PUB 523 - Excluding the Gain (primary Residence)

[ERD50]

One (or several) of you smart people here can probably provide a 'plain English' answer to this question/situation:


My wife and I have about $240K in adjusted gains in our current home (with no immediate plans to sell). We qualify for the combined $500K exclusion, so the home can increase another $260K before any tax considerations. That is roughly another 50% increase in value, so it will be a long time before any action may be needed.

So, my tax planning question is: what if one of us were to die after the gains exceeded $250K? Is there something we can do to lock in the combined $500K exclusion? I see pub 523 has something on this, but it is a multi step process, and, as I said, someone here can probably explain it in plain English.

you owned your home jointly with your spouse who died:

1 fill out a worksheet, lines 1–13, making adjustments to basis only for events before your spouse's death.

2 multiply the amount on line 13 of that worksheet by one-half (0.5) to get the adjusted basis of your half-interest on the date of death.

3 use the rules under Surviving spouse to find the basis for the half-interest owned by your spouse.

4 add the amounts from steps 2 and 3 and enter the total on line 5 of a second worksheet.

5 complete the rest of the second worksheet, making adjustments to basis only for events after your spouse's death.

Based on this, I'm guessing you would get an appraisal in the year the death occurs, adjust the cost basis up to that point in time. Then, the deceased spouse's $250K credit could be applied to half the gain up to that point in time, and the surviving spouse could use their $250K exclusion against the 'other' half? And further, I'm assuming that the home sale would not need to occur in the same tax year as the spouses demise - this would all be a 'backward - looking' analysis?

Even though my above guesses sound confusing (even to me!), they do seem to make some sense (at least 'tax code sense', an oxymoron if ever there was one). And, if it works that way, there is probably no planning to do, just get the appraisal in year of death, check the numbers and maybe decide to sell when your exclusion maxes out?

I'd like to understand this, and get something written up for my wife in case I go first, and for myself, so I remember what needs to be done.

TIA for any help and/or translations

-ERD50

PS - I did do a search of the forum, could not really find anything addressing this. So I decided to try a new topic.

 

[Martha]

  Publication 523 does address the issue. http://www.irs.gov/publications/p523/ar02.html#d0e897

By way of example, say you and your wife bought a home for 100,000.  She dies and as of her date of death it is appraised at $400,000.  You inherit the home from her.  Your basis is 1/2 of the 100,000 plus 1/2 of the 400,000, for a total basis of $250,000 as of the date she died.   Say a couple of years go by.  The value of the home increases to $500,000.  Your gain would be $500,000 less your basis of $250,000 less closing costs/commission.  So you would be within the $250,000 exclusion amount.

If you are, however, in a community property state, pub 523 says:

Community property.   In community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin), each spouse is usually considered to own half of the community property. When either spouse dies, the fair market value of the community property generally becomes the basis of the entire property, including the part belonging to the surviving spouse. For this to apply, at least half the value of the community property interest must be includible in the decedent's gross estate, whether or not the estate must file a return.

  For more information about community property, see Publication 555, Community Property

So it looks like those in a community property state have an even better deal: a step up in basis for the entire property.

 

[ERD50]

Thanks Martha - that helps a lot.

Yes, now I see their example under 'surviving spouse' in PUB 523.

So, another way to say this, is that the surviving spouse inherits one half of the house from the other spouse. And, like any inheritance, it get a 'stepped up' value at the DOD (or other specified date within the rules).

I'm going to do a little number crunching on this - thanks for the fast reply.

-ERD50

 

[ERD50]

I'm going to do a little number crunching on this...

OK, it's simple - really no planning can be done (if I have this right).

Say your home is currently appraised @ $700K with a $200K cost basis. The $500K gain is not taxed as a married couple. Any further increase in value would be subject to tax.

If one spouse passes. The new basis is $350K plus $100K = $450K. A $700K sale would not be taxed with a $250K exclusion. Same boat either way.

Seems obvious now, sometimes I just need to go through an example to get it through my thick skull.

Thanks again, ERD50

 

[Peter]

Martha, thanks for pointing that out -- I never would have realized!

I wonder what happens if the value of the property declines between the time it was purchased and the time of a spouse's death? Does the basis get 'stepped down'?

And before someone says that would never happen, well, it happened to me. When my wife died 9 years ago, the appraised value of the house was about 4% less than the original purchase price. This was just at the end of the early '90s California property slump.

I seem to remember twisting the appraiser's arm to get him to come up with as low a number as possible for estate tax reasons. This was a potential issue since, at the time, I was not a US citizen, and estate tax would have been payable. Talk about shooting yourself in the foot!

Peter

 

[Martha]

Martha, thanks for pointing that out -- I never would have realized!

I wonder what happens if the value of the property declines between the time it was purchased and the time of a spouse's death? Does the basis get 'stepped down'?

And before someone says that would never happen, well, it happened to me. When my wife died 9 years ago, the appraised value of the house was about 4% less than the original purchase price. This was just at the end of the early '90s California property slump.

I seem to remember twisting the appraiser's arm to get him to come up with as low a number as possible for estate tax reasons. This was a potential issue since, at the time, I was not a US citizen, and estate tax would have been payable. Talk about shooting yourself in the foot!

Peter

Man, I didn't think about the possibility of a step down in basis.  I haven't looked it up, but  (if logic ever applies to the tax code) logically the basis could go down as well as up. This is how pubication 523 literally reads as well.  This would really stink if you are in a community property state as the entire adjusted basis would drop.

If that is the case, then it seems that the thing to do is sell the property in the same year the spouse died and file a joint return for that year, getting the $500,000 exclusion and the pre-death adjusted basis. This could be a major drag just to save some tax money. (if you even can do this, I didn't check)

You know this discussion applies not just to your home  but any assets you and your spouse jointly own when one dies.

 

[honobob]

I wanted to point out that in California a married couple needs to do more than hold property in joint tenancy. It also seems to me unclear about what gets stepped up upon death in community property states. From what I read it says that if held as joint tenants the half passes through probate and only it is stepped up but that seems confusing as I've always been led to believe that property in joint tenancy does not pass through probate. I think it would be prudent to confirm how to hold title in CA and other community property states.


Community Property


This option is available to husbands and wives only in
community property states. California is a community
property state. Each spouse owns half the property and
can pass it on by will either to the surviving spouse
or someone else. A special advantage to community
property title is that when willed to a surviving
spouse , a new stepped-up basis at market value is
assigned on the date of death. This stepped-up
basis advantage is also available to husbands and wives
holding joint tenancy titles in community property
states. It requires spouses to acknowledge in writing
to each other that their joint tenancy property is also
community property.

 

[jclarksnakes]

.....This tax stuff can get mighty complicated. It sure is nice that Martha knows this stuff and helps folks so much.
jc

 

[riskadverse]

Can someone confirm, or point me to a link that confirms the rules I should be following to exclude the gains of a primary residence in California. ie: how to hold title?; does the property get stepped up 50% or 100% at time of death of the first spouse; the documents required to acknowledge in writing
to each other that their joint tenancy property is also
community property.

This is important to me as we have already exceeded the $500K limit, and I would like to lay out a plan of how to handle the house issue after the death of the first spouse.

 

[Martha]

Can someone confirm, or point me to a link that confirms the rules I should be following to exclude the gains of a primary residence in California.  ie: how to hold title?; does the property get stepped up 50% or 100% at time of death of the first spouse; the documents required to acknowledge in writing   
to each other that their joint tenancy property is also
community property.

This is important to me as we have already exceeded the $500K limit, and I would like to lay out a plan of how to handle the house issue after the death of the first spouse.     

I am not a California lawyer, but I did find this statute:

California Civil Code 682.1.
(a) Community property of a husband and wife, when expressly declared in the transfer document to be community property with right of survivorship, and which may be accepted in writing on the face of the document by a statement signed or initialed by the grantees, shall, upon the death of one of the spouses, pass to the survivor, without administration, pursuant to the terms of the instrument, subject to the same procedures, as property held in joint tenancy. Prior to the death of either spouse, the right of survivorship may be terminated pursuant to the same procedures by which a joint tenancy may be severed. Part I (commencing with Section 5000) of Division 5 of the Probate Code and Chapter 2 (commencing with Section 13540), Chapter 3 (commencing with Section 13550) and Chapter 3.5 (commencing with Section 13560) of Part 2 of Division 8 of the Probate Code apply to this property.
(b) This section does not apply to a joint account in a financial institution to which Part 2 (commencing with Section 5100) of Division 5 of the Probate Code applies.
(c) This section shall become operative on July 1, 2001, and shall apply to instruments created on or after that date.

Also look at www.irs.gov/publications/p555

 

[honobob]

http://www.sfgate.com/cgi-bin/artic...+tenancy+in+community+property&sn=001&sc=1000

Riskaverse  I'm not sure I posted this link correctly but this is an article on SFGate you can search joint tenants in community property.  Even in his example which is similar to the Pub 523 the whole property is stepped up to current fair market value.   IRS Revenue Ruling 87-98 seems to be the place to explain this.   

Still seems weird that they talk about 50% of the property when they're actually saying death steps up 100% of the property! 

I'm not sure how well I'd sleep if the spouse knew of possibility.


http://www.nysscpa.org/printversions/cpaj/2006/806/p52.htm


100% step up seems to be the case for community property states. What a deal!

 

[riskadverse]

Thanks for the replies. It looks like filing a simple document will step up the cost basis for us at the time of the first spouse's death. This one tip will make a big monitary difference for the surviving spouse in our case.

 

[Texas Proud]

If that is the case, then it seems that the thing to do is sell the property in the same year the spouse died and file a joint return for that year, getting the $500,000 exclusion and the pre-death adjusted basis. This could be a major drag just to save some tax money. (if you even can do this, I didn't check)

Martha,

Unless something has happened in the past 20 or so years it will NOT work... I used to do estate taxes along with the 1040s... When someone died, that is the date that they no longer are part of the 1040... all items of theirs going forward would be considered in their estate... so a sale after death would be on the 1041 for the deceased spouse... I do not know if they could get the capital gain deduction since the basis has 'changed' the date of death....

 

[retire@40]

Martha,

Unless something has happened in the past 20 or so years it will NOT work...  I used to do estate taxes along with the 1040s... When someone died, that is the date that they no longer are part of the 1040... all items of theirs going forward would be considered in their estate... so a sale after death would be on the 1041 for the deceased spouse...    I do not know if they could get the capital gain deduction since the basis has 'changed' the date of death....

Martha is correct in a married situation. You are thinking of a situation where someone is single.

 

[Martha]

Martha is correct in a married situation.  You are thinking of a situation where someone is single.

I am quoting you because I like it when someone says I am right.

But I do want to clarify. I know that you can file a joint return in the year your spouse dies. Can the surviving spouse in the same tax year as the death occured, sell some or all of the deceased spouse's assets and take the loss or gain without a step down or step up in basis? That is what I suggested as a resolution to the step down issue--sell in the year of death and file a joint return. I didn't look it up and so I was unsure of the answer.

 

[retire@40]

...Can the surviving spouse in the same tax year as the death occured, sell some or all of the deceased spouse's assets and take the loss or gain without a step down or step up in basis?  That is what I suggested as a resolution to the step down issue--sell in the year of death and file a joint return. I didn't look it up and so I was unsure of the answer. 

The surviving spouse can't avoid a step-up or step-down since the new valuation occurs at date of death.

If there is going to be a step-down and the death can be anticipated, the dying spouse can gift to the surviving spouse all his/her assets subject to the step-down, thus avoiding the step-down.

 

[Texas Proud]

Martha is correct in a married situation.  You are thinking of a situation where someone is single.

Nope... I did a tax return for a muti-millionaire... died in March... It took me forever to figure what he had earned early in the year and what he had earned after death... (lots of passive income)...

IT was audited on one of those 'random' audits where they check every line on the return.. the guy was there for a week... found nothing wrong...

SO, like I said originally... UNLESS SOMETHING HAS CHANGED... when you die, you can not longer do things with an asset and put it on the 1040.. the 'joint' part stops the day the person died... (ie, the tax year is Jan 1 to the day he/she dies)...