Inherited property capital gains

Hercule08

When my grandfather passed in 1990, he left myself, five siblings and four cousins (10 people total) a 37 acre piece of property. We were all “tenants in common”. At the time of his death, the property was valued at $90k. This past year, we sold the property to the Berrien County, MI to expand an adjacent county park. Now it gets complicated….

I live in Indiana and the property is in Michigan. During due diligence by Berrien County, they paid for a stake survey and appraisal. The appraised value was $700k. We sold the property for $425,00 agreeing to donate (charitable contribution) the difference of $275k. The proceeds were divided into 10 equal shares.

While I’m just beginning to research the tax implications for myself, I’m wondering if I can simply take my proceeds from the sale, $42,500, deduct the value at the time of my grandfather’s death, $9,000, for total net proceeds $33,500. If I am allowed to do this, can I reduce my taxable portion from the sale by deducting my portion of the donation or $27,500 for a net (taxable) gain of $6,000? Would this be reported only on the federal return? Since I live in Indiana but the sale took place in Michigan, would I need to file a Michigan return? Is it necessary to report anything on my Indiana return?

Any insight would be greatly appreciated. Thank you in advance!

Henry

Hi Hercule08! It sounds like you may have what the IRS refers to as a bargain sale. This happens when you sell or exchange property for less than fair market value with the intent of making a gift. In this situation, the transaction is partly a sale and partly a charitable contribution. You need to report each part of the transaction separately.

First, if you inherited the property, then your cost basis will usually be the fair market value of the property at the time of your grandfather's passing.

Next, you need to determine if Berrien County is considered a qualified charitable organization. According to the IRS website, you may deduct a charitable contribution made to, or for the use of, an organization that otherwise is qualified under section 170(c) of the Internal Revenue Code and is a state or United States possession (or political subdivision thereof) if made exclusively for public purposes. You will need to decide how the IRS rules apply to your situation and can reach out to Berrien County for further guidance on their qualified charitable organization status. If you still aren't sure, you can refer to this IRS website which allows you to do a tax exempt organization search: https://apps.irs.gov/app/eos/

Finally, if a charitable deduction for the contribution is allowable, you must allocate your adjusted basis in the property between the part sold and the part contributed based on the fair market value (FMV) of each. The adjusted basis of the part sold is figured as follows:
Adjusted basis of entire property × [Amount realized (FMV of part sold) / FMV of entire property]

(see pg 4 of IRS Publication 544)

Based on the information you have provided, that might look something like this:

$90,000 x ($425,000/$700,000) = $54,643 adjusted basis of the part sold

$90,000 - $54,643 = $35,357 adjusted basis of the part contributed to charity

To report the part of the transaction that is a sale, you would select Income > Stocks or Investments Sold (1099-B) from the menu bar. Indicate that the investment was inherited. Then you will be prompted to enter the sales proceeds and the adjusted basis of the part sold. Remember that you only need to report your share of the proceeds and cost basis, which would be 1/10 of the amounts. When you are done, you should have a long-term capital gain on Schedule D.

Now to report the part of the transaction that is a charitable contribution. Select Deductions/Credits > Itemized Deductions > Donations from the menu bar. As you enter information about your donation, you will be prompted to enter the date of contribution and FMV, as well as your cost or adjusted basis. Once again, remember to only report your share there, which would be 1/10 of the FMV of the donated portion of the property and 1/10 of the adjusted basis of the part contributed to charity. When you are done, your donation will show up as an itemized deduction on Schedule A.

When it comes to preparing your state tax returns, your resident state will generally tax all of your income. In fact, the Indiana instructions specifically say that if you received income from another state while you were an Indiana resident, you must report that income on your Indiana income tax return (see pg 36 of the IT-40 booklet).

Since the income came from the sale of property in Michigan, it is typically considered Michigan-source income, which means that Michigan will also expect you to file a Michigan tax return and report that capital gain income. The good news is that if you end up paying taxes on this income to both Indiana and Michigan, you may be able to take a credit for taxes paid to another state on your IN return.

Henry

Hercule08, I found some additional information regarding qualified charitable organizations and added it to the original response. You'll want to consider that before deciding how to proceed.

Hercule08

Thank you so much for your response, Henry. If I understand your answer, the gross proceeds are $54,643 and gross charitable deduction (if allowed) is $35,357. As my actual amounts would be 1/10th of the two figures, and for the purpose of completing my taxes, would I use your computation or 1/10th of those numbers? Thank you again for your response.

MatthewD

Hi Hercule08,

good question. Since your share of the inheritance is 1/10, you would use 1/10 of the example amounts above.