31 Dec Will sale of inherited home cause a tax liability?
Q. My mom transferred the deed of the house over to me in Nov. 2014 with a life estate for herself. She passed late 2016. She paid approximately. $18,000 for the house in 1960. This is my primary and only residence. I will be placing the house on the market for sale at an estimated price of $375,000. I understand there may be a capital gains tax? How much would be and will it be considered income for the year of sale? And can repairs for the home be deducted?
A. The good news is that you probably won’t owe any tax on the sale of the house.
Let’s take a deeper look into the issues here.
When a house is sold, the seller is responsible for paying tax on the profit in the year of the sale, said Andrew Novick, a certified financial planner and estate planning attorney with The Investment Connection and Brookner Law Offices in Bridgewater.
“The profit can be calculated by subtracting the cost basis from the sales price,” he said. “Cost basis is the original purchase price plus any capital improvements.”
You spoke about repairs, but what you really need to look at is capital improvements, which Novick said can be a grey area.
The IRS definition is “add to the value of your home, prolong its useful life, or adapt it to new uses,” he said
The improvements must still be evident when you sell, he said.
“So if you put in wall-to-wall carpeting 10 years ago and then replaced it with hardwood floors five years ago, you can’t count the carpeting as a capital improvement anymore,” he said.
Repairs, like fixing sagging gutters or painting your house, don’t count as a capital improvement. However, the cost of painting the kitchen would count if it was part of a bigger kitchen remodel, he said.
Another example: If you replace a few shingles on your roof, it’s a repair. If you replace the entire roof, it’s a capital improvement.
“If you don’t have receipts for the capital improvements, you can use reasonable estimates, but the IRS may not accept them if you are audited,” he said.
Inherited property receives a “step up” in cost basis to the fair market value as of the date of death. So the original purchase price of the property and any capital improvements prior to the date of death are no longer relevant, he said.
“If a property is sold after it is inherited, the profit is calculated by deducting the date of death value from the sales price adjusted for any capital improvements made to the property after the date of death,” Novick said.
You also said your mom had a life estate in the home.
This is a special type of real estate ownership where the owner retains the exclusive right to live in the property for as long as he/she is alive, but a remainder interest is given to someone else, typically a future heir, and the “remainderman” automatically becomes the owner of the property upon the death of the life tenant, Novick said.
“Despite this curious ownership structure, a life estate property receives a full step-up in cost basis upon the death of the life estate owner,” he said.
Additionally, the first $250,000 of profit on the sale of a primary residence is exempt from tax as long as the seller owned the home and lived in the home for two out of the last five years, he said.
This all means the basis of your home will be the fair market value of the home in 2016 when you inherited it as the remainderman of the life estate deed, plus any capital improvements you made since that date, Novick said.
“Since you’ve owned and lived in the house for two out of the last five years, you can exclude up to $250,000 of profit,” Novick said. “Based on an estimated sale price of $375,000, I assume you will not owe any tax.”
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This story was originally published on Dec. 31, 2020.
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