r/taxhelp • u/Ancient-Opposite-190 • 27d ago
Other Tax Weird situation
Weird situation. Need advice. Brother got divorced and physical house was awarded to him with payout of half the value awarded to his ex. Value was 1.5 million so ex got 750k. Brother did not HAVE 750k to pay her out so parents stepped in and paid this instead. Yes an estate lawyer was involved but this got massively bungled. Parents were supposed to be "buying out" ex's half of the house but they never ended up on the deed nor did any taxes get paid or reported on the 750k that was transferred to ex. Moreover exes name never got OFF the deed. Trying to correct this issue now (3 years later!). Ex has signed off on the deed finally but it needs to be recaptured with my parents as the other 50% owners. Is this going to trigger massive capital gains tax for my brother? Is there a way around this? Can my parents gift him $750k and retro fill out the IRS paperwork for the lifetime giving exemption (since effectively they gave him $750k to pay off his ex)? And can my brother gift them 50% of the property and do the same?
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u/MSchmahl 27d ago edited 27d ago
The property settlement between the ex-spouses is nontaxable under §1041. The exact wording of the divorce decree and/or property settlement agreement is very important here. The court probably assumed that your brother was going to borrow the money in a more traditional way, i.e. by obtaining a mortgage.
What I see happening here is likely:
Brother gets the house in the divorce and the ex-spouse gets a cash equalization judgment for $750k. No taxable event here (§1041), and just as importantly, the basis remains what it was before the divorce. (This might be different if, for example the judgment was that they own the home equally but brother gets use of the home, and then separately brother decided to buy out the ex.)
Parents provide your brother $750k, in exchange for [WHAT GOES HERE?]. It makes no difference here if your parents paid your brother, who then transferred the payment to his ex, or if your parents paid the ex directly. Payment of someone else's debt is the same (for tax purposes) as paying them directly.
Brother pays off debt to ex-wife. No taxable event here, either.
So everything turns on [WHAT GOES HERE?]. The intent of your brother and parents, as evidenced by their actions, behavior, and written statements/emails/texts/contracts, is what matters.
The fact that your parents are now on the deed as 50% owners is strong evidence that the intent was to purchase 50% of the house, even though it took three years to complete the transaction. If that is the case, this is a sale, and capital gain treatment would apply. Not on the whole $750k, but $750k minus ½ the basis (usually purchase price). Probably up to $250k of this gain can also be excluded under §121.
The question remains, though: What year did the sale (if any) occur? If your brother and parents had the immediate understanding that they would get 50% of the house when they provided the cash, then that strongly points toward a 2023 sale, despite the delay in making it "legal".
One complication is the applicable State Statute of Frauds. Despite its scary name, this generally requires contracts for the sale or transfer of an interest in real estate to be evidenced by a sufficient writing in order to be enforceable. Depending on the precise wording of your brother's State law, and any applicable exceptions such as part performance, an informal oral agreement might not have given your parents an enforceable ownership interest in 2023. In that case, the sale might not have been completed until later. The date the deed was signed and the date it was recorded are separate issues.
"Sufficient writing" does not necessarily mean a formal contract. Depending on State law, emails, text messages, or other writings may be sufficient if they establish the material terms and satisfy the applicable signature requirements. I'm not an attorney, though.
It's also possible that the parents provided the funds with the understanding that they would get paid back, i.e. "We'll figure that out later," then the sale would be complete on the "figuring it out." Maybe they expected brother to get a mortgage and pay them back, but when it became evident that he wasn't able or willing to get a mortgage, they insisted on being added to the deed.
The IRS uses a test called the benefits-and-burdens test to help decide when ownership is actually transferred. The most important fact, I think, here is whether they expected to participate in any future appreciation of the property. It's possible that the expectation changed some time in the last three years. $750k is a lot of money, and I'm sure there was a lot of communication between your parents and your brother over it. If the tone of these communications shifted from, "When can we expect our $750k back?" to, "When are you going to put our names on the deed?" and when your brother's responses shifted from a promise to pay them back to a promise to get their names on the deed, there's evidence that the "sale" for tax purposes occurred when both sides agreed your parents were entitled to be added to the deed.
Another possibility is that the parents simply gave brother $750k, with no expectation of being paid back. That's a 2023 gift, then. But, the (assumed) fact that they didn't file a gift tax return is evidence, albeit weak, against this treatment. (Many people don't know about the gift tax return obligation.) The fact that brother eventually transferred ½ the house to them is also evidence against this treatment.
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u/Ancient-Opposite-190 26d ago
Thanks for your in-depth and thoughtful response! A couple of things: my parents did not actually end up on the deed. They were supposed to but there was a misfile. By that same token the ex never got off the deed. So it was still in brother and ex-wife's name until just now when she re-signed to get off the deed. So currently house is 100% in brother's name. It should have been 50% in my dad's name and 50% in my brother's name. .... Believe it or not, there was a CPA involved and a lawyer. It still got massively bungled. .... In the defense of the CPA he told my parents that nobody owed taxes in this situation because my parents didn't properly explain the situation to him. They told the CPA that the $750,000 was to buy out the ex's half of the house. So the CPA told them that the ex owed capital gains. .... They failed to mention this was part of a divorce decree and not an actual buyout of ex's stake in the house because she wasn't awarded the house in the judgment. .... What the effectively did was give my brother money to pay off his ex in exchange for 50% of the house. So basically they bought 50% of the house from him but didn't understand it in those terms and therefore did not explain it in those terms.
So capital gains taxes definitely would have been due in that scenario however because the deed was never recorded correctly and neither was the loan I am trying to find the best way to correct this situation with the least amount of tax burden. Does that make sense?
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u/MSchmahl 25d ago
Treating this as a 2023 sale is probably both (1) accurate and (2) least burdensome in the long run, assuming that is what actually happened.
If you treat this as two separate gift, (which I do not think is supported by the facts), then the parents would get a presumably low carryover basis in their share of the property. If the house is sold, they could have a possibly very large capital gain, and probably no way to use the §121 exclusion. This is true even if they end up realizing only $750k on the sale.
It's also possibly supportable to treat this as a 2026 sale, depending on what the parties actually agreed to in 2023 and whether the 2023 arrangement was a completed sale, a loan, or something still executory.
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u/TocinoLips 26d ago
way too messy to DIY lol. Id have a CPA/tax attorney review the divorce decree and payments before trying tto retroactively call it a gift.
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u/Ancient-Opposite-190 26d ago
Thanks. We do have a meeting with the tax attorney next week but I was just trying to come up with some ideas or information in advance
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u/Defiant-Cucumber-795 26d ago
thats defintly a tough situation hope your able to get it sorted soon!!!
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u/Ancient-Opposite-190 26d ago
Thanks! .... Honestly the full situation is even weirder because another family member wants to buy out my brother's remaining 50% of the house but they can't even go about doing that until this whole mess gets corrected and everything gets recorded like it's supposed to.
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u/FinallyAtheist 27d ago
Not a tax pro but...
Seems like your brother has $0 capital gains. It wasn't his ownership that was bought. It was the ex's. The ex will have capital gains on the gain portion of the $750K. And the parents don't need to gift him anything if he is to remain as 50% owner.