]

13 minutes ago, Lee B said:

Reading your post was like the script for a True Detective plot

Right!  I've known these people all my life, and they were clients since my time employed with a CPA firm and came with me once on my own. The whole original basis was even more complicated involving an old farm with a 1031 exchange into a former residence and then a deferred gain under the old tax laws into this one, but I have all of those records, so that isn't an issue in this story.  Who ever said taxes was boring! 

I told DIL that I may not take this return on but said I'd ask the questions here. 

[jklcpa]

1 minute ago, BulldogTom said:

I think you can take the DOD basis since that is the day the SP acquired the home.   I am having an issue with the additional 20K unless it gets reimbursed.   

Based on the position above, I don't see any chance for §121 exclusion applying.

Not commenting on the reimbursement - that is a legal issue.   

Tom
Longview, TX

 

I think it may have a chance for reimbursement. I'm just not sure if it can easily be done at settlement but I told the guardian I thought she should get court's approval at this point. I not doubting that son did the work but am uncomfortable with receipts being in his name and probably not showing the actual address of the property, but if court approves it, should I be ok with adding to the basis?

Oh, and son wanted to be paid for his time spent working on the house.      I already said "no way."

[Gail in Virginia]

Curious why son wants to be paid for time spent working on house - is he trying to get part of the money or trying to save mom some taxes?  Wondering if he realizes that if he gets paid for his time working on the house it would be considered self employment income and he would have to pay income and SE tax on that money.  Might make getting paid a little less attractive to him, depending on the bracket he is in if he realizes he will be paying half or better in tax.  

[jklcpa]

2 hours ago, Gail in Virginia said:

Curious why son wants to be paid for time spent working on house - is he trying to get part of the money or trying to save mom some taxes?  Wondering if he realizes that if he gets paid for his time working on the house it would be considered self employment income and he would have to pay income and SE tax on that money.  Might make getting paid a little less attractive to him, depending on the bracket he is in if he realizes he will be paying half or better in tax.  

I'm sure he just wants money, doesn't realize about the SE or regular tax issues, and wouldn't think it through to be saving taxes for mom. He is the sole heir at this point anyway, so it's not like he's trying to keep more for himself. 

[Bart]

1 hour ago, jklcpa said:

I'm sure he just wants money, doesn't realize about the SE or regular tax issues, and wouldn't think it through to be saving taxes for mom. He is the sole heir at this point anyway, so it's not like he's trying to keep more for himself. 

He could get the same amount of the inheritance without taxes and SE tax if he takes it as inheritance instead of payment for work

[DANRVAN]

On 10/31/2024 at 11:38 AM, jklcpa said:

the transfer with no life estate set up as far as I know

The facts here indicate an implied life estate, as held by case law. Also in RR 78-409, IRS held that an implied life estate existed even though adult son and DIL were given title and resided in the house along with decedent. 

The authority comes from sec 2036(a).

On 10/31/2024 at 11:38 AM, jklcpa said:

use the stepped up basis at daughter’s death in 2021

But not if she held a life estate.  Even though she went into a nursing home she might still have an implied life estate to the house with the right to come back and live in it.

[DANRVAN]

This is an unusual situation.  Usually an implied life estate is used to establish a stepped up basis when the house is sold after the death of the transferor.  But in this case the transferee died first and the house reverted to mom.

So as I see it, there is a question as to whether the life estate terminated between the time mom went into nursing care in 2020 and death of daughter in April of 2021?  Otherwise there is no step up in basis.

[DANRVAN]

16 hours ago, Bart said:

He could get the same amount of the inheritance without taxes and SE tax if he takes it as inheritance instead of payment for work

As I read it, he not inheriting anything at this point in time.  The house will be sold on the behalf of mom who is still alive, possibly the funds will be used for her long term care.

If the court allows reimbursement for his time, I question as to whether the activity would rise to the level of a trade or business subject to SE tax.

[Catherine]

From the original post, the son paid for materials & supplies with that $20k. That is a completely valid claim against the property & there should be no issue with him being reimbursed at close.  If for materials, he could put a lien on the property.

I had a case (that I got after the house sale dust settled) of a surviving spouse who was not part owner of the house - it was 100% owned by the spouse who died - who paid all the house costs until the legal paperwork was settled to the point of the house being salable. Mortgage, maintenance, repairs, even replacement of a furnace that died. Added up to nearly $100K over some years (spouse died in the early days of C19 [from cancer] and the courts were shut down for months, so it was a long haul to settle this). Survivor got a big chunk paid directly as reimbursement. Executor then split the proceeds among the heirs (of which SS was one of 3, the other 2 being children of a prior marriage). 

As for basis, I think a lawyer's opinion on the implied life estate is needed before any other determinations can be made. No life estate = basis is FMV when adult daughter died. If there is legal basis to claim life estate, basis = basis on date of transfer, plus daughter's improvements. Ah, these juicy convoluted weird situations people get themselves into. 

[jklcpa]

Sadly, I have to report that my questions are now moot. The mom passed away this morning and now it will be up to the estate to carry out the contract for sale of this house. At this point no one is sure if she had a valid will or who the executor is, if there is one. It may be that the guardian will be appointed as executor, and the estate will have to go through probate. Certainly this will delay settlement of the sale that was scheduled for the 15th of this month.

[Catherine]

Oh, dear. My sympathies to the family, and to you on the far larger mess you now have. Perhaps the lawyers will earn some of their pay and figure out the legal ownership questions.

[DANRVAN]

On 11/5/2024 at 4:56 PM, Catherine said:

you on the far larger mess you now have.

Actually it sounds to me like there is a much clearer picture after mom's death.

 

On 10/31/2024 at 11:38 AM, jklcpa said:

Daughter has no children so mom (SP) inherits house and back in her name.

As I understood OP, the question was whether mom received a step up basis upon death of daughter; or if she retained her pre-gifting basis due to a life estate and a gift that was bequeathed back to her.  That is now a moot point since either way mom had ownership at the time of her death and therefore her estate gets a step up in basis.

[jklcpa]

I'd already come to the same conclusions as Dan. Whoever the seller is, the heir or the estate, will have a small loss from the house sale when selling expenses are factored in. Either way, at this point I'm out of the picture unless engaged to prepare a 1041 for the estate. The heir and wife have never been my clients and I intend to keep it that way.