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Tax Court: Individual's Sale of Personal Residence to Parents was Part Sale, Part Gift

(Parker Tax Publishing September 2017)

The Tax Court held that an individual's sale of a personal residence to his parents, in which he discharged two mortgages but received no cash or other property, was a sale in part and a gift in part. The individual's amount realized was the amount of the liabilities discharged, and his gain was determined by subtracting from that amount his basis and settlement costs and excluding $250,000 of the gain under Code Sec. 121. Fiscalini v. Comm'r, T.C. Memo. 2017-163.

In 1993, Robert Fiscalini and his parents bought a house in Hollister, CA for approximately $274,000. The parents paid $40,000 and Fiscalini took out a mortgage for the balance. Fiscalini, the owner of a construction company, lived at the property until August 2007. In 2002, he built a swimming pool with equipment used in his business and converted a detached garage into a game room. In 2003, his parents transferred their interest in the house to Fiscalini as a gift. Fiscalini did not give them any cash or other property in return for their interest in the property.

Fiscalini refinanced the property several times. In 2007, he was unable to make his mortgage payments and sold the house to his parents in order to avoid foreclosure. Fiscalini's parents borrowed $682,000 to finance the purchase. Most of the loan was used to discharge Fiscalini's outstanding loan balances totaling approximately $664,000. The closing statements on the sale showed total consideration of $975,000 and a gift of equity to the parents of around $295,000. Settlement costs of almost $17,000 were also incurred. Fiscalini received a Form 1099-S, Proceeds from Real Estate Transactions, showing gross proceeds of $975,000.

Fiscalini did not file a tax return for 2007 because he was unable to pay any tax due for that year. He eventually filed a return for 2007 in 2013 but did not report any gain on the sale of the house. In a notice of deficiency for 2007, the IRS claimed that Fiscalini had $975,000 of long term capital gain from the sale of the house. The notice also said that Fiscalini was liable for penalties under Code Sec. 6651(a)(1) and Code Sec. 6662(a). Fiscalini challenged the notice in the Tax Court.

Fiscalini argued that his gain on the sale was approximately $70,000 after taking into account the exclusion of $250,000 of gain on the sale of a personal residence under Code Sec. 121. He claimed that his basis in the property was approximately $330,000 and his amount realized was around $650,000, which represented the discharge of his liabilities minus settlement costs. In determining his basis, Fiscalini said that his cost basis of $234,000 was increased by $40,000, his parents' basis in the property when they gifted their interest to him in 2003. Fiscalini argued that his basis was also increased by his costs of $50,000 for the swimming pool and other improvements he made. According to Fiscalini, the 2007 transaction with his parents was in part a sale and in part a gift to them. He said the amount of the gift was the difference between the total consideration of $975,000 and his discharged liabilities of $664,000.

The IRS argued that Fiscalini's basis was $234,000 and his amount realized was the $975,000 sale price less the $17,000 in settlement costs. According to the IRS, Fiscalini's basis was not increased when he received the partial interest from his parents; it asserted that coowners of an asset have only a cost basis in the amount each has paid for the asset. As to the amount realized, the IRS said that the $975,000 sale price was the fair market value on the date of the sale, and therefore the amount realized.

In determining Fiscalini's basis in the property, the court held that Fiscalini received a carryover basis of $40,000 in the interest he received from his parents in 2003 which increased his basis to approximately $274,000. The Tax Court did not agree, however, that Fiscalini's basis should be increased by his claimed costs to build a swimming pool and make other improvements because he failed to substantiate those costs.

Turning to the amount realized, the Tax Court agreed with Fiscalini's characterization of the transaction as part sale, part gift. The court noted that Fiscalini received no cash or other property from his parents in the sale, although his mortgages in the amount of around $664,000 were discharged. Fiscalini's amount realized was determined to be approximately $647,000, equal to the liabilities discharged minus the settlement costs.

Subtracting his basis and taking into account the exclusion of $250,000 of gain on a personal residence under Code Sec. 121, the Tax Court concluded that Fiscalini's gain on the sale was approximately $122,000.

The court also found that Fiscalini was liable for penalties under Code Secs. 6651(a)(1) and 6662(a). Fiscalini's inability to pay his taxes in 2007 was not reasonable cause for failure to file a return, according to the Tax Court. The Tax Court also found that when Fiscalini did file a return for 2007, it did not include any gain from the sale, even though he knew that his mortgage loan balances had been discharged. An accuracy related penalty therefore applied because Fiscalini made no attempt to comply with the Code in determining his gain and therefore failed to do what a reasonable person would do under the circumstances. Fiscalini did not have reasonable cause for, or act in good faith with respect to, the underpayment, according to the Tax Court.

For a discussion of the exclusion of gain on the sale of a personal residence, see Parker Tax ¶77,710. For a discussion of the measurement of gain or loss on a sale or exchange, see Parker Tax ¶110,140. For a discussion of the penalty for failure to file a return see Parker Tax ¶262,105.05. For a discussion of the accuracy related penalty for negligence or disregard of rules or regulations, see Parker Tax ¶262,120.05.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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