I’m selling an inherited home. Can I offset losses against stock gains?

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Q. I am expecting a loss from the sale of my mom’s two-family house that I inherited. It was reported to me on a Form 1041, K-1. Can I offset this loss from sale of property against any gains in my stock portfolio on my New Jersey tax return?
— Beneficiary

A. We’re sorry to hear about your mom.

We’re also sorry to hear you had a loss on the sale of the home.

Inherited assets, such as your mom’s house, receive a step-up in basis to the fair market value as of the date of death of the owner, said Gerard Papetti, a certified financial planner and certified public accountant with U.S. Financial Services in Fairfield.

He said for federal tax purposes, you can offset capital gains with the capital loss from the sale of the inherited real estate provided you sold the house in “an arm’s length transaction,” you sold the house to an unrelated person, the property was not used for personal purposes and you didn’t intend to convert the property to personal use before the sale.

An arm’s length transaction is a transaction where the buyers and sellers have no relationship to each other, Papetti said. When dealing with an inheritance, related parties include the estate, the executor and beneficiaries of the estate.

“For federal tax purposes, K-1 income flows through to the taxpayer’s personal return and retains its type of income — business, rental, interest, dividends and capital gains or losses, where capital losses from an estate can offset capital gains from the sale from the taxpayer’s securities,” Papetti said.

Then there’s New Jersey, which has its own specific rules for a taxpayer’s ability to offset capital gains with capital losses, Papetti said.

“Under the New Jersey Gross Income Tax Act, losses in one category, such as a distributive share of a capital loss from a partnership or S-Corporation, cannot be used to offset capital gains from another category,” he said. “It appears that the real estate was sold by the estate and not you personally as you received a Form 1041 K-1 from the estate.”

New Jersey treats business and pass-through entities, including estates and trusts, as their own separate category, which limits the ability to offset income, gains, and losses within the same category, Papetti said.

“Therefore, capital losses from your mom’s estate cannot offset capital gains from your stock portfolio,” he said.

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This story was originally published on Nov. 10, 2022.

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