Q&A: Selling an inherited house to a relative will affect tax treatment

Dear Liz: My mother recently died, leaving a house to my three siblings and me. We had the house appraised in February. My sister is buying the rest of us out. We decided to give our sister a break and sold her the house below the appraised amount. As the “selling price” (which will be a public record) will be below the appraisal, can I take my “loss” on my taxes this year? I gave her a $25,000 reduction, so I assume I can take $3,000 a year for eight years. Is this true?

Answer: Probably not.

The sale to a family member probably dooms any chance of taking a capital loss, said Mark Luscombe, principal analyst for tax and accounting at Wolters Kluwer.

“The law is not entirely clear on this topic with the IRS perhaps taking a more severe stand than the Tax Court, but both seem to frown on any use of the real estate for personal purposes after the death of the parent,” Luscombe said.

For a capital loss, the IRS appears to require that the inherited property be sold in an arm’s length transaction to an unrelated person, Luscombe said. The IRS also requires that you and your siblings did not use the property for personal purposes and did not intend to convert the property to personal use before the sale.

Even the Tax Court cases appear to at least require a conversion to an income-producing purpose before the sale and no personal use of the property after the death of the parent.

“The reader may find a court willing to say that personal use by a sibling is not personal use by the reader, and, from the reader’s perspective, it was converted to investment property,” Luscombe said. “However, since this was a sale to a sibling and not an unrelated person, I think that the IRS would disagree with that position.”

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