Tax implications of being "bought out" of a percentage of a realty trust
January 24, 2013 1:11 PM   Subscribe

My two sisters and I were equal beneficiaries in a realty trust. This past year, my older sister bought my 1/3 share (as well as that of my sister.) According to the legal documents, it was a "transfer of beneficial interest". Other than signing and notarizing the documents to transfer the real estate share, nothing else official occurred and my sister just paid us our fair share of the assessed market value. She is not planning on reporting the transaction. I have no idea if I owe taxes on the money I've received (and will also be receiving this year - it was divided into a few payments) and if so, what kind of tax that might be.

I have tried to do some research about this but have only ended up more confused. From what I've gathered, it's not a gift because my sister received something in return. It might just be regular income. It also might be assessed a state tax of some sort, like the Massachusetts (my state) Deed Stamps/Transfer Tax that has to be paid when you sell real estate. Regardless, the more I read, the more confused I get. I know YANMTA (you are not my tax accountant) but some guidance would be great.

I also need to note that my taxes will be done by a professional, but I'd like to walk in there with some sense of whether I need to mention that I received this money and prepared for the event that I might owe taxes on it.
posted by nekton to Work & Money (10 answers total) 2 users marked this as a favorite
You need to talk with an accountant. Roughly, taxes will (probably) be long-term capital gains taxes, based on the difference between what you received for your share and what that share was worth at the time you received it (if inherited after a parent's death) or when they acquired it (if it was a pre-mortem gift). But pay no attention to what you read here. Talk to an accountant. Not H&R Block, but an accountant.
posted by megatherium at 1:16 PM on January 24, 2013 [1 favorite]

whether I need to mention that I received this money and prepared for the event that I might owe taxes on it.

Yes, and yes.
posted by Admiral Haddock at 1:18 PM on January 24, 2013 [3 favorites]

Definitely discuss this with your tax preparer. Always be prepared for the event that you will owe taxes on something. This should be your life default position, so that when you do not owe money it is a pleasant surprise.
posted by elizardbits at 1:23 PM on January 24, 2013 [1 favorite]

Response by poster: Thanks thus far. I have simultaneously asked this question of a friend who is a CPA, so I am hoping she has some insight. As far as declaring the money and expecting to pay, I was planning on both. Regarding the latter, I've kept most of the money in savings with the express intention of paying any taxes first before applying it to other purposes (debt, IRA, fun, etc.)
posted by nekton at 1:29 PM on January 24, 2013

Agreed that you need a well qualified tax professional. Ideally someone who is familiar with both probate and tax law.

In most cases, it's easy to multiply your salary times the tax rate and have a clear amount of tax you owe. This is not one of those cases. In family transactions, the IRS regularly decides that value paid is not representative of the taxable value.

You could be in a position where the IRS takes a wildly low market value when you acquired the property, and a wildly high market value when you sold it. You would then owe capital gains on the entire difference. The difference between the cash you received and the value of the property would be deemed a gift to your sister, and might be taxable due to other factors.

You need to not only properly report the tax you owe (which we are not qualified to tell you), but also make sure that you get the documentation you need to make this transaction audit-proof. These are the sorts of transactions where the taxable basis is not clear cut, and you need to protect yourself. That means that your sister needs to report the sale, pay all applicable excise taxes, and be willing to validate the paper trail you need in case of an audit.
posted by politikitty at 1:40 PM on January 24, 2013

This is way more complex for me, but there's a pretty good chance that you might not owe as much tax as you fear. In general, if you inherit an asset and then sell it, you owe taxes only on the increase in the value of the asset while you owed it. For example, if you inherit $1 million in stock and sell it a month later for $1,000,001, and your tax rate was 20 percent, you would owe only 20 cents.

But as politikitty points out, things can get very complex if you are dealing with assets that that are not widely traded.
posted by Mr.Know-it-some at 1:43 PM on January 24, 2013 [1 favorite]

Best answer: To simplify it a little. The money you received was a capital gain. You sold something you owned and got more money than you paid for it. (Right?) That part is easy.

If you held it for less than a year, then capital gains are taxed as regular income. More than a year, they are taxed at the lower capital gains rate.

Whether that gain is taxable is a different story. There are loopholes and limits that come into play. For example, there is a pretty good loophole for selling real estate- you don't owe capital gains if it was your primary residence and you held it for more than 3 years. (I think, these numbers are just off the top of my head. YMMY, look it up yourself, etc.) I think there are limits based on your income as well- if your income is low enough, and the gain falls under some dollar amount, then different tax rates apply.

But it probably wasn't your primary residence, so that's out. You inherited it, I'm guessing, and that's when Mr.Know-it-some's answer comes into play. You would only owe tax on the increase in value since it came into your possession. (Because the presumption is that the rest of it was taxed appropriately via gift/estate tax when the transfer was made.)

So then politikitty's answer about valuation comes into play. Stocks are easy to evaluate- the price on the day you got it and the price on the day you sold it are historical facts. Real estate is trickier. Hopefully, when you obtained the property, there was a legit appraisal done. And when you sold your share, you probably should have had one done as well. Because they will check that, since you and the other party can *say* it was worth whatever you want, but the tax you owe depends on the value of the property, not the price.

Finally, there is the issue of the timing of the payments. Chances are, you only have to report income you actually received in each year.

All of this is what a tax professional is for, but in very basic terms, you will owe anywhere from nothing to whatever the capital gains rate is.
posted by gjc at 2:16 PM on January 24, 2013 [1 favorite]

I've found consumer tax software to be pretty good. If your sister has the deed registered in her name, which would be wise, she may have to pay transfer tax depending on what state it's in. You have to figure capital gains tax.

Capital Gains Taxes
When an heir sells an inherited house, he has to pay capital gains tax on the profits. The usual process for calculating capital gains is to subtract the market value of the home at the time it was inherited from the sale value. The heir can subtract costs such as the agent's commission from the sale amount; if the adjusted amount is less than the house was worth when it was inherited, the heir may be able to claim a tax loss.
posted by theora55 at 6:21 PM on January 24, 2013

Response by poster: I finally found out more about this from a very knowledgeable tax preparer (haven't had ours done yet, but asked someone in advance so I could be prepped with additional info to fill out forms.)

This was considered a "like-kind exchange" between "related taxpayers". Essentially, when you make a like-kind exchange, no gain or loss is recognized but you still have to report it on a Like-Kind Exchange form (Form 8824, if future readers ever need it). If it occurs between related taxpayers, there is a 2 year hold on disposing of the property in any way, or else you lose that zero net gain benefit.

In addition, property that is included in the exchange but not part of the like-kind property is considered "boot", and that is considered gain for which the recipient owes capital gains tax. That's the cash I received.

There is an additional part to this, which is that it is considered an installment sale because the transactions were completed over more than one year (i.e. received cash in 2013 as well as in 2012). Apparently MA doesn't recognize installment sale income, so the state taxes it all in the 2012 year. The IRS taxes it in 2012 and 2013 (this is Form 6252, again, for the future).
posted by nekton at 3:40 PM on February 28, 2013

Repeating the recommendation to talk to an accountant. Your post said that you received money for your interest in a trust. That is not a like-kind exchange, that is a sale for money.

Talk to an accountant. Not a tax preparer. An accountant.
posted by megatherium at 5:32 PM on March 21, 2013

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