Question. My husband recently died of a massive heart attack, leaving me a widow at a young age. I was thrust into a new life status that was not my choice or my desire. I believe I am being penalized for something that has already devastated my life in many ways.
We were fortunate to have invested wisely in our principal home many years ago, and have made more than $250,000 in profit. I want to sell, and it now appears I will have to pay the tax on any profit over $250,000, since I no longer file a joint return. If couples are making the life choice to divorce, they can sell their home prior to the divorce and get the $500,000 exemption recently enacted by Congress. A widow has no option or choice in the change that has happened in her life.
Please advise me how I should proceed; I need the money for my future more than the government.
Answer. It has often been stated that two things are inevitable: death and taxes. However, there is a measure of hope based on an often forgotten concept in the tax law known as the “stepped-up” basis. And, fortunately, this was not modified or repealed under the new tax law that was just enacted.
Oversimplified, this means the value of a person’s real property on the date of his/her death becomes the basis of the person who inherits that property.
Let us take this example: in 1995, you and your husband purchased your first home for $100,000. You took title as tenants by the entireties — which is the common form of ownership for married couples. Your husband died in 2017, and the property was valued at $800,000 on the day he died.
Your basis is as follows:
Initial basis: (half of purchase price) $ 50,000
Inherited (stepped up) basis: 400,000
New basis: $450,000
Please note that since the property was worth $800,000 on the date your husband died, you inherited his half of the property — namely $400,000.
If you sell your property today for $800,000, your profit (before excluding such items as real estate commissions, legal fees and fix-up costs) will be $350,000 ($800,000 – 450,000). As you correctly pointed out, since you are now filing a single tax return, under the current tax laws, you are entitled to completely exempt the first $250,000 of this gain. Once again, Congress did not repeal or amend this important homeowner benefit.
Thus, your capital gain tax will be on $100,000 ($350,000-250,000). Because the income tax brackets were changed under the new law, please talk with your financial advisors as to what your tax obligation will be.
However, let’s analyze this even further. Did you and your husband make any improvements to your house over the many years of your ownership? If you put on a new addition, installed a new kitchen, or significantly improved the back yard, all of the costs of these improvements are added to your basis. Thus, if the costs of your improvements were at least 100,000, you will not have to pay any capital gains tax at all.
Furthermore, try to find the settlement statement when you first purchased the property. There were a number of costs which you incurred — title examination, title insurance, legal fees — which can properly be added to basis.
Keep in mind that for every dollar you add to basis, you are going to save from paying capital gains tax. Clearly every dollar can add up to a considerable tax saving.
Although you did not raise this next issue, I want to take the opportunity to comment on a question I often get: should you put your children on title now?
Generally speaking, my answer is no. The reason is the same as discussed above — on your death, your children will get the benefit of the stepped up basis, and indeed under the circumstances may not have to pay any capital gains tax. For example, were you to die when the property is valued at $800,000, if your children sold the property for this price, they would have no gain at all — and thus no tax to pay.
However, if you were to gift them the house now, during your lifetime, their basis for tax purposes would be your basis — i.e., $450,000. The law requires that the basis of the donor becomes the basis of the donee. If they sold the property for $800,000 — and the house was not their principal residence — they would have to pay capital gains tax on profit of $350,000 ($800,000 – 450,000) At the maximum rate, this could be a nice gift to Uncle Sam.
You must, of course, fully discuss these issues with your tax advisors. These are not easy questions, and the answers are even more complex.
So much for “tax simplification.”