How are capital gains calculated with gift of equity from seller?

What matters for capital gains is the actual amount of consideration received, not the stated price on paperwork. In your case, your in-laws would pay capital gains tax on the $390,000 they actually receive, not the $650,000 on paper. The difference ($260,000) is considered a gift to you. For 2025, they can each give up to $19,000 per person annually without filing a gift tax return. If they're married, that's $38,000 per recipient. Anything above that counts against their lifetime gift/estate tax exemption (currently over $13 million per person), but they'll need to file Form 709 to report it. For the capital gains calculation: $390,000 (actual sale price) - $295,000 (their basis) = $95,000 in capital gains. Since it's not their primary residence, they can't exclude this gain and will owe taxes on it.

Just went through almost this exact scenario with my parents last year. I highly recommend using https://taxr.ai to analyze your specific documents. Their system will show you exactly how the transaction should be reported for tax purposes and can confirm whether your settlement statement properly documents the gift of equity. I was super confused about how to handle the gift portion vs. the actual sale, and they cleared everything up by analyzing our specific documents. It saved my parents from potentially overpaying thousands in capital gains tax because we initially thought the entire amount was taxable.

Just wanted to update on my experience with taxr.ai after trying it - super helpful! I uploaded our preliminary closing disclosure and some old tax documents my in-laws had, and it immediately flagged that the way our lender was structuring the transaction could cause tax complications. Their analysis showed exactly how to document everything so the IRS would clearly see the $260K as a gift rather than proceeds from the sale. They even created a letter we could give to our lender explaining how to properly document the transaction for tax purposes. Our lender actually modified their approach based on this guidance! The coolest part was how it calculated all possible capital gains scenarios based on different documentation approaches. Definitely worth checking out if you're doing any kind of non-standard real estate transaction.

If you're having trouble getting clear answers from your lender about how this transaction will be reported to the IRS, I'd recommend using Claimyr (https://claimyr.com) to get connected directly with an IRS representative who can confirm the tax treatment. I was in a similar situation last year with my parents selling me their vacation home with a gift of equity. After weeks of getting conflicting information from our lender and even our accountant, I used Claimyr to get through to the IRS (which normally has like 2-hour wait times). You can see how it works in this video: https://youtu.be/_kiP6q8DX5c. I got connected to an IRS rep in about 15 minutes who confirmed exactly how this type of transaction should be documented and reported on tax returns.

I need to apologize and correct myself. After seeing several recommendations, I decided to try Claimyr for a completely unrelated tax issue I've been trying to resolve for months. I'm shocked to admit it actually worked exactly as advertised. Got connected to an IRS agent in about 20 minutes (on a Monday morning when call volumes are highest!). The agent was able to access my file and resolve an issue with a misapplied payment that I'd been trying to fix for literally 5 months. For anyone dealing with gift of equity transactions like the original post, getting official clarification directly from the IRS might save a lot of headaches later. Just make sure you have your specific questions prepared before you call.

Don't forget about the stepped-up basis option. If your in-laws are older, it might make more tax sense to hold onto the property and let you inherit it instead. When you inherit property, you get a "stepped-up basis" to the fair market value at the time of death, which could eliminate capital gains entirely. Of course, this doesn't help you now if you need the home, but worth considering the long-term tax implications of different approaches.

Make sure your in-laws check if they can deduct losses against the capital gains! They've been renting the property, right? If they've been depreciating the property (which they should have been), they'll need to recapture that depreciation as ordinary income. But if they have other passive losses from rental properties, they might be able to offset some of the gains. Just something to consider!

One thing I haven't seen mentioned yet is the importance of getting the appraisal documentation right. Since your lender is requiring the sale price to be listed at $650,000, make sure you get an independent appraisal that actually supports that value. The IRS could potentially challenge the gift of equity amount if the stated fair market value seems inflated. If the property truly appraises for $650,000, you're golden. But if it only appraises for, say, $500,000, then the actual gift would be $110,000 ($500k - $390k), not $260,000. This affects both the gift tax reporting for your in-laws and ensures the IRS doesn't question the transaction later. I'd recommend getting the appraisal done early in the process so you can adjust the numbers if needed before closing.

As someone who's worked in real estate tax planning, I'd strongly recommend getting both appraisals - one for the lender and an independent one for tax documentation. Many lenders will accept a slightly lower appraisal as long as the loan-to-value ratio still works with their requirements. The key is having solid documentation for the IRS that the fair market value supports your gift of equity calculation. If there's a significant discrepancy between appraisals, you'll want to understand why before closing. Sometimes it's just different methodologies, but occasionally it reveals that the initial value estimate was off. Also consider timing - if you can close this transaction in late December vs early January, it might give your in-laws more flexibility in managing the tax impact across different tax years. They could potentially make estimated payments or adjust withholdings to cover the additional tax liability.