Legal Question in Tax Law in Texas

Re: What taxes will each person be subject to after sale of family property?

The parents will need to allocate their basis in the property (cost they paid for the land and any buildings that were on the land when they bought it plus the cost of improvements they added after they bought the land) between the part that is their residence and the rest. The difference between the sales price (less costs of the sale, such as real estate broker's commission) and the basis will be capital gain.

Up to $500,000 of gain is excludable for the portion of the property that qualifies as the parents' principal residence.

The remaining capital gain must be reported on the parents' income tax, since the land and building are in their names.

When the parents give each of the children 1/8 of the sales proceeds, they will be making gifts. The amount above $11,000 per donor per recipient is a taxable gift, so if each child gets more than $22,000 ($11,000 from the mother and $11,000 from the father), the parents will have to file gift tax returns. They will have to pay gift tax if the lifetime amount of gifts for either one of them exceeds $1 million.

The children won't owe any tax on the gifts they receive, as gifts are excluded from income for income tax purposes.

Both the tax on the capital gain and any gift tax owed will be due on April 15 the year following the year of the sale. The parents would probably want to calculate the taxes in advance and withhold an equal amount from each person's share to pay the taxes.

The answer above is assuming a cash sale rather than seller financing. Ultimately, the amount of capital gain recognized will be the same, but it could be spread out over a period of years by using the installment sales method.

If gift tax is a problem, the parents may want to consider structuring the gifts to the children in such a way as to transfer ownership by $11,000 per donor per recipient per year (for example, through the use of a family limited partnership).

If the capital gains are going to be substantial, it might be worth doing a tax-deferred like-kind exchange on the children's portion of the land (this cannot be used for the parents' residence, but it can be used for investment property)

The sort of lawyer you want is someone who has a good grasp of both income tax and estate and gift tax law. If you're in the region of the Austin - San Antoinio corridor, I'd be happy to talk to you. My office number is 210-223-9389 (San Antonio), and my Austin number is 512-470-8225.