Losing a loved one is difficult on many fronts – emotionally, physically and legally.
People grieve differently. However long it takes, after the tears are mostly gone, there is the business part of things.
A frequent question is whether or not there will be any capital gains on the sale. In most situations, the answer is no because the home is acquired by the heirs at a “stepped up basis.”
We will define that in a moment but first a high level over view of the capital gains tax as it relates to real estate.
A BRIEF OVERVIEW OF CAPITAL GAINS – APPLIED WHEN THE HOMEOWNER IS ALIVE
Capital gains taxes are paid on the “gain” from a sale of a property. For a personal residence each homeowner has a $250,000 exemption. Married couples have $500,000.
Assume a single person bought a home for $100,000 and sold it many years later for $550,000. The gain is $450,000 ($550,00-$100,000). But the seller has a $250,000 exemption thus capital gains are paid only on the $200,000 difference. ($450,000 gain less $250,000 exemption)
For most folks the capital gains rate is 15% to 20% depending upon income.
There is a bit more that goes into calculating capital gains. Expenses such as acquisition closing costs, selling expenses, capital improvements and expenses to prepare the home for sale can all be thrown in to make the gain a bit smaller but I think you get the idea of how it is calculated.
A BRIEF OVERVIEW OF STEPPED UP BASIS – APPLIED UPON THE DEATH OF THE HOMEOWNER
When a homeowner dies, the heirs inherit the home at the current market value. So, if a home is sold within a relatively short period after the death of the homeowner, there would be no capital gains tax applied as it can be assumed that the sale price was the market value at time of death and thus there was no profit.
Say a home was bought for $100,000 many years ago and the owner just passed. Within a month or two or three, the home is sold for $550,000. There would be no capital gains as it can be assumed that the sale price equals the value at time of death. The fact that it was purchased for $100,000 is irrelevant.
HOW TO DETERMINE VALUE AT THE TIME OF DEATH
Now, it is important to note that in the last section I wrote, “if the home is sold in a relatively short period after the death of the homeowner.” What is a short period?
That is a question for an accountant, but in my lay opinion, if you selling in the same selling season as of the date of death, you can use the sale price as the value at time of death (TOD). Or if you are selling in a declining market, there would be no capital gain.
I have had cases where a person passed 3 or 4 years ago and for various reasons, the house was not sold quickly. In that situation, there very well could be capital gains.
Say the value at TOD was $550,000 and it sold a few years later for $650,000, there would be a capital gain of $100,000 less the expenses I mentioned above in the Capital Gains Overview section.
If the TOD was several years ago or you are selling in a rapidly appreciating market, to determine the value at the time of death, you will need to hire an appraiser to do a TOD appraisal. Some heirs have asked me to give them a value at TOD. I can run comps and give a general idea but if you want a document that would stand up in an audit, you need an appraisal by a licensed appraiser.
There is really no limit as to how far they can go back. For complicated reasons, I had one last year where the heirs needed to know the value in 2004. The appraiser was able to do that.
Most heirs sell quickly and it is my experience that they use market value for TOD value. Whether or not to get an appraisal is up to you and your accountant.
Questions? Don’t hesitate to call.