My parents purchased a home back in 1978 for $300,000. They recently gifted me the home and added my name to the title. The house is now worth $1,500,000. I own a business and use about 1500 sq ft out of the 2990 sq ft of the house for business. How much capital gains will I be able to defer after the $500,000. Also, how much capital gains will my parents be liable for if we were to use 1031 on part of the home too for business use? We have lived in the house for 2 of the 5 years and have also been working out of our home for the same amount of time.

ANSWER

The BIDaWIZ Team's Answer:

Was the entire home gifted to you or do your parents still own the home (i.e. they are still on the title along with you)? You are correct that you can exclude up to $500,000 per IRC Section 121 and California tax law follows suit. However, you wouldn't be able to elect the 1031 exchange unless this was a rental or investment property. We understand that you have a home-based business, but that is different than the criteria for IRC Section 1031.

If both you and your parents own the home, we do believe that each meet the IRC Section 121 capital gains exclusion of $500,000 per joint filers. Please note that when your parents added you to the title, you own half the home and have half of their $300,000 basis or $150,000. As such, if the home is sold for $1.5 milllion, you would report $750,000 in proceeds less your $150,000 or $600,000 in capital gains. However, after the $500,000 exclusion, you would have $100,000 in capital gains to report to the federal government and California. The same holds true for your parents as they own half of the home as well. Please note that you may have to claim depreciation recapture for the expenses claimed on your home office when you eventually sell your home.

References: IRC Section 1031, IRC Section 121, IRS Publication 523
State: California