Capital gains implications on gifted house transfer - selling property not in our name

My wife and I are in a complicated situation with our current home. My father-in-law purchased our house about 15 years ago for $270k, but we've been the ones living in it and making all the payments. We've completely paid off the house over the last several years, but the deed is still under my father-in-law's name. We're now looking to sell this house (current market value around $1.1 million) and purchase a new home. About 90% of the proceeds will go toward our new primary residence. Here's my question: If my father-in-law transfers the deed to me first, and then we sell it and use the money for our new house, will we still have to pay capital gains tax? From what I understand, if we sold it while keeping it in his name and he simply gifted us the money, we might avoid capital gains altogether. However, my father-in-law has been somewhat unreliable with financial matters in the past, and I'm concerned he might not transfer the full amount to us. Having the house in my name before selling would eliminate a lot of anxiety. Any advice on the tax implications and best approach would be greatly appreciated!

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18 comments

Philip Cowan

•8M

This is definitely a tricky situation with both tax and family dynamics at play. Let me break this down: If your father-in-law transfers the deed to you first and then you sell, you would inherit his cost basis ($270k) and holding period (15 years). When you sell for $1.1M, there would be a capital gain of approximately $830k. However, you may qualify for the Section 121 exclusion which allows you to exclude up to $500k of capital gains (for married filing jointly) if you've owned AND used the home as your primary residence for at least 2 of the last 5 years. The catch here is that while you've lived in it, you haven't technically "owned" it yet. If your father-in-law sells it while still in his name, he likely wouldn't qualify for the exclusion since he hasn't lived there. He would owe capital gains tax on the profit. If he then gifts you the money, he could use part of his lifetime gift tax exemption. I'd recommend consulting with a tax professional about potentially using a Qualified Personal Residence Trust or exploring other options that might help minimize the tax impact while addressing your concerns about ensuring you receive the full proceeds.

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Philip Cowan

•8M

The father-in-law can use part of his lifetime gift and estate tax exemption (currently $12.92 million per individual) to avoid paying gift tax when transferring the house. He would need to file a gift tax return (Form 709), but no tax would be due unless he's already used up his exemption. As for the payments, this is where things get interesting. Since they've been making all the payments, they could potentially argue they've had "beneficial ownership" of the property all along, even if the legal title was in someone else's name. This could possibly help establish ownership for the Section 121 exclusion, but it's not straightforward and would require documentation of all payments and the original understanding between parties.

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•8M

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Melina Haruko

•8M

Just wanted to add that timing matters a lot in your situation. If your father-in-law transfers the house to you now, you should wait as long as possible before selling to establish ownership time for the Section 121 exclusion. Also, make sure to document EVERYTHING about the payments you've been making over the years. Bank statements, canceled checks, anything that proves you've been financially responsible for the house. This creates a paper trail showing beneficial ownership that could help if you're ever audited.

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Melina Haruko

•8M

Try to gather documentation going back as far as possible, but the past 7 years should be sufficient for most IRS purposes since they typically don't look back further than that for audits. If you can show a consistent pattern of payment responsibility, that strengthens your case. Utility bills in your names are excellent supporting evidence! They help establish that you were truly treating the property as your primary residence. Also gather any documentation showing you were responsible for property taxes, insurance, maintenance and repairs. The more comprehensive your paper trail showing you were acting as the true owners, the stronger your position.

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