No. Foreign Real Estate holdings are not required to be reported on an FBAR nor on a 8938 because it is not a specified foreign financial asset.
If the father died and willed the estate to your wife and brother, her cost basis at the time of the inheritance is ($500,000) X (.4) + $50,000= $250,000. The capital gains would be $150,000 in this case.($400,000-150,000). Here you will report the actual proceeds from the sale., which is $400,000. The $100,000 difference does not need to be reported as a gift.
Keep in mind this is all reported in US dollars. To calculate correctly, you would need to know the conversion rate at the time of the inheritance and at the time of the sale. In this case, you may need to do some homework to calculate the historical currency conversion rates between these two events as well as when the improvements were made. To simplify it some, you might wish to take an average rate over the 16 year period between the inherited and sell dates.
No, no additional information is not normally documented as the IRS has relied on best faith estimates. This doesn't mean though that if you are audited, they won't ask for it so keep whatever photos and other proof handy if you are asked for it. As far as conversion rates, I have briefly mentioned it already. You may wish to use a conservative average for the period of time the improvements were made.
Yes, you would use the $40,000 converted to USD to report the foreign tax credit. You would use the date of the sale to determine the USD conversion.
Her Canadian tax refund is not reported as taxable income on her US return. Please reach out if you have addtional questions.
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