Capital Gains Tax Question

[zaj]

3 people own a house (all 3 names are on the deed). The house is sold (lets say $99K) and by contract, each person is to receive 1/3 of the proceeds of the sale (33K each).

How do you calculate the capital gains tax on that sale?

Is there a single tax rate for the sale (ie, 20% of the gain on the entire property)? In which case each person would pay 1/3 of that tax on the total gain.

Or do the proceeds flow to each individual's personal tax return to be calculated based on their own private tax rate (which in some cases could be lower than 20%).

I'm negotiating an agreement which has the following language:

“One-third of the capital gains taxes due, if any, shall be the responsibility of each co-owner. Each co-owner agrees to hold the other co-owners harmless from capital gain taxes beyond the one-third share. Distribution under this agreement may be withheld until proof of any tax due has been provided.”

[unblock]

1. i wouldn't use that language at all.

1/3 of the sale proceeds flow to each person.
presumably the cost basis for each was also 1/3 (however, expenses might not have all been shared equally).

in any event, each person made a particular $$ amount of profit and has individual tax liability depending on their own tax circumstance.

one might have capital losses carryforward, for instance, and owe nothing on the gain. the other two might be in different brackets, etc.

best is to have language that spells out how the sales proceeds are apportioned and to leave each party individually responsible for their own individual taxes and hold the other parties harmless for any tax liability other than their own.


if you DO come to an arrangement where the total tax liabilities are shared, then there's implicit income received by the person who "should have" owed more taxes, and he must pay taxes ON THAT.


disclaimer: i'm not a tax lawyer, but trust me on this one.

[zaj]

2. Thanks, I've incorporated your thoughts into my response...

... this is a "hostile" agreement, so I'm not sure I can force that kind of language, but I will be trying, because you raise some important issues that I suspected.

[banana republican]

3. Calculate it this way.

This is a partnership by definition and it would be treated as a partnership.

Each individuals interest in the partnership would be based on the assets that they have contributed to the partnership. If all three names are on the deed you would need to know how much each individual paid to buy the house. e.g. one individual could have put $10K down and the two others $5K down on the purchase. The individual who put the $10k would get 50% of the gains and losses with the other two would only get 25% each.

The answer would change if one of the $5k contributors later paid an additional $5k to reroof the house.

This is one of the most complicated areas of tax law....

[zaj]

4. The trick is that no one paid anything for the property...

As I understand it was owned by my grandparents, but as part of the estate planning process, about 5-10 years before my grandfather (last surviving grandparent) died, the property was moved into the name of the 3 siblings and no payment was made by the three.

If I understand the details correctly, no one paid anything to my grandfather for the house.

So I'm not sure how to calculate the "partnership" percentages. The agreement I am negotiating explicity says that the siblings will distribute the proceeds from the sale equally. Also, I think this makes the capital gains tax based on the the entire sale price since the property was acqired for $0.

[boomboom]

6. If a gift

Which it would be if property was transferred prior to death, your "cost" of the property is 1/3 of your grandfather's original cost of the property, plus improvements plus any gift tax paid by your grandfather.

If it had been passed at death (inherited) your "cost" would be 1/3 of the fair market value of the property at date of death.

Each sibling reports 1/3 of their proceeds on their personal 1040. Each sibling reports 1/3 of their cost plus closing costs, selling expenses, etc as their basis against these proceeds. The capital gain tax is 15% (long-term) and is calculated on the excess of proceeds over basis.

Unless you were depreciating the property (such a rent house) in which case a portion of the gain would be at 25%

(CPA here)

[Egalitariat]

5. Is it rental property, or is it your home?

If it's your home, you won't have to pay any tax on any gain up to $250,000 if you live there for 2 years.

If it's rental property, you should at least incorporate the partnership as an LLC (with each partner owning 1/3 of the membership units).

Then the taxes would flow through to your personal tax return, and you don't have to worry about your partners paying theirs. The IRS will do that for you.