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.”

[1monster]

1. Pay the capital gains tax up front to the IRS BEFORE

distributing the remainder to the three owners.

The IRS is not going to give a hoot if you have an contract that says you are responsible for only 1/3 of the capital gains tax. If one of you doesn't pay his/her share of the capital gains tax, then they will come after the other two. THEY don't give a damn who pays as long as it is paid.

ON EDIT: You would be wise to consult with a tax lawyer or tax accountant before you make any decisions on this matter.

[welshTerrier2]

2. a few points to consider ...

first of all, you haven't indicated how the house was acquired and for what cost ...

you are not taxed on the proceeds of the sale but rather on the amount your proceeds (less sales expenses e.g. commissions) exceed your "basis" in the property ... your "basis" is the original amount paid (if any) plus improvements made to the property ... so, if you sold the property for $99K (and paid $9K in commissions) your net proceeds would be $90K ... but let's also say that you paid $50K to buy the house and added another $10K in repairs ... your "adjusted basis" before the sale would be $60K ... your taxable gain would be your net proceeds, $90K, less your "adjusted basis", $60K, giving you a total taxable gain of $30K ...

I must admit that i haven't done taxwork for about a billion years, but i don't see a way to pay the taxes as part of the sale ... i think you have to distribute, pro rata, the gain to the 3 owners ... assuming you share equally in the property, each owner would have to report a gain on the sale of real estate of 1/3 of the taxable gain ... if the property was a primary residence, each owner may be able to defer the tax due on the gain under certain conditions ...

finally, i'm not sure that the way you're wording the agreement makes any sense ... i don't think you can say that each owner is responsible for 1/3 of the taxes due because the tax due is conditional based on each owner's individual tax situation ... the only way that might not be true is if the house were owned as part of a partnership agreement or perhaps as part of a trust ... but that's beyond stuff I know much about ...

you can download IRS publication 523 by clicking right here ... the publication describes all the rules about sale of residence ... it might be worth checking with a tax account ... it might also be important, if you have control over the sale date, to determine whether you're better off deferring the sale until after the 1st of the new year ... then, the tax issues wouldn't affect your return until April of 2006 instead of 2005 ...

hope this helps ...

- wt2

[zaj]

3. It does help...

This was the language proposed to me by the atty handling the estate (not me or my atty). I'm asking because I thought the language was strange and unequitable.

I responded with the following reply:

--snip--
And finally, I noticed the following language regarding the capital gains tax:
“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.”

My understanding of capital gains tax regulations is that each person will have their own (likely unequal) tax burden based on their personal circumstances (i.e., individual income tax bracket, capital losses carry-forward, etc.). It’s possible that one of the 3 siblings might have NO TAX due at all (even with equal distribution of proceeds), but this language would require such an individual to pay a portion of the other two siblings tax with no offsetting compensation in return for this payment. This loophole would also complicate tax liability calculations because the two siblings (those who receive such a payment from the 3rd) would also likely owe taxes on this implicit “income” from the 3rd, raising the combined tax burden. This language creates a possible tax mess.

The language needs to be rewritten to reflect the following spirit:
"Each party individually is responsible for payment of their own individual tax due, and holds the other parties harmless for any tax liability other than their own."

This will greatly simplify everything for everyone involved while still retaining the protection everyone wants.

--snip--

[welshTerrier2]

5. important ... read this ...

your first post hadn't made it clear that the property was obtained as part of an estate ... it may be possible, i think as part of probate but not sure, to have the estate pay the taxes due on the sale if that happens before the property is transferred to the new owners (i.e. you and your siblings) ... if that didn't happen up front, then i'll stick with my original post ...

i'm also not that familiar with the whole estate thing, but i believe that when you inherit property, you can assume the basis from the estate ... so, for example, let's say this property was left to you and your siblings as part of the estate when your last surviving parent died, your basis (i.e. cost plus improvements) in the property would be the same as their basis had been on the day the property was transferred to you ...

so, if they had paid $25K to buy the property and added another $50K in improvements (e.g. new roof, paved driveway, added family room, etc.), their basis would have been $75K ... if you and your siblings sell the property for $99K and incur $9K in "selling costs" (e.g. advertising, fix up expenses, real estate commissions, etc.), your net proceeds would again be $90K ... the gain in this example would be only $15K ($90k - $75K) ... each owner would be responsible for reporting $5K as a gain on the sale of a residence ...

the important point here is to make absolutely sure that you are not just paying tax based on the "gross sales price" ... even though you weren't the people who paid for the house initially, you should be able to deduct your parents' costs from the amount you sell it for ... you really should read the booklet to ensure you're not overpaying ...

[no_hypocrisy]

4. I heard that you can (temporarily) avoid capital gains if you

the entire proceeds of the sale into purchasing another house. Either that or $125,000 of the proceeds is exempt from capital gains if you purchase another house within a year of the sale of the original property.