I might be making this more difficult than it is, but here are the facts so far:
1. Father (A) owned two rental properties that he inherited. He wants to retire to Florida and needs money to buy a house there. Instead of selling the properties outright, in 2007 he sells 2/3 of the interest in the two properties to his two sons for $550k, and retaining a 1/3 ownership interest.
2. The two sons get mortgages totaling $550k on the properties, give it to A, who adds their name to the deeds and he happily moves to Florida. The ownership of the property is split three ways, the debt split 50/50 between the two sons.
3. A pays tax on the $550k. C thinks it was gift tax, but I think it was probably capital gains tax.
4. Neither son put any money down, it was completely financed. There is no settlement statement, just an informal deal between the family.
5. One brother (B), is in charge of all the financial dealings, collecting rents and paying the bills. He lives in his own house 30 minutes away with his wife. The other brother(C) (my client), lives on the property with his wife and is responsible for all the repairs, maintenance, improvements etc. He is a Firefighter and a licensed contractor.
6. They split the income/loss each year 50/50 on their returns.
7. There are 5 rental units in total, C deposits his share of the mortgage, insurance and taxes each month (1/3 of the total for that property) as well as his own utilities, etc. into the rental property bank account.
The above is all the easy part. Now...
8. In 2019, C was injured in the line of duty and could no longer do either job. It took almost a year for his disability checks to come in. His wife also left him and filed for a very nasty divorce. C could not make his monthly payments anymore and fell far behind. B and C are constantly fighting.
9. C wants to sell the properties to get out from under the debt. B does not want to, A is on B's side.
10. in March 2022 A, B and C finally reach an agreement to sell C's 1/3 interest in the properties to B for $210k, and a settlement agreement (not a HUD1 statement), Quitclaim deed and promissory notes are drawn up and signed, C's name is taken off the deed but not the mortgages. There are no schedules to show how they came up with the $210k, it was just through back and forth negotiations over 2 years.
11. In Sept 2022, one of the properties is sold and C is paid his $210k plus an extra $7k because it sold $21k over the appraised value from March 2022. Both mortgages are paid off, and the remaining property refinanced to make this payment. He no longer has any interest or debt in the remaining property. His name was not on the deed at the time of sale.
It doesn't seem that difficult, except..
12. What is C's basis? The last time an accountant did his return was in 2015, and there was only $3,286 in depreciation per year recorded (not sure how many years), and only for one property. I am guessing that was for improvements, and the accountant never included the purchase price of $550k/2 on his return. Of course the depreciation schedules were not included in the clients return, and C does not have any records to back up the improvements over the years because either B or angry wife have them and won't give them back. Prior accountant is currently B's accountant, and will not cooperate.
13. His soon to be ex wife did his returns in 2016 to 2020, and did not record any depreciation.
14. Do I include the beginning and ending mortgage in the basis calculations? If so, then he received the $217k plus approx $350k from the release of his share of the mortgage, and we use $275k as the beginning basis?
15. If I do that, then do I have to recapture the depreciation for the last 15 years on the initial purchase even though it was never taken?
16. Will B issue a 1099 to C for the $217k?
17. Can I exclude the portion of the gain related to the unit C used as his home for 15 years?
18. The return needs to be filed by April 15, or he will lose his disability.
19. This return will also be used in the divorce this year, and it is unclear at this time if he will have to share the gain with soon to be ex. It will be scrutinized.
20. My best guess is the gain is around $100k before depreciation recapture. He thinks he has a loss of around that amount.
He wants to file the return without the sale and amend it later when we have more details. (If we have more details).
21. How much should I report as capital gains in 2022?
22. Do I report any of the rental income/loss in 2022? B was paying the difference in the mortgage for the last two years, totaling over $17k, and says C has no right to take 1/2 of the interest and taxes. There is not really any taxable income from the rentals, so I am tempted to just leave it off entirely.
Sorry this is so long, believe it or not this is the simplified version of the facts. Any help would be very welcome.
Thank you.
