Taxes And Capital Gains On Sale Of Family Home When Owner Passes

Dealing with the death of a loved one is difficult, and navigating the tangled web of estate tax, probate, and disposition of assets can be overwhelming. Many Fuoco Group and TFG clients have asked if they inherit a home do they qualify for the $250,000 / $500,000 home sale tax exclusion? The answer may be no, but don’t panic. You will benefit from the stepped-up basis rules for inherited property, and as a result, you may not need the exclusion when you sell the home.

What is the Home Sale Tax Exclusion? A very generous tax exclusion for folks when they sell their property. Up to $250,000 of any gain from the sale received by a single homeowner is tax free, or $500,000 for married homeowners filing jointly is excluded from income. To qualify for the exclusion, the home must have been used as a main home for two years out of the prior five years before the sale, so when you inherit a home, you won’t qualify for this exclusion unless you moved into the home and lived there for at least two years.

Not sure what a step-up-in-basis is in this case? Basis is generally the amount of your investment in property for tax purposes, or think of it as “cost basis” plus improvements. When an owner of a home (sole or otherwise) passes away, the fair market value of the home on the date of death becomes the new basis, no matter what was paid for the home originally. If there are several owners, the new basis is pro-rated.

Some have inquired if there is a capital gains write off, if not lost at death, is there a time limit? The answer is no – no time limit on the sale for capital gains purposes because the basis doesn’t expire or fade away. However, the longer you hold onto the residence, the more likely it is to appreciate in value and increase the capital gain.

For example – say your Mom bought her home for $200,000 and it was worth $350,000 at her death and you just sold it a year later for $400,000 – you would then have capital gains income taxes on that $50,000 capital gain. The capital gain on that sale is $50,000 because the original purchase price is no longer applicable, and the new basis is $350,000. Capital gain is calculated according to this formula: Selling Price – Basis = Capital Gains (or loss).

There’s typically no write-off or loss, taxpayers can deduct capital losses on the sale of investment property but can’t deduct losses on the sale of property they hold for their personal use. Capital losses do not apply to a personal residence or other personal property like your car or boat. Only losses associated with property used in a trade or business and investment property, like stocks, are deductible. If you have a capital loss that can be deducted because you don’t use the home as your personal residence, it is first applied against other gains, and then the excess, up to $3000, can be deducted against your ordinary income per year.

Exceptions might apply for estate property though. If the family home is held by the estate for investment purposes, you may be able to treat it as a capital asset and realize a loss. Also, an alternate valuation date can be used in certain circumstances. You can elect to use the value on the date six months from the date of death if both the value of the gross estate and the estate tax liability is reduced. Best to consult with your Fuoco Group tax professional first!

Here is another very different example – Instead of transferring the property after your Mom died, let’s say that she gifted the home to you during her lifetime, by deed in your name only, what would the result be? Your tax basis in the property would then be $200,000 because of the carryover basis rule. When the property sold for $400,000 after Mom’s death, you would then have capital gains income taxes on that $200,000 capital gain. Ouch! Special rules apply for gifted property you sell at a loss. Your basis is the lesser of the carryover basis or the fair market value on the date of gift.

Joint ownership is another situation in which the tax basis rules are confusing. If Mom or Dad added you as a joint owner of their property, there is a different income tax treatment depending upon whether the property is sold before or after they pass.

  • If sold during Mom or Dad’s lifetime, you would have to pay capital gains income taxes on the property using your share of Mom or Dad’s carryover basis. There is no step-up in basis for these types of gifts when they are sold during the original owner’s lifetime.
  • If the joint property was not sold until after your Mom or Dad’s death, you get a full step-up in basis of that property to the value on Mom or Dad’s date of death. As long as you contributed nothing to the purchase, and they retained an interest in the property at the time of their death, you would only pay capital gain income taxes on the increase in value after their date of death. To minimize the income tax burden, your parents should not take their name off their property and their property should not be sold until after their death.
  • The step-up in basis rule is a little different with joint ownership between a husband and a wife. It does not matter which spouse contributed to the purchase of the property, if held jointly by a husband and wife, each spouse is deemed to own one-half of the property. Upon the death of one spouse, the surviving spouse gets a step-up in basis in the half received from the deceased spouse and a carryover basis in their own half. (Exceptions apply for community property states: On the death of a first spouse, community property may be written up to its full fair market value.)
  • An unmarried surviving spouse is allowed to claim the larger $500,000 joint-filer gain exclusion for a principal residence sale that occurs within two years (24 months) after the spouse’s death. You must have owned and lived in the house for two of the five years before the spouse died. Of course, being eligible for the larger exclusion won’t matter if the gain from selling your home is less than that. But it might matter with a highly appreciated home.

Want to know what income tax rate applies? A home is a capital asset, which means any gains are taxed as capital gains. The general rule is that you must hold an asset for more than one year to get the lower long-term capital gains rates. BUT, when you sell inherited property, including a home from your Mom or Dad, any gains are always taxed at the lower long-term capital gains rates no matter how long you or your parent owned the home. An inheritance is always a long-term capital gain upon sale regardless of how long the donor owned it.

CONTACT US: Selling an inherited home can result in taxable income, any gains you realize have to be included in your taxable income. However, special rules apply to inherited property, such as a house, that may reduce or eliminate the taxable gain you’re required to include on your income tax return. Check with our professionals to be sure what your liability might be and how to properly position yourself.  Feel free to contact me, Cory Lyon, directly at 561-209-1120, with any questions. I act as a fiduciary for all my clients.

TFG Financial Advisors, LLC is a registered investment advisor. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any securities, and past performance is not indicative of future results. Investments involve risk and are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed here.

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