Q: My question is about the capital gains tax. My parents, at their own expense, built an apartment onto my house. They have lived in the apartment for the past 10 years.
I am now getting close to retirement age and am thinking of selling this large house and investing the money. If both my parents and I are owners of the property, would we all get to claim $250,000 in profits tax-free? In other words, could we claim a total of $750,000 in profits tax free, including $250,000 for me and $500,000 for my parents?
Right now I am the sole owner of the property. Would it be advantageous to add my parents on the title to take advantage of the IRS rules? Thank you.
A: Your question is one you should put to an experienced tax professional. But there is at least one big obstacle that I see.
First, to claim the $250,000/$500,000 tax exception, your parents must have lived in the home for at least two of the past five years. Yours have been there for 10 years. They’re supposed to have been owners for at least that long.
If you have been the sole owner, and then you add your parents to the title and immediately list the property for sale, they won’t have owned it for the required past two years.
Sometimes the IRS will allow children who live in a home owned by their parents but who pay the mortgage, taxes, and insurance to write off these items on their federal income tax return. But it doesn’t sound like your parents pay those expenses directly (they’d have to be writing the check directly to the lender and tax assessor).
You and your parents must meet two others tests of ownership in order to qualify for the tax-free exclusion. According to IRS Publication 523, “Selling Your Home,” you must meet the “use” test, which states that you must have used the home as your primary residence for the past two years. And, “during the 2-year period ending on the date of sale, you did not exclude gain from the sale of another home.”
It seems from Publication 523 that there is no limit to the number of people who are owners and who live in a property as their primary residence for the required amount of time who would be able to exclude up to $250,000. So, if four individuals were 25 percent owners in a four-family dwelling, and they had $1 million in profits from the sale of the profits, it would appear that they’d each be able to shelter up to $250,000 of gain.
It’s worth investigating, particularly if you think your profits from the sale of the home will exceed $250,000. Remember, to determine your profits on the sale you add up what you paid for the property along with the closing costs to buy the property and add to that number any capital (major) improvements you made to the home, including the addition that was put on for your parents. Then take the sales price and subtract closing costs and expenses.
I don’t know who does your taxes but you should find an accountant or Enrolled Agent (NAEA.org) near you and have a conversation about whether your plan to add your parents to the title of your property would allow them to keep up to $500,000 in profits tax free while you keep up to $250,000 in profits tax free.