Scenario: Person is mid-30’s, an only child, and executor of her parent’s estate. The part of the estate that will go through probate is not very large. The highest valued asset that will go through probate is a home worth 550k, with no mortgage. The purchase price of the home was 215k. The house is to be sold.
I believe this is more of tax question than anything else, but would appreciate other thoughts. Would it make any difference if the heir:
sold the home while in probate, thus leaving the 300k profit for the estate to deal with.
took possession of the home, but immediately sold it (with the stepped up basis) for practically no profit. I am unfamiliar with any length of ownership requirements or whether they have any bearing on a no-profit sale.
The heir has a lawyer, but I like multiple opinions, especially from the type of shrewd thinkers who inhabit this board. Besides, she is an estate lawyer and may not be as well versed in tax issues as one would like.
Are you sure she’s an estate lawyer? Because the first thing she should have done is put that home in a trust. Trust assets are transferred directly to the beneficiary and avoid probate. Also she really should brush up on her tax knowledge as that’s pretty relevant to being an estate lawyer .
For #1, I think she’d only be able to sell it while in probate because she’s the executor, not because she’s the heir – the heir is not the owner and doesn’t have the authority to sell, the executor does (it happens to be the same person but I think the distinction is important). The 300k is not “profit” any way you look at it – it’s not a capital gain because she gets the stepped-up basis, plus there’s the ~$5M+ estate tax exclusion.
For #2, the capital gains tax exemption is $250K/person or $500K/couple if she lives in the house for 2 out of the previous 5 years. I’d guess the count down starts when she becomes the owner. My guess is that if she listed it shortly after taking posession, then whatever amount she sold it for would be the fair market value and therefore her cost basis, so no capital gain. Plus don’t forget the costs associated with selling (~5-10%). Not sure if she could use those as a capital loss to offset other gains…
IANAL (for our acronym-challenged readers: IAm Not ALawyer).
There can be any number of situation-specific nuances that can come into play. So there is no universal truths to blindly follow.
But in general, the estate selling the home will subject the estate to capital gains taxes on the sale. Waiting until after the estate is settled gets you the stepped-up basis, as you mentioned, and thus no gain to be taxed (and any gain would be ‘short term’). Since the estate is not close to “death tax” territory - the full $550k value will be what’s considered - obviously the latter is better than the former.
Of course, we dont know what’s going to happen the next 6 months-1 year. The home could drop in value more than the tax bill from selling it immediately, especially if the estate still qualifies under the $250k primary residence exclusion. But only you (she) can decide if that risk is worth it.
AFAIK, the stepped up basis is as of date of death. Doesn’t matter when the property actually transfers.
If it’s not sold near that time, there could be gains or losses (may need an appraisal after a certain amount of time that would establish the value at time of death, or something, not a lawyer or tax expert).
It’s the same for other assets like the free stepped up basis for stocks (securities), it’s based on the value on date of death, not on the date they’re sold.
Just to make sure I’m clear before asking even more stupid questions … Are you saying that if the executor sells the home promptly for $550k (fair market value), the estate pays no capital gains due to the step up basis.
And one last even more on-the-edge question, if you don’t mind. Will the sale of the house by the executor affect the decendent’s final tax return, since, technically, they didn’t sell it.
Thanks again for taking the time to render your opinions.
So the estate gets the primary residence exclusion, even though it has not owned the residence for 2 years or has occupied it for 2 of 5 years? If so, the decision seems pretty simple - let the estate sell it and only pay cap gains taxes on the ~$50k.
Again, not what I do (it does look like there’s a $250k primary residence exclusion for decedents as well…), but I think that actually means you pretty much don’t have to worry about a “gain” between the value at time of death vs the sale. You would still get the free step up in basis…
But as long as it didn’t rise in value by more than $250k from the stepped-up basis, I think there will not be any part of the gain subject to taxes. Not the $50k you reference. And again it doesn’t look like (not a tax expert) it matters if it’s passed from the estate to the heir or not to still qualify for the $250k exemption either.
It’s based on the decedent (or combination of the decedent and the heir) satisfying the requirements.
Sounds nonsensical? Yeah… the free step-up in basis and some other gifts to (primarily) wealthy families is pretty crazy. IMO we need to get rid of the tax loopholes at some point. Or at least adjust them so they benefit everyone more evenly. Real estate and estate taxes have some of the largest carve-outs.
I realize that you said “primarily”, but I’ve got to say she isn’t close to wealthy, at least by my definition. Excluding the life insurance (not part of the estate), she performed so much work as caregiver and is continuing to perform as the executor will not make the inheritance a windfall by any stretch of the imagination.
Yes, and she’s not receiving as much a benefit as the uber-wealthy do from the loopholes. I wasn’t saying it was wrong to use the benefits that are there or that it makes the person extremely wealthy. An outsized portion of these tax benefits go to the very high wealth percentiles. Just like the last round of “tax cuts”… but that’s getting off topic…
In my opinion, it doesn’t make any sense at all that if the person gave her the property before death, she’d have to pay capital gains taxes on it (the basis would carryover). But not if it’s inherited.
I’m a little off, having ignored certain details. Once the person has died, there really isnt any decisions to make. What we’re talking about in this post more applies to selling property prior to death (so cash is inherited) and inheriting the property.
The taxable event is generally death, not distribution from the estate - so in your situation the property already has the stepped up basis (It is more abstract, but in theory the property has already been transferred from “Bob” to “Bob’s estate” at it’s market value when Bob died). The only question is if the estate sells it and pays any tax out of the proceeds on the estate’s tax return (I think), or if it’s distributed to the heir who then sells it.
The decision is basically if you sell it now and avoid any future loss in value, or hang onto it and pay tax on any further gain. But your cost basis in the sale is $550k either way.
Again, there can be a whole lot of nuance involved. It’s all “typical”, but not a blanket rule.
But not really - that’s the offset to the so-called “death tax”. You get the stepped up basis, but only after the estate has paid tax on the full asset value (including the unrealized gain). You arent paying any tax, but only because the estate already paid it. So it’s only a benefit to the non-wealthy who’s assets do not exceed the exclusion value.
Except there’s a limit on how much can be gifted annually.