Sometimes, kindness to a family member can backfire in unexpected ways. It is best to be fully informed about the short and long-term impact of any well-intentioned actions. The woman in this example gave her sister a $25,000 reduction in the price of the home, which was sold far below the appraisal value, according to the Los Angeles Times’ article “Selling an inherited house to a relative will affect tax treatment.”
For her generosity, the sister will not be able to take any kind of a loss on her taxes as a result of the lowered price.
The law is not entirely clear on the topic, because every situation is different, but the IRS and the Tax Court both frown on any use of real estate for personal purposes after the death of a parent.
When it comes to a capital loss, the IRS appears to require that the inherited property be sold in an “arm’s length transaction” to an unrelated person. This means that both parties in the transaction, the buyer and the seller, are both acting in their own best interest and are not imposing any pressure or duress on each other in the transaction. Selling an inherited home to a sister is definitely not an arm’s length transaction because of the relationship of the buyer and the seller.
The IRS also requires that the heirs and siblings did not use the property for personal purposes and did not intend to convert the property to personal use before the sale.
Even the Tax Court cases appear to at least require a conversion to an income-producing purpose before the sale, and no personal use of the property after the death of the parent.
While the family may find a court willing to say that a personal use by a sibling is not a personal use by the heir, and from the Personal Representative’s (or Executor’s) position, it was converted to investment property. However, in this case, an outright sale to a sibling and not an unrelated person makes it highly unlikely that the IRS would be amenable to the person taking a tax loss on the sale.
Talk with an experienced estate planning attorney before selling any large inherited asset. There are tax implications for the sale of inherited property that may not be readily apparent. The estate planning attorney will be able to explain the tax consequences and help create a plan for achieving your goals – without creating any unnecessary or unexpected additional costs.
Reference: Los Angeles Times (June 2, 2019) “Selling an inherited house to a relative will affect tax treatment.”