Category: Real Estate
Subject: Joint Property
Title: Basis Issues
IRC Sections:
Filename: 1232.html
Date Produced: 05/95

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Background
Mother-in-law (ML) owned a personal residence with a basis of $8,000 and a value of $50,000. In 1985, ML entered into an agreement with daughter-in-law (DL) to the effect that ML would convey to DL a 50% interest in the home. DL then invested $50,000 to renovate the home. Now the home has been sold for $134,000. The issue is what is the basis of ML and DL's respective interests in the home.

Discussion
This is really a factual determination. The basis issue is quite easily resolved once the proper characterization is placed on the 1985 transfer. It seems to me that the 1985 transaction is either a gift or a sale. Based on the facts as I understand them, a sale seems the more plausible explanation. Consider the following.

Sale Scenario
ML sold to DL a 50% interest in the home. Renovation of the home in the amount of $50,000 was quid pro quo for conveyance of the 50% interest. DL "paid" $25,000 (in the form of one-half the renovation money) to ML. ML then invested that $25,000 in renovating the home. ML's basis is then $29,000, one-half the original $8,000 basis plus the $25,000 renovation. DL's basis is $50,000, $25,000 she paid for the 50% interest she purchased plus $25,000 of renovations to her interest.

Gift Scenario
ML conveyed a 50% interest in the property without any commitment on the part of DL to do anything. DL then independently invested $50,000 in the home. I assume that the property interest in question is such that each party has a 50% undivided interest in the whole property. Accordingly, DL's renovation represents a $25,000 gift to the ML related to renovation of the ML's one-half interest and a $25,000 increase in basis to DL's half. Accordingly, ML's basis is $29,000, one-half the original $8,000 basis plus $25,000 of renovations gifted by DL. DL's basis is also $29,000, $4,000 of carried over basis with respect to the gifted interest plus $25,000 of renovations to DL's portion of the property.

Comments and Conclusions
Discuss with the parties and review the written agreement (if any) to determine whether the renovation of the property was a condition precedent to the transfer. Also, the real estate transfer documents may also be rich with clues as to the underlying facts.

As stated above, it seems to me the most plausible explanation of the situation is DL renovated the home in exchange for a one-half interest. The gift scenario really requires that the transfer of the interest be disconnected from the subsequent renovation. This strikes me as unlikely although not impossible.

Reporting Issues
Presumably nothing was reported in 1985, neither a sale nor the two gifts. Absent successful assertion of fraud, which seems unlikely, 1985 is a closed year with respect to reporting a sale. On the other hand, unless gift tax returns for both ML and DL were filed for 1985 reporting any other gifts that may have been made that year, the 1985 gift reporting is still open.

If it is determined that the facts better lend themselves to sale treatment, ML's basis presumably contains $25,000 related to unreported sale proceeds from 1985. This is very troubling. In fact, there is a considerable amount of conflicting case law in this area some of which holds that under the doctrine of estoppel, taxpayers are prevented from claiming basis related to previously unreported income items. I think the conservative approach is to exclude the $25,000 from basis. (Query: is ML eligible for the $125,000 lifetime exclusion? If so, the issue is moot.) If ML wants and needs to take a more aggressive position, it is possible that such a position is supportable based on the existing case law, but this requires considerably more study. I would be happy to further pursue the matter if ML desires it and is willing to underwrite the cost. Please advise.