What capital gains tax would apply to the sale of a home received as a gift?

Dollar sign on house

Q. My wife's father signed his house over to her Aug. 24, 2010. She now wants to sell it to her son for $163,500. How will the capital gains tax apply?

A. We took your question to Clint Costa, an attorney and CPA at the Chicago law firm of Shaheen, Novoselsky, Staat, Filipowski & Eccleston. Here's what he says.

The wife in this case would be subject to short-term capital gains treatment on any gain from the sale of the house before Aug. 24, 2011.

Not until Aug. 25, 2011, would she be able to get long-term capital gain rates (for capital assets owned for greater than one year).

It is not clear what the wife's tax basis in the house is, but she would take whatever basis her father had in the house since she received the house as a gift (as opposed to an inheritance in which her basis would be stepped up to its fair market value on the father's date of death).

Assuming the father paid $50,000 for the house 30 years ago, his daughter -- the wife in this example -- would have a basis of $50,000. If she sells it for $163,500 (assuming this is the amount of net proceeds), her gain would be $113,500 ($163,500 minus $50,000), and she would be taxed on that $113,500 gain. Since it is short-term gain until August, ordinary income tax rates would apply.

If the wife were to wait to sell until after she's owned the house for a year, she would at least get the benefit of long-term capital gains rates.

She also might be eligible to have the entire gain exempted from tax as a sale of a primary residence if she both lived in the home as a primary residence and owned the home for two years out of the five years prior to the sale (among other rules that apply). That may not be possible if this is a home in addition to her regular home.

Your wife should have a local CPA or a tax attorney review all the specifics of the transfer and pending sale to make sure she doesn't run afoul of the IRS.