Purchase of Daughters Home - Then Rented To Her

Go for it!  That's what it cost them to get the title so I don't think it matters who the $65,000 was paid to as long as it was the cost to acquire his interest in the home.  If the $65,000 was for some other part of a settlement to make him disappear, it wouldn't be part of the acquisition cost but if it represented his share of the house you are good to go.

So the daughter got no cash, just a happy ex-husband and a paid-off mortgage on her credit report?

Something is not adding up.  Mortgage payoff, no prob.  $65,000 was ex's portion of the FMV, implying there's the daughter's, which would add another $65 grand to the FMV.  Yet, the total of $252,000 ($122,000 + $65,000 + $65,000) is still significantly smaller than the FMV of circa $300k.

Have the gift tax implications been considered?

Ignore gift tax, for clients like these it's an archaic remnant of earlier times.  But don't forget the rules for basis of gift.  If daughter shared title to house and she gave her equity to parents, what was her basis in it?  Not that I would believe that the only consideration was love and affection.  There would be a reason for money under the table, if cash to daughter would affect amount of child support or spousal maintenance.  

Appreciate everyone chiming in with their thoughts.  I have to go feed my clients horse now.  Talk later.  

Not sure if there is a settlement statement, or a legal agreement, or a tracking workpaper involved? These would provide supporting cost basis info for your workpapers and allow you to add certain closing costs for additional depreciation and possibly amortization, or cost expensing (title transfer, real estate tax allocation, etc.). If this is truly a sale, then cost basis would be the $187k as calculated plus any additions to cost basis from the settlement. If this is indeed an oral or handshake transaction (not a good idea imo) then the transaction becomes more basic of course (the flat $187k).

BobK raises a good point: is this a part-gift/part-sale transaction? Even so, when a transfer is a part-gift/part-sale transaction, the transferee's/donee’s basis is the greater of the amount paid for the property or the donor's basis at the time of the transfer, plus any federal gift taxes paid. Seems like the $187k would again prevail. Also, I would think the daughter is benefiting in other ways from financial/grandkids support, loan repayment to parents, etc. and thus not a part-gift in any case?

Then of course there is the future inheritance and step-up in basis to consider. Since there would then be no recapture, the parents should certainly maximize the depreciable cost basis. 

Never a dull moment. (and yes, I have grown kids and also a client in a similar situation, which drew me to this thread) : )