Capital gains tax owed on `gifted' home

Tax Talk

Tax Talk

Your Money

April 10, 2007

Editor's note: Every Tuesday through the end of tax season, The Sun will run an edited transcript of baltimoresun.com's weekly tax advice column featuring three experts from the Hunt Valley accounting firm SC&H Group.

My father "gifted" his house to my sister and me in October 2005. He retained lifetime rights. He passed away in June last year, and we sold the house in December. Do we owe capital gains tax? If so, on what portion?

- Valerie, Pocomoke, Va.

The tax basis in the house will be the same as your father's basis - increased by a proportional amount of any gift tax that he paid when he transferred the house to you. Assuming that he purchased the house, your dad's basis would be the cost that he paid plus any improvements made to the house.

The gift tax is allocated by multiplying the appreciation in the house at the date of the transfer (fair market value less your dad's basis) divided by the fair market value of the house on the date of the transfer multiplied by the gift tax paid.

Your gain would be the difference between the amount you sold the house for and the tax basis reduced by any costs of the sale. You would have a long-term holding period, since your father's period carried over to you, thus the gain would be subject to preferential long-term capital gains rates.

I have a Health Savings Account through work. I pay in, and my employer does as well. Are there any special steps I need to take to report this account?

- Sean, Bel Air

You should receive Form 5498-SA, HSA, Archer MSA, or Medicare Advantage MSA. This form shows your contributions and your employer's contributions for 2006. Your employer's contributions are reported in box 12 of your 2006 W-2, with a code W.

You need to report all contributions made to your HSA on Form 8889, Health Savings Accounts. This form calculates your HSA deduction and is filed with your 1040. The deduction you calculate flows to line 25 of your 1040. Note that you are allowed to make contributions to your HSA for 2006 until April 17. There is a limit to how much you can contribute each year.

A taxpayer over age 70 1/2 has two traditional IRAs, one with a balance of $20,000 consisting of $6,000 of nondeductible contributions and $14,000 of deductible contributions and earnings. The second IRA has no nondeductible contributions. When a direct transfer of $1,000 is made from the first IRA to a qualified charity by the IRA trustee, how is that tax-free exclusion reported on Forms 1040 and 8606?

- John, Eldersburg

The entire $1,000 distribution to the qualified charity is treated as being made from the deductible contributions and earnings of the IRA (i.e., entirely out of the $14,000 balance). So none of the distribution is included in the taxpayer's gross income. Further, the taxpayer is not entitled to a charitable contribution deduction on his/her individual tax return.

If the only distributions made from the IRA during the tax year were qualified charitable distributions, then the taxpayer is not required to file Form 8606.

For purposes of completing Form 1040, enter the total amount of the distribution on line 15a. If the total distribution is a qualified charitable distribution, enter $0 on line 15b. If only a portion of the distribution is a qualified charitable distribution, enter the amount of the distribution that is not a qualified charitable distribution on line 15b.

When you take a distribution of tax-deferred savings after retirement, why do you have to pay federal income taxes on Social Security income for the year in which you took the distribution?

- PSB, Baltimore

The amount of tax you pay on your Social Security income depends on how much provisional income you have. Your provisional income is made up of all your other income; including tax-exempt interest income and taxable retirement distributions, plus half of your Social Security income. Compare provisional income to the adjustments you have on your 1040, line 36.

If your provisional income after adjustments exceeds the threshold for your filing status ($32,000 for married filing jointly, $25,000 for single, head of household and qualifying widower), you will be taxed on a portion of your Social Security income.

Social Security benefits are not taxable in Maryland, and you might be eligible for a pension exclusion. See the instructions to state Form 502.

NEED HELP? To submit a question to the "Tax Talk" experts, go to baltimoresun.com/taxtalk

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